Increased use of the Antimonopoly Law in the pharmaceutical and medical device sectors reflects China’s desire to drive down prices on essential goods.

Nearly 60 pharmaceutical manufacturers—both domestic and foreign owned—were subjected to Antimonopoly Law (AML) probes in 2013. Many analysts believe these events should be understood largely, if not entirely, through the optics of China’s domestic politics.  Others submit that China is entering a phase where it is going to become increasingly hostile towards foreign companies. Our study of how the AML has actually been enforced leads us to believe that while political motives are important to take into account, pharmaceutical and medical device companies need to understand that the government has a more practical, less threatening set of goals for its increased use of the AML.

The visible increase in AML investigations in 2013 can be interpreted as part of the National Development and Reform Commission’s (NDRC) increasing confidence over the past two years that the AML is the best tool to fulfill the mission of “price control” over basic daily consumption goods, including pharmaceutical products.  Unlike the anti-corruption probes of the summer of 2013, the AML investigations tend to be much more predictable than investigations into  endemic corruption in the hospital tender and bid process. As such, AML probes are largely uncolored by the motivations and regulations affecting the Chinese government’s anti-corruption efforts. However, companies that have felt the AML’s weight know that AML investigations are disruptive and damaging.

Because the power to enforce the AML belongs to multiple bureaucratic entities, the AML’s use today is not necessarily indicative of how it will be used in the future. An AML investigation can be initiated at the central government level and at various sub-national levels of government.  Structurally, this should remind multinational pharma companies of the diverse and fragmented stakeholders at work as the Anhui pricing model was adopted across China. The Anhui Model was a blind bid and tender process where pharmaceutical manufacturers had to submit their best price to the local authorities.  This proved to be quite successful in driving prices down, but less so at ensuring product quality or patient safety.  The Anhui model was different in form and substance than what officials were working on as a national pricing framework in Beijing, but the needs of the local authorities prevailed.  Even though it lacked the policy lacked the overt blessing of the central government, a destabilizing policy on prices was allowed to spread across the country.

Keeping all of this in mind, pharmaceutical and device companies need to take two steps if they are to successfully navigate potential AML cases over the next couple of years.  First, develop a deeper understanding of how laws, regulators, and judicial bodies interact to shape application of the AML. Second, companies need to build an internal capacity to cultivate more proactive and diverse relationships with various regulators in China in an attempt to mitigate AML risk by actively engaging in conversations on market price setting.

While you cannot change China’s politics, you can and must become an active political analyst and participant, to the extent possible. For pharmaceutical companies in particular, who saw how rapidly the Anhui Model spread through China’s provinces—even though it lacked the overt blessing or active efforts by the central government—it should come as no surprise that effective blocking and tackling in China now requires more than key relationships and lobbying in Beijing.  Today, political participation in China is more granular and local than ever before.

Understanding the AML

Last year, China’s regulators made a variety of AML allegations against domestic and foreign firms. While not all were healthcare related, most of the industries involved were visible to the consumer and represented situations where the consumer was paying prices above what the market would have dictated had producers not been in some sort of collusion. Some have argued that China pursued these companies largely to redirect public anger away from the government towards the profit-seeking private industry, or to stomp out corruption in the consumable goods sector. And the responses of various foreign pharmaceutical companies appeared to do little to suggest such an interpretation was wrong.  Indeed, over last summer and through the fall, a variety of foreign pharmaceutical manufacturers announced price reductions within China. Most notable was GlaxoSmithKline (GSK), who was quick to announce price reductions following its public shaming during a separate anticorruption probe in the summer of 2013.

The investigations brought in 2013 have to also be understood as part of a movement that began considerably earlier.  In 2011, the NDRC announced the “whip inflation” campaign (also known as the 打击通胀 campaign). Angela Huyue Zhang, a lecturer at the King’s College of London, wrote in the Peking University Law Review in early 2011, “the NDRC invited a number of private chambers of commerce to meet and pressured them not to increase prices” on a variety of key consumer goods, one of which was pharmaceuticals. In March of 2011, the Shanghai Price Bureau, an agency under the direct control of the NDRC, “fined Unilever ¥2 million ($320,000) for disseminating price increase news and violating the Price Law.” Importantly, the fine came immediately on the heels of an interview that the NDRC held with Unilever and other household goods manufacturers that month.

Unilever was the first of many companies—including foreign multinationals, private domestic firms, and SOEs—that felt the sting of the AML investigations. What makes these investigations stand out is that all of them appear to have been preceded by an invite from the NDRC to an interview session. These interviews, which media outlets have characterized as informal, seem to be a venue where the subject is given an opportunity to cooperate in return for immunity from further persecution. After milk powder manufacturing giant Wuliangye refused to lower prices after its interview with the NDRC in 2011, Wyeth Pharmaceutical chose to voluntarily reduce its prices across the board by an average of 11 percent. In the end, Wyeth and other cooperating companies were granted full immunity, and companies that did not cooperate, including Wuliangye, were assessed a fine totaling ¥668 million ($107 million).

The Wyeth case, if anything, illustrates how the NDRC’s AML probes are being applied in a nonbiased manner that does not favor domestic companies over their foreign counterparts. The connection between the AML probes and the anti-corruption probes against pharmaceutical and medical device companies may have understandably muddled the picture. The bottom line, however, is that what the NDRC is pursuing with the AML actually seems to have little to do with collusive behavior. Instead, the wide-ranging powers of the AML are being used as a threat in order to induce companies in certain, explicitly prescribed sectors to lower their prices. Using the AML to challenge the market position of firms would be a far stickier scenario for the NDRC to navigate, because challenging the market positioning of domestic firms, particularly SOEs, would challenge the dominance of the state—a major stakeholder in many, perhaps most, dominant domestic private firms and SOEs—in key consumable sectors across industries.  Any analysis that attributes the recent step up in AML enforcement either to the political expedience of punishing politically weak foreign companies or to the perceived corruption in the pharmaceutical space will fall short.

Other regulators and the uncertain future of the AML 

This analysis only applies to how the NDRC is currently using the AML—and perhaps for some firms affected by the NDRC’s current probes this is more than adequate. However, the political agenda of the NDRC is not necessarily the political agenda of the two other regulators with the power to enforce the AML: the State Administration of Industry and Commerce (SAIC) and the Ministry of Commerce (MOFCOM).

Of the two, SAIC has particular interest in pursuing companies that seem to have interfered with the process as part of a hospital’s public tender for pharma or medical device goods as evidenced by the SAIC’s activities within China’s Tier 1 cities in particular.  Historically, SAIC has been uniquely sensitive to companies that have what it deems excessive market share in markets where the government is the primary purchaser, and, in situations where companies seek to limit, geographically or by product type, who distributors can do business with.  In the last year, SAIC has said it will use a “rule of reason analysis” when evaluating a potential AML case. While this rule offers concessions on previous standards that viewed geographic limitations within distributor agreements as monopolistic behaviors, it still retains some teeth specific to product bundling and market share, which affect device companies in particular.

Given the likelihood that mergers and acquisitions for pharmaceutical and device companies will become an increasingly important part of their market access strategies for China, it is equally important to understand how MOFCOM uses the AML. Recently, MOFCOM chose to review the Thermo Fisher Scientific Inc. acquisition of Life Technologies Corporation. After a six-month review, a clearance decision issued on January 14, 2014 attached five conditions to the planned acquisition. Two of these were behavioral conditions that are the remedy most often seen when United States and European Union agencies conduct merger reviews. But the remaining three remedies were structural. The law firm Shearman & Sterling summarized this as follows:

MOFCOM required (i) the sale of Thermo Fisher’s 51 percent shareholding in China’s Lanzhou Minhai Bioengineering Co. Ltd., (ii) a commitment by Thermo Fisher to reduce catalogue prices for two specified product categories by 1 percent each year over the next 10 years, without lowering the discount rates offered to Chinese distributors, and (iii) a commitment to supply those products to third parties under original equipment manufacturer (OEM) terms or, at the third party’s option, offer a perpetual, non-exclusive technology license in respect of those products.

Of particular concern to pharmaceutical companies is the second remedy listed above, the requirement that Thermo Fisher reduce prices of certain pharmaceutical products by 1 percent each year. The AML gives MOFCOM the power to take into consideration the “development of the national economy” when conducting a merger review. What this means is that MOFCOM must take into account, at the very least, the policy goals of key industrial sectors impacted by any merger. Clearly the requirement that Thermo Fisher reduce its prices is in line with the goal of China’s health reforms to keep a low ceiling on drug costs.

Of all the above AML situations that pharma and device companies are likely to encounter, the political motives are easiest to see. They are also sometimes the hardest to deal with constructively.  In situations where the Chinese government— regardless of whether it is the NDRC, SAIC or MOFCOM—has decided to pursue an AML case against a foreign company, there is little a private company can do to prevent this from taking place.  Politically, few industries are more precariously positioned in China than consumer goods (in particular food products) and healthcare (in particular pharmaceuticals).  In the latter case, China’s central government is under extreme pressure to spin off more responsibility to the private sector to address the country’s middle class healthcare needs.  This is easier said than done, however, and as pressures mount to expand healthcare access and make it more affordable for both the middle class and China’s poor, the government is going to be willing to try a number of tactics to get the concessions it needs from private companies that desperately want to access the China market.

What can companies do?

Knowing that political pressures are likely to be important drivers of China’s AML, what can companies do?  First, pharma and device companies need to take a key lesson away from their experience pushing back against the Anhui Model.  Now infamous within the industry as a blind bid and tender process that drove prices of various drugs available at hospitals down quickly, the Anhui Model took root across China’s provinces because it presented provincial leaders with a rough but useful tool to accomplish two goals:  lower prices on pharmaceuticals and expand coverage.  In hindsight, multinationals have been quick to recognize that in China they can no longer protect their interests by focusing on relationships at the central government level in Beijing.

Now, companies are aware they have to intentionally cultivate relationships between central, provincial leaders, and even sub-provincial leaders.  In this same spirit, companies that want to survive likely AML cases and thrive in the aftermath need to embrace the reality that no one regulatory body holds the keys.  A good relationship with MOFCOM in Beijing may offer no help to you if the SAIC is driving the crackdown: the former does not have the power to shut down a case that the latter might initiate, and vice versa.

Similarly, it is always important to remember that in China’s decentralized political economy, local governments’ preferences trump that of central government goals in almost all areas, but especially in business-related matters. Moreover, the way that the NDRC, SAIC, and to a lesser extent, MOFCOM, are structured, is that central government-level directives are dependent on corresponding local and provincial branches to carry out or enforce the policies. Owing to the dominance of local governance and the diminished presence of agencies at the sub-national levels of government, it is not enough to understand just inter-agency dynamics, but also the power sharing arrangement between agencies as they exist at sub-national levels and the local governments that often have the final say over what those agencies can do.

In addition, companies will need to be fundamentally more proactive in their communication with regulators, especially in markets where the company knows— or suspects—they have a dominant position.  Rather than wait for China’s regulators to come and find them, companies should seek out regulators and propose solutions for common AML situations that have characterized past crackdowns. If cooperating during an interview initiated by the NDRC can result in full immunity from further prosecution, as in the above-described case of Wyeth Pharmaceutical, then it is logical to assume that being the initiator of the conversation can be beneficial as well.

It is worth emphasizing that the current AML enforcement is a far different animal than the anti-corruption drive initiated by the NDRC and China’s criminal enforcement bodies last summer. In an article we wrote for CBR on the latter matter we touted the importance of the Chinapology, which is the willingness to publicly acknowledge ones faults when cornered. In the case of these AML actions, that sort of Chinapology would be counterproductive. This AML drive is not about corruption, but about price control, and any sort of apology would not simply be unnecessary, but it may also complicate matters and make things worse, because it would tip the NDRC’s hand and force them to make enforcement of the AML about market position.


About the Authors

Benjamin Shobert ([email protected]) is the founder and managing director of Rubicon Strategy Group. Damjan DeNoble ([email protected]) is a partner at Rubicon Strategy Group. [/box]

(Photo by Auntie P via Flickr)


Posted by Christina Nelson