Analysis: The marginal turning point of China's pharmaceutical industry has accelerated or appeared

Business News Agency reported on September 2 that the impact of recent policies on industrial governance measures is worthy of attention. Will the profit cycle of China's pharmaceutical industry, which started its revenue growth in 2006, be a turning point?

Recently, the government has successively or soon introduced a series of policies such as deepening the governance of commercial bribery, strengthening drug pricing management, and the new version of GMP certification, which has caused investors to argue more about the profitability trend of the Chinese pharmaceutical industry.

According to the boom cycle since the 1990s, the government’s stringent and large-scale administrative measures are usually the trigger for the turning of the boom cycle in the pharmaceutical industry. However, the essential factor that drives the cyclical cycle of China's pharmaceutical industry is mainly the speed with which production capacity expansion will consume new demand. The government's unbalanced impact on capacity expansion and new demand will affect the industry's economic trend.

The substantial increase in the Chinese government's investment in the funding budget for the medical security system, and the resulting incentive effect for the release of potential demand for pharmaceuticals, has provided the pharmaceutical industry with additional room for new demand, making the pace of demand growth significantly surpassing capacity expansion. The speed of this is the main reason why the Chinese pharmaceutical industry made a turning point in the economic cycle in 2006. However, in the recent period, the capacity expansion of the pharmaceutical industry has accelerated the consumption of new demand, and the relationship between supply and demand has been detrimental to the evolution of the supply side, and the upward pressure on the industry has become increasingly heavy.

The series of administrative governance measures that the government will issue in the near future will have a concern for the impact of the expansion of production capacity in the pharmaceutical industry. Historical experience shows that the introduction of similar measures will usually stimulate the consumption of new capacity in the short term, thus accelerating the emergence of the marginal turning point of the industry's profitability.

However, in the medium to long term, the positive effects of government governance measures on increasing barriers to industry entry and regulating the order of market competition will gradually emerge, which will help to promote the rebalancing of supply and demand so as to push the pharmaceutical industry into the next round of booming segment.

1 Administrative governance is the precondition of the boom cycle

The development history of China's pharmaceutical industry since its market-oriented reform has shown a typical cycle of industrial disorder: Given the high pricing power of medical institutions and the unequalization of the drug consumption market, the supply-side homogenous competition and overcapacity will gradually increase. Catalytic market competition pressure, resulting from corruption, distortions in the industry and other industries chaos are also gradually highlighted. When the industry chaos seriously threatens the quality of medicines and the security of supply, the government will inevitably carry out severe administrative interventions and industry rectification. In general, in the early period, strict control measures were put in place in the fields of drug sales terminals, circulation links, and retail prices, for example, regulating the order of circulation and lowering retail prices of medicines. As medical institutions have stronger market power, the pressure of similar control measures will be more transferred to the pharmaceutical industry, which will weaken its profitability. After that, the government will try to increase the barriers to entry and restrain the number of manufacturers by tightening the conditions for approval and tightening regulatory standards. This will promote the rebalancing of supply and demand in the pharmaceutical industry. While the effectiveness of government governance is gradually sinking in the evolution of the structure of supply and demand, the pharmaceutical industry has begun a new round of spiralling uprising cycle.

In the early 1990s, the release of the productivity of the pharmaceutical industry drove the relationship between supply and demand of drugs into the buyer's market, and the intensification of competition gradually led to problems such as corruption in drug purchases and sales, and safety and quality. In response, the "State Council's Urgent Circular on Further Strengthening Drug Administration" issued in September 1994 called for the rectification and regulation of the order of drug production and operation, marking the beginning of the round of government governance. However, the notification failed to improve the low-level repeat production of drugs, and new pharmaceutical companies and new batches of generic drugs are still increasing. The expansion of excess capacity has further intensified market competition and exacerbated the problems of corruption in drug purchases and sales and safety and quality. Therefore, the government is determined to take measures to eliminate backward companies and curb the expansion of production capacity so as to solve the problem of confusion in the production and circulation of medicines. The "Notice of the General Office of the State Council Concerning Continuing the Rectification and Regulation of Drug Production and Business Order and Strengthening Drug Administration Work" issued by the Ministry of Health in 1996 and the Ministry of Health "conscientiously implemented" the General Office of the State Council on continuing to rectify and standardize the order of drug production and operations and strengthen the management of pharmaceuticals. The notice of “Notices” has achieved the effect of reducing production capacity by canceling the power of local approval of drug production, tightening the approval of new and restructured pharmaceutical companies (workshops), and increasing the conditions for drug production approval.

In the same period, the profitability of the pharmaceutical industry reached a high point in 1992 and then began to decline with the intensification of homogenous competition. Since the industry management started in 1994 failed to effectively suppress the expansion of production capacity, it not only failed to reverse the downward trend of profitability. It also exacerbated the pressure on the profitability of the pharmaceutical industry, making its profitability cycle at the bottom of the cycle. In 1996, the measures to reduce excess production capacity went into effect, and a large supply of supply capacity was withdrawn from the market. This prompted the pharmaceutical industry to begin entering the booming range in 1998. The medical insurance system for urban employees started to be established in early 1999 basically covered the main target groups in around 2000, and the incentive effect of the demand release has further boosted the profitability of the pharmaceutical industry.

As the pharmaceutical industry digested the effects of the last round of industry governance, and as the industry's profitability boom attracted new entrants, the market supply and demand relationship gradually evolved in the direction of unfavorable to the supply side. At the same time, local standards permitting pharmaceuticals from 2002 to 2003 can be raised to national standards, releasing a large number of homogeneous supply capabilities to the market. Therefore, under the catalysis of SARS public health events stimulating demand growth during 2003 and 2004, the profitability of the pharmaceutical industry has shifted to the down cycle through the inflection point. As a result, a new round of industrial chaos cycle began to appear: After 2003, the intense market competition has triggered a large area of ​​corruption, market disorder, and major drug safety incidents. In this regard, in March 2006, the Ministry of Health launched special work on commercial bribery in the field of governance of pharmaceutical purchases and sales. In May of the same year, the eight ministries and commissions issued the “Opinions on further rectifying the order of prices for medicines and medical services in the market”, and in July of the same year, the State Council announced the nationwide reorganization. As an indication of the special action plan for regulating the market order of pharmaceuticals, the central government has launched a new round of special rectification actions of about 18 months. Affected by this, the profitability of the pharmaceutical industry fell to the bottom of the cycle since 2000 in 2006. Afterwards, as the government increased the budgetary investment in the medical insurance system to promote the release of demand, as well as the effectiveness of the strengthening of supervision and suppression of the capacity of the administration, the supply and demand relationship in the industry appeared to be conducive to rebalancing the supply side, thereby promoting the profitability of the pharmaceutical industry. Significantly rebounded in 2007.

2The government budget is limited, demand growth will fall

In general, economic factors are the main factors that determine the level of national health care investment. Since 2000, China's total health expenditure/GDP has basically maintained between 4.6% and 4.8%. In 2009, the national health expenditure as a percentage of GDP was approximately 4.73%. This proportion is basically the same as the level of low- and middle-income countries in the world, which reflects the limits of the level of China's economic development, especially per capita income, on the scale of health investment. In the longer term, the overall scale of China's healthcare investment will remain at a very limited level.

In recent years, the rapid release of demand from the pharmaceutical industry was mainly due to the fact that the government substantially increased the budget subsidies for residents' basic medical security system and improved the social welfare level of the medical service system, thus forming a Pareto improvement incentive. Since 2007, the basic medical insurance for urban residents, mainly funded by government subsidies, and new-type rural cooperative medical care have quickly completed the protection coverage target for the target population, and their contribution to the fundraising amount of the basic medical insurance system has also been significantly improved.

However, the budget constraint of government finances also limits the sustainability of the rapid increase in the funding of the basic medical insurance system. Although the government promised to invest 850 billion yuan in 2009-2011 to promote the equalization reform of medical and health services and use more of them to supplement the fundraising budget of the basic medical insurance system, it is to increase the risk sharing and compensation of the basic medical insurance system for residents. The level of effective support, however, is still insufficient to support the fundraising amount of the basic medical security system to maintain the rapid growth trend between 2007 and 2009.

After the release of potential demand suppressed by institutional deficiencies, the overall scale and growth rate of China's pharmaceutical demand will still return to the long-term trend determined by the stage of economic development and per capita income. In fact, the growth rate of urban residents’ basic medical insurance and new rural cooperative medical care in 2009 has significantly slowed down. The overall increase in the total fundraising of the basic medical insurance system more closely matches the growth rate of urban workers’ basic medical insurance fund income. Lowered the year-on-year increase in total health expenditure.

3 or repeat excess capacity

Similar to the previous period of industrial capacity expansion (around 2001-2003), the profitability climate provided financial support for the expansion of the pharmaceutical industry's capacity, which stimulated an increase in the number of manufacturers and investment in fixed assets. In May this year, the number of pharmaceutical manufacturing companies was 6,852, an increase of nearly 28% from 5,368 in 2006. In 2009, the pharmaceutical manufacturing industry achieved fixed asset investment of 146.257 billion yuan, an increase of nearly 11 percentage points over the same period last year.

At the same time, it is expected that the newly revised pharmaceutical GMP that will be promulgated in the near future, except for the newly established enterprises (workshops) who must obtain certification, the rest of the companies should pass the revised GMP certification for pharmaceuticals within 2 to 3 years, with WHO's GMP as a guide. Quality and process management. Although the investment in this certification is expected to be lower than the GMP-approved capital expenditures of the 98th version (SFDA estimates that it needs to invest 30 to 50 billion yuan, much lower than the 150 billion yuan for the previous round of mandatory certification), and there is a three-year buffer period. However, the improvement of quality standards and the strictness of the process specification will still significantly increase the operating expenses of pharmaceutical companies.

Therefore, through the expansion of production capacity and the dilution of capital expenditures and operating expenditure pressures, it becomes a logical and most likely competitive behavior choice for pharmaceutical companies and has been verified by the history of the last round of GMP mandatory certification: to meet the chemical materials before the end of June 2004 Pharmaceuticals and all pharmaceutical preparations meet regulatory requirements for production under GMP conditions. The pharmaceutical industry began in 2000 and concentrated on the transformation of equipment, plants, and other facilities in line with GMP requirements in 2003, which stimulated a substantial increase in the overall capacity of the industry. Therefore, despite the implementation of the GMP certification system to eliminate some of the backward companies, the expansion of production capacity has quickly pushed up idle capacity, which has become one of the important reasons for the intensification of competition after 2004.

4 new round of turning point

With the rapid increase in the consumption rate of new demand as a result of capacity expansion in the pharmaceutical industry, the time-lag gap between capacity and demand release has narrowed, and the upward pressure on the industry's economic climate has become increasingly heavy. At the end of 2009, the growth rate of the number of pharmaceutical manufacturing companies exceeded the growth rate of business income per household, which reflected that the speed of capacity expansion exceeded the speed of demand growth, and the marginal output of enterprises tended to decline. Historical data show that this phenomenon has appeared in all previous years (2003 and 2006).

In addition, the competitive pressures brought about by capacity expansion will also be reflected by the operational efficiency of receivables (channel pressure level). Since 2008, the growth rate of accounts receivable in medicine manufacturing industry has been higher than that of main business income; at the end of 2009, the growth rate of main business income has dropped by 4.63 percentage points, while the growth rate of accounts receivable has only fallen by 1.17. The percentage points show that the market competition has increased resistance to sales efficiency. According to the statistics on A-share listed companies (GICS Pharmaceuticals, Biotechnology and Life Sciences), the accounts receivable in 2009 totaled RMB22.633 billion and the bills receivable amounted to RMB10.740 billion, both of which increased by 12 percentage points year-on-year. Among them, accounts receivable increased by 5.72% year-on-year, notes receivable increased by 28.03%. In the same period, the difference between the total operating income and the increase in operating receivables (accounts receivable and bills receivable) was 0.14 percentage points, and the difference between the total operating revenue and the increase in operating receivables in 2008 was 8.18 percentage points.

Recently, the government has successively or soon issued a series of policies to deepen the governance of commercial bribery, strengthen drug pricing management and the new version of GMP certification. This is in fact the logical consequence of the government's adoption of industry consolidation measures in the context of pressure from market competition to generate industrial chaos. These series of measures serve as a policy signal for a new round of industrial governance, or they will apply the repeated cycle of industry chaos to the trajectory of the economic cycle to accelerate the emergence of the marginal inflection point of the economy.

However, benefiting from the influence of industry evolution and regulatory improvement, leading companies with a solid business foundation and distinct differentiated advantages will gain more buffer space during the downturn of the economy, and have the opportunity to further consolidate their competitive advantages and increase market share. .