An essential strategy for the Essential Drug List

By Franck Le Deu, Jin Wang, and Li Ma

Pharmacos will need to confront the implications of the new Essential Drug List on their growth opportunity and prepare for the new world with a clear strategy and fresh capabilities.

In a recent survey of 50 top executives from MNC pharmacos, almost two-thirds of the respondents expect the new Essential Drug List (EDL) to have a negative impact on their business.1 Why are industry leaders so strongly of this view? Are there any opportunities among the provinces’ diverse implementation approaches? What should pharmacos do to cope with the changes, mitigate their impact, and potentially capture some upside?

In this article, we offer our perspectives on the new environment, what it really means, and on the implications for MNCs.

EDS – A cornerstone of healthcare reform

The Essential Drug System (EDS) is seen as one of five priorities that support the government’s overall objective of establishing, by 2020, a universal basic healthcare system that provides safe, effective, convenient and low-cost healthcare services.

Since the introduction of the official EDS concept in 2009, China has established the initial EDL and the supporting tendering policies, along with a purchasing and distribution system, and guidance on clinical usage. However, some significant challenges have remained unaddressed, including the lack of coverage of certain diseases and of certain patient groups, such as women and children. Furthermore, physicians’ and providers’ motivation to use more EDL products has been eroded by the implicit effect of decreasing revenues and profit for healthcare institutions.

The four areas of significant change in the new version of the EDL and its related policies demonstrate the government’s bid to establish a more comprehensive and sustainable system:

  • Expanded coverage

  • Standardized list, with tighter control of provincial additions

  • Broader usage across healthcare institutions

  • Increasing focus on quality

Expanded coverage

The EDL coverage increased from 307 molecules to 520; the number of Western drugs increased from 205 to 317, and traditional Chinese medicines from 102 to 203. Disease coverage has broadened to include cancer, and deepened for blood diseases and psychiatric disorders, with drugs in these three treatment areas accounting for approximately half of the newly-listed Western molecules. The broadened coverage also includes more products for women and children, for example, obstetrics/gynecology products and children specific formulations.

Standardized list, with tighter control of provincial additions

While the number of molecules on the EDL has expanded by an additional 70%, the number of formulations decreased by approximately 50% (from 2600+ to 1400+). The specification of formulation and dosage is part of the effort to build a standardized EDS.

The central government also clearly requires local governments to strictly control provincial additions to the EDL. Provincial supplementing is still allowed, but only after thorough scrutiny of the existing national EDL (NEDL) and provincial EDL (PEDL). Those products with similar clinical efficacy to drugs already on NEDL, products with unclear efficacy, and different formulations of NEDL drugs may not, in principle, be added to the PEDL.

Broader usage across hospitals

To enforce the implementation of the EDS, the central government has extended the requirement for broader EDL usage beyond grassroots institutes and into Class III and Class II hospitals. More than twenty provinces have already published EDL-usage requirements for their hospitals; most of these follow the requirements set by the central government on EDL revenue-share (by value), which is 100% in grassroots hospitals, 25-30% in Class III hospitals, at least 40% in Class II hospitals, and at least 50% in county hospitals that are participating in reform pilots.

The government recognizes that there are clear challenges in achieving the EDL implementation goal, especially with respect to implementation in Class II and III hospitals: a deputy director of the National Health and Family Planning Commission (NHFPC) declared that “only when physicians have incentives to prescribe, when patients have no doubts about the product quality, and when clearly favorable supporting policies are in place, can the EDL implementation in large hospitals be realized.” Nevertheless, we believe that the stringent government requirements will have effect, because the heads of public hospitals in China act partly as government officials and therefore consider fulfilling government requirements to be one of their priorities for career advancement.

Increasing focus on quality

Since the “double envelope” tendering practice was adopted, first by Anhui province and then several other provinces, the resultant excessive focus on price – at the cost of quality – has widely been blamed for creating a market environment that is unsustainable for manufacturers. Low-quality products have come onto the market, and there have been shortages of supply. With the emphasis on “quality first, appropriate price” in the State Council’s No. 16 document (released in the same month as the 2012 EDL), the industry now expects more focus on the quality side of the price-quality balance. This is believed to be a long-term trend that is in line with the government’s push to raise industry standards, as seen in the end-of-2015 deadlines to reach new GMP compliance for all generics manufacturers, and to establish bio-equivalence evaluation methodology and standards for all EDL drugs.

Too big to ignore?

Before the release of 2012 EDL, the significance of the EDL market was limited; industry players, especially MNCs, had the leeway to “manage” the EDL’s short-term impact and “kick the EDL headache down the road.” While avoiding EDL tenders at the national level, MNCs have chosen to tender and sell their products as EDL only in those selected provinces where price levels can be legitimately maintained. A notable exception to this pattern has been MSD’s decision to pilot a broad EDL push with Zocor (simvastatin), which has had mixed results (see sidebar: “MSD’s EDL push with Zocor”).

This “wait and see” approach is no longer viable. The rapid changes in market dynamics present MNCs with two major implications:

  • The expanded List becomes more critical to MNCs’ business, with several “China blockbusters” directly exposed

  • Linkage of EDL and RDL tenders limits flexibility for “RDL only” strategies

The expanded List becomes more critical to MNCs’ business

Of the 520+ products from member companies of the R&D-based Pharmaceutical Association Committee (RDPAC), the number on the EDL more than doubled, from 56 to 126, representing 30% of total revenue after expansion.2 Ten of the top 50 of RDPAC member companies’ products were new additions to the list (Exhibit 1).

Exposure of MNCs to the EDL has increased significantly with the newly released list

Examples include top-selling revenue contributors such as Sanofi’s Plavix (clopidogrel), Novo Nordisk’s Novolin (human recombinant insulin), Bayer AG’s Glucobay (acarbose), and Pfizer’s Norvasc (amlodipine). Companies with the greatest exposure will have up to 60% of their revenues directly or indirectly impacted by the EDL (Exhibit 2).

Exposure to EDL varies widely across MNCs; on average, 30% of the business could be impacted

Linkage of EDL and RDL tenders limits flexibility for ‘RDL only’ strategies

In the past, MNCs have had the flexibility to sidestep EDL tenders so as to avoid intensive pricing-pressure, and focus instead on large hospitals as RDL players.

There is an emerging tendering model that links EDL and RDL in provincial tenders. Therefore, a company that loses an EDL tender (or decides not to participate in the EDL) will automatically lose the RDL tender altogether; alternatively, products bid as RDL must follow the price of the winning EDL products at the same quality level. This linkage model increasingly leaves pharmacos with limited flexibility to adopt an “RDL only” strategy.

If the linkage model is enforced at scale, the question for MNCs will shift from “whether to play” to “how to play” in the EDL market. Not playing could mean losing access to an entire province. Playing would preserve access, but could have implications on pricing in other provinces, given the widely adopted practice of inter-provincial tendering price reference.

Making sense of local dynamics

It is not news that the Chinese market consists of more than 30 provincial markets, each representing different opportunities for pharmacos to capture and different hurdles to overcome (see sidebar: “China is not a single market”).

When it comes to EDL, provinces vary widely in their implementation of central government guidance (Exhibit 3).

There are clear gaps between intent and implementation, with large variations at provincial level

Flexibility of PEDL expansion

Among thirteen provinces that have published their PEDL since March 2013, four – Shanghai, Shaanxi, Jilin and Hunan – made no additions to the 2012 NEDL, and the other nine added an average of approximately 250 molecules (in a range from 57 to 535). Roughly half of the molecules in the nine newly-announced PEDLs are TCM products. Among the Western medicine molecules, 6%-37% (23% on average) are in the portfolios of leading MNCs.

Pricing pressure

As of May 2014, about a year after the 2012 NEDL release, eleven provinces have conducted new EDL tenders.3 The tendering policies of these provinces show big variations in focus on quality and the intensity of pricing-pressure (see sidebar “Provincial variations on pricing pressure”). Eight of these provinces (Beijing, Shanghai, Jilin, Qinghai, Hunan, Ningxia, Gansu, and Anhui) adopted a balanced quality-price approach, leaving sufficient room for MNCs who wish to participate; the other three (Guangdong, Shanxi and Shandong) still lean heavily on price (Exhibit 4).

8 out of 11 provinces apply a ‘balanced price-quality’ position to the tendering process

EDL-RDL linkage model

As of May 2014, eight out of the eleven provinces that have conducted new EDL tenders have moved towards the linked EDL-RDL tendering model. Some of those still allowed some exceptions that benefit MNCs, such as leaving separate tenders open for originator brands. At present, MNCs can enjoy this “special” benefit, but they need to monitor and anticipate the policy changes in the provinces as the approach to linkage becomes more stringent.

Formulating a brand-by-brand strategy

The EDL expansion and the varying provincial environments call for an EDL strategy beyond simplistic “stop/go” approaches.

EDL strategy should be considered brand by brand on the basis of an accurate assessment of such factors as competitive environment, market reach, patient flow and patient affordability. Brand strategies must also take into account the varying provincial dynamics. Executives need to consider the following questions to formulate a coherent strategy:

  • Overall competitive dynamics: What is the EDL status of my products, and of their direct competitors? What opportunities and risks do I potentially face?
  • Assessment of the potential revenue upside: What are the volume and price implications, and how do they vary at the province level?
  • Formulation of a coherent national EDL strategy: How can I formulate a coherent national EDL strategy for each of my products?

Overall competitive dynamics: Understand EDL status – beyond your own products

While it should be straightforward for pharmacos to be alert to the potential EDL-related opportunities and risks for their EDL products, they may fail to realize the impact of new dynamics for products that are not on EDL. For example, one MNC’s non-EDL product may lose its market share to another MNC’s product that treats similar diseases but tenders as an EDL product with a significantly lower price. Another example is that an MNC may be able to realize increased RDL opportunity in price-focused provinces when its major competing products are on the EDL, but be forced to drop the tender due to intensive EDL pricing-pressure.

Assessment of the potential revenue upside: Understand the price and volume implications at province level

After the EDL status is clarified, along with the related opportunities and risks, pharmacos need to consider two questions at brand level to get a good estimate of the revenue implications: What pricing-levels are needed for an EDL play? What volume upside can be realistically expected? Beyond this, they also need to assess the bottom-line implications of playing in the EDL (Exhibit 5).

Key considerations for EDL strategy formulation
  • What volume upside can be expected from an EDL play?

    Pricing-pressure is the area in which EDL policies have attracted most criticism. Over half (55%) of our survey respondents consider the negative impact of EDL policies to arise from intensifying pricing-pressure.

    To anticipate the pricing-level needed for an EDL play, MNCs must assess the tendering environment, analyzing the intensity of a province’s pricing-pressure. In “price-focused” Guangdong, only 22 MNC products were winners, among the total of 1,516 winning products in the first round of the 2014 EDL tender. Of these 22 products, 18 have “exclusive” status, and only four faced direct competition from local generics (Exhibit 6).

    Another angle to evaluate is the competitive dynamics at brand level. At what point do the generics competitors play? How convincing and how sustainable are the MNC products’ sources of differentiation (for example, quality standards)? What are the historical winning-prices and winning-rates over competitors?

  • How much volume upside can be realistically expected from an EDL play?

    Though volume upside is the major attraction of an EDL play, it cannot be assumed as an automatic outcome of the product’s EDL status. Rather, the potential volume upside is highly dependent on local policies and specific TA dynamics.

    In provinces tendering with multiple quality categories, it is common to see the EDL policies channeling high-quality winners to Class II/III hospitals, and low-price winners to grassroots institutes. In this situation, the “high-quality” EDL product’s market reach will be no further than that of the RDL products. A volume upside from the broad grassroots market can usually be realized only in “richer” provinces, whose public health insurance budget can afford higher-priced MNC products for the whole patient population in the province.

    Even if MNCs’ winning products have the potential to access a broader market, the actual volume upside will depend on TA dynamics. For example, it is not straightforward for products in oncology and psychiatry TA to realize their high volume-potentials in grassroots institutes, simply because of the shortcomings in physicians’ clinical capabilities in such locations.

    Another factor in estimating the volume upside of an EDL play is the affordability of patients: is price a real hurdle for the patient to pursue/maintain treatment? How does the out-of-pocket impact differ between EDL and RDL plays? Only when pharmacos see clear motivating forces towards purchase can they expect to gain meaningful volume upside.

  • What are the implications for the bottom line?

    Besides developing a clear view on revenues from the assessments of price and volume dynamics, the profit dimension must also be considered. With increased local manufacturing and the consolidation of distribution in EDL, can pharmacos maintain their profit margins while accepting price cuts? Given the necessarily different commercial model for an effective broad reach into the lower-tier market, with its large numbers of small accounts, how can pharmacos establish a cost-efficient model to maintain their profit margins?

Few MNC products won the 2014 Guangdong EDL tender

Formulating a coherent national strategy

To formulate a strategy for China’s EDL business, pharmacos must consider the price/volume drivers in the context of each province, so as to make province-level strategic decisions and then roll-up an integrated national plan.

We have classified in four archetypes those provinces that have conducted EDL tenders or published tender policies since the release of 2012 EDL. The archetypes are based on two critical dimensions that determine the EDL environment: the intensity of the pricing-pressure in the province and whether the EDL-RDL linkage model is adopted (Exhibit 7).

Province archetypes based on two dimensions of tendering policy

As prices and volumes of a given EDL product will be affected differently in the various archetypal contexts, EDL strategy is likely to vary accordingly.

  • In provinces with a balanced quality-price approach and the EDL-RDL linkage model, it is likely to be an easy decision to go for an EDL play; the question is how to win the tender
  • In provinces with a balanced quality-price approach, and no linked model for EDL and RDL tenders, pharmacos should evaluate the potential price premium and volume downside, if bidding as RDL product
  • In provinces with intensive pricing-pressure and no linked tendering model, focusing on RDL is a natural choice
  • In provinces with intensive pricing-pressure and the linkage model, MNCs may have to consider walking away. Giving up the provincial market (both EDL and RDL) is then the likely choice so as to avert price-erosion in other provinces, since the cross-provincial reference is commonly adopted when setting the tendering ceiling-price

Preparing for the new world

Taking on EDL business is a whole new ball game for MNCs. In the past, their core focus in China has been on RDL and on innovative products without reimbursement, for which the necessary capabilities involved fast market access for advanced treatments, access to the RDL, and differentiation from the “mature” treatment options or generics products in big hospitals. For success in the EDL context, MNCs must now equip themselves with a new set of skills that do not sit naturally with the “advanced treatment play.” MNCs need to be alert, so as to act in a way that keeps pace with the changes in the environment, rather than waiting to have all the uncertainties settled. They also need to come to a clear conclusion on how important success in the EDL is to their overall success in China. Not every company has the means, or the need, to pursue an EDL strategy.

For those who do, four sets of capabilities are critical to achieve a successful EDL play:

  • Close monitoring of the EDL’s evolution, updating strategy accordingly

    Pharmacos need to maintain an up-to-date view on the latest developments in EDL policy, at both central and provincial levels. Critical information includes announcements of new PEDLs; provincial tendering policy, especially on pricing-pressure and the EDL-RDL linkage model; and EDL implementation requirements and enforcement mechanisms at the various levels of healthcare institutes.

    Pharmacos should assemble a cross-functional and regionally-based EDL task force led by Government Affairs / Market Access. A regular communication process should be established for the clear signaling of the latest EDL developments, along with updated risk and opportunity profiles, so that EDL strategies can be updated in a timely manner.

  • Deep understanding of the needs of stakeholders at provincial level, and actively engaging them on a long-term basis

    In the highly-regulated EDL environment, practices such as pricing, tendering, and PEDL listing are all highly responsive to pharmacos’ capabilities to interact with key government stakeholders and shape EDL policies.

    When aiming for their products to be listed on PEDL, pharmacos must be clear about those product characteristics that the key stakeholders most value. Is it the product’s efficacy for a disastrous disease? Is it the potential for wide adoption in grassroots institutes that will help divert patients from large hospitals to the primary care system? On the basis of insights about key stakeholders’ needs, pharmacos should establish a long-term engagement plan and create “win-win” situations with them.

  • Institutionalization of the bidding process and consistent execution of pricing strategy

    It is important for pharmacos to clarify their internal roles and responsibilities within the bidding process, and ensure alignment and implementation across all functions and regions in the face of a fragmented tendering process.

    Since the tendering price in any province will quickly be propagated to the whole nation through the increasing adoption of an inter-province price-reference approach, pharmacos must ensure consistency by monitoring prices and establishing the threshold at which a proposed price would be rejected. Enacting such a “gatekeeper” role could involve walking away from business in a given province.

  • Market shaping and establishing an EDL-specific commercial model

    To achieve successful EDL play, pharmacos need to work out how to engage with more dispersed and smaller-scale hospitals; they need to work with a less-sophisticated cadre of physicians. These significant differences between the EDL market and MNCs’ habitual core market present particular challenges in market shaping and establishing an effective commercial model for the EDL business.

    New questions need to be addressed to achieve a successful EDL play: How to design an effective physician-education program, using the language that is suitable for physicians in grassroots institutes? How to create an efficient and cost-effective marketing/sales model to cover the large number of smaller hospitals? How to improve patient awareness and initiate patient-access programs in remote settings?

Without a doubt, the EDS will continue to play a central role in China’s ongoing healthcare reform; the long-term themes are expected to be expanded coverage, standardized formulation, centralized management, and broad implementation. As the EDL evolves into something that pharmacos can no longer avoid, they will need to work out how to protect their existing RDL business while stepping up to fresh challenges and opportunities.

To thrive in the highly dynamic EDL environment, MNCs will need to build new competences: monitoring the EDL’s evolution to update strategy, with particular care to grasp province specifics; understanding and engaging with stakeholders, so as to be productively connected; institutionalizing the bidding process and also achieving a tight management of the pricing process; and establishing an EDL-specific commercial model that meets the specific demands of a different market.

The watchwords must be vigilance and nimbleness as pharmacos aggregate their local/provincial strategies into a coherent overarching plan for the significant market that China presents.

About the author(s)

Franck Le Deu and Jin Wang are partners in McKinsey’s Shanghai office. Li Ma is an alumna of the Beijing office.

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