Pharmaceuticals: Chinese Companies to Increase Efforts in Innovation and Expand to Higher-Added-Value Processes

Abstract

Given China’s aging population, the ability of the country’s pharmaceutical companies to provide high-quality products has become a critical issue. As the world's second-largest individual pharmaceutical market, China exhibits a competitive landscape in the pharmaceutical industry that still has room for further development compared to the US, the leading market in the world. In China, the contradiction between rising medical demand and a lack of innovation in pharmaceutical products may be one of the core issues affecting people's livelihoods. We believe it is critical for the government and public sector to improve the innovation capabilities of the pharmaceutical industry and to build value chains locally, expanding to processes with higher added value on the value chain and narrowing the gap with the world’s leading market. In this chapter, we analyze the Chinese pharmaceutical industry’s upgrading trend from the perspective of the pharmaceutical supply chain system and ecosystem innovation.

Pharmaceutical supply chain systems are classified based on the R&D process. Pharmaceutical R&D has a long cycle. It is relatively independent as it has to meet various types of needs. The economies of scale achieved from the division of labor in the R&D process can substantially reduce R&D costs. Therefore, core pharmaceutical supply chain systems are classified according to the process from R&D to production and marketing. Meanwhile, hardware such as equipment and reagents are used in R&D and production, and they constitute a secondary supply chain system.

Pharmaceutical R&D is an ecosystem in which the software is more important than the hardware. Given that every individual has personalized pharmaceutical needs, allocating resources to pursue breakthroughs in a single category cannot improve the competitiveness of the whole industry. Therefore, a well-balanced and evolving ecosystem is the key to competitiveness. The ecosystem includes systems for regulation, scientific research, payments, as well as the capital market, among other factors. Good products can only be continuously incubated to meet patient needs by achieving a dynamic balance of these factors and through market-oriented means. These “soft factors” are the key to competition between countries. Although hardware factors such as medical equipment and reagents are important, most weak hardware processes can be solved or replaced through R&D. As a result, software is more important than hardware in pharmaceutical R&D.

A new national system to strengthen the software of the pharmaceutical ecosystem; Chinese companies to increase their presence in higher-added-value processes. Since 2015, China has implemented a comprehensive reform of the pharmaceutical industry, aiming to improve the ecosystem’s competitiveness and to encourage domestic companies to expand into higher value-added processes. Regulation: R&D efficiency of new drugs has improved notably since the drug review reform, and integrating its drug review system with global standards has accelerated the integration of China’s R&D ecosystem. Market-based payment: The National Healthcare Security Administration (NHSA) is accelerating the exit of inefficient products so that more resources are channeled to high-quality products. Capital market: The introduction of Chapter 18A (The Stock Exchange of Hong Kong Limited introduced Chapter 18A to permit the listing of biotech companies that do not meet any Main Board financial eligibility tests.) and the establishment of the SSE STAR Market has made financing more convenient for innovative companies. The primary market has become more active in investing in the pharmaceutical industry, attracting a large amount of investment for innovative product incubation. Comprehensive reform has improved the pharmaceutical ecosystem, making it more competitive. We expect the domestic pharmaceutical industry to gradually shift from R&D outsourcing toward high-value-added innovative products.

Authors of this chapter: ZOU Peng, ZHANG Jin, FENG Xipeng, FU Jiaying, LIU Xiyuan, WU Wanhua. Translator: SUN Tong. Editors: Kenneth HO, Michael HOARE, WU Wanhua, LIU Xinran.

Pharmaceutical innovation is an important part of the upgrading of high-end manufacturing industries, and there has been increasing discussion in recent years about what constitutes an appropriate development model. The COVID-19 pandemic has put countries’ healthcare systems and pharmaceutical industries to the test. Only a few countries and regions developed drugs and vaccines for COVID-19. Though designed for cancer treatment, mRNA technology was first used in vaccines. These types of use cases raise the question of what type of pharmaceutical system can meet increasingly personalized or urgent medical needs.

Medicines, primarily non-standard products designed for different diseases, typically have several rounds of iteration, and utilizing public resources to seek breakthroughs in a single direction is usually inefficient. We believe new technologies and competitive products can be cultivated only by building a market-oriented ecosystem driven by end-market demand. This effort requires supportive policies in fields such as regulation, payment, investment, and financing to create a virtuous cycle, which can then form a new national system. Such complexity explains why only a few countries and regions can build a competitive system.

This chapter reviews the pharmaceutical supply chain system and ecosystem, and discusses the necessity of and core directions in developing a new national pharmaceutical system.

15.1 R&D is the Core of the Pharmaceutical Supply Chain System

15.1.1 Pharmaceutical R&D: A Progressive Screening Process

Pharmaceutical R&D is a one-in-a-million progressive screening process. R&D of innovative drugs must go through several processes, including project launches, drug discovery, preclinical and clinical trials, and marketing. Drug development is often characterized by high investment, a long cycle, and a low rate of success due to the complicated R&D process and strict approval standards. For every 10,000 compound candidates, there might be only one drug that makes it through the R&D process and enters the market (Fig. 15.1).

Fig. 15.1

Source Frost & Sullivan, CICC Research

A typical timeline for new drug development. Note GMP = good manufacturing practices; DMPK = drug metabolism and pharmacokinetics; IND = investigational new drug; NDA = new drug application; FDA is the US Food and Drug Administration.

According to scenario and type of asset used at different stages, new drug R&D can be divided into laboratory, hospital, and factory stages.

Laboratories: Preclinical development; skilled worker-intensive. In the early stages of drug discovery and preclinical laboratory in innovative drug R&D, laboratories are the primary R&D scenario. Laboratory R&D consists primarily of repeated trials in three dimensions: Drug safety (toxicological studies), efficacy (pharmacological studies), and chemical manufacturing and control (CMC, pharmacological studies or druggability). New business projects such as drug discovery and optimization have emerged to help innovative drug companies. Only one drug out of 5,000–10,000 compound candidates may reach the market. The size of laboratories and the number of laboratory staff are the primary indicators of production capacity, and laboratories are skilled-worker intensive.

Hospitals: Clinical trials are resource and labor-intensive. Clinical trials are the continuation of preclinical drug R&D, in which systematic studies are conducted on patients and healthy volunteers. Clinical trials aim to confirm or discover the pharmacological and pharmacodynamic effects, adverse reactions, absorption, distribution, metabolism, and excretion of the experimental drug to determine its efficacy and safety. Clinical trials are generally divided into phases I, II, III, and IV. They have high barriers to entry and require high-quality clinical resources. The core sub-businesses of clinical trials, including site management, clinical monitoring, data management, and statistical analysis, are closely related to the project execution team. The number of personnel is a primary indicator of production capacity.

Factories: Marketing applications and commercial production are capital-intensive. Factory production, which is asset-heavy and capital-intensive, mainly refers to the production and packaging of clinical drugs, intermediates, active pharmaceutical ingredients (APIs), and preparations. Pharmaceutical equipment and related consumables used in process and formula development, such as small molecule and macromolecule reactors, are involved in production.

A pharmaceutical innovation and R&D system comprises pharmaceutical R&D, the hardware supply chain, and the software ecosystem. The hardware supply chain includes scientific research equipment and reagents (upstream of laboratories), patient recruitment (upstream of hospital clinical trials), and pharmaceutical equipment and consumables (upstream of manufacturing). The software ecosystem includes education-related basic science, regulatory systems for approval and review, a capital market that could help accelerate incubation, and end-market payment systems. (Fig. 15.2).

Fig. 15.2

Source CICC Research

Value chain and ecosystem of pharmaceutical R&D.

15.1.2 The Hardware of the Pharmaceutical R&D Supply Chain System: Configuration of the R&D Process

Scientific research equipment is upstream of laboratories. Life science research equipment covers several sub-categories, including sequencing equipment for genetic inheritance, biochemical analysis equipment, mass spectrometry equipment, chromatography equipment, and analytical equipment for other specific indicators. Scientific research reagents are upstream of laboratories. They include both chemical reagents and biological reagents. The chemical reagents have reached a relatively mature stage of development, and in recent years, biological reagents have developed rapidly thanks to the boom in macromolecular biologic drugs, medical testing, and cell and gene therapy. These biological reagents are also new upstream raw materials with high barriers to entry.

Clinical patient recruitment is upstream of clinical trials. Clinical trials in Phases I to III typically require thousands of patients. Clinical time is made up of clinical enrollment time and experimental execution time. As the experimental execution time is relatively fixed, clinical enrollment time becomes an important variable in overall clinical time. China has a large population, with many disease types and cases, and abundant clinical research resources.

Upstream of factories are equipment and consumables for large manufacturing industries. Pharmaceutical equipment includes machinery equipment and packaging materials used in pharmaceutical production, testing, packaging, and other manufacturing procedures. The pharmaceutical equipment industry is in the upstream, and an important component of the pharmaceutical industry. The four components of the biological drug preparation process can be divided into drug screening and cell strain construction, cell culture, downstream purification, and preparation canning.

15.1.3 The Software of the Pharmaceutical R&D Ecosystem: Scientific Breakthroughs, Regulatory Guidance, Capital Acceleration, Market Feedback

End-user demand is personalized and fragmented, and concentrated R&D tends to solve problems with a limited scope. Due to the diversity of the human genome, different patients will have different drug responses. For example, a single antitumor drug might only be effective for 10–30% of patients. Therefore, it is necessary to provide personalized solutions based on the characteristics and conditions of patients, including diagnosis, drugs, treatment plans, and rehabilitation. In this context, it is crucial to build an ecosystem that can evolve sustainably and incubate companies that innovate continuously.

Scientific research (education system): Target discovery and addressing curative mechanism. Innovations at the beginning of the drug development process such as mechanism research and target discovery need to be driven by high-quality basic research in academia. Transforming basic research findings into clinical research requires systematic translational science and support from skilled workers. The support of pharmaceutical companies can help maximize the clinical and commercial value of cutting-edge discoveries. Basic disciplines such as life sciences and translational medicine’s exploration of the relationship between pathogenesis and potential targets provides the foundation and guidance for R&D of new drugs. The laboratories of scientific research institutions are the primary source of drug innovation.

Regulation (approval system): Regulations guide the direction of R&D. The allocation of more high-quality resources in evaluation and approval of innovative drugs urgently needed for clinical trials requires regulatory support and guidance. Pharmaceutical development is closely related to regulatory science. Functional departments are involved in registration management, production quality, pricing, circulation, and intellectual property to create a favorable institutional environment for a series of changes in concepts and innovation of mechanisms. Optimizing the supply of approval and review resources, and thus reducing institutional and regulatory costs, can help remove barriers to launching new drugs. The guiding role of regulators is also important in strengthening industry standardization, including raising quality requirements for the design of clinical studies for new drugs. In our view, regulation plays a unique role in allocating resources and setting directions for improving the innovation ecosystem and optimizing the industrial structure of China’s pharmaceutical industry.

Capital (investment system): Accelerating progress in drug R&D and solving funding issues. Government investment is needed to strengthen basic scientific research capability, and social investment is needed in the risk-sharing of cutting-edge innovation commercialization. As the basic scientific research system plays a supporting role but is unlikely to generate high returns in the short term, the government is the primary source of investment. Meanwhile, investing in innovative drug R&D is characterized by high risk, high investment, and a long cycle. It is difficult for individual researchers to raise funds for sustained R&D and to bear R&D risks. Therefore, early-stage venture capital is crucial to the biotechnology industry's development, and securitization financing is required to diversify risks. High pricing encourages investment in high-risk projects, while low pricing stimulates investment in low-risk projects.

Market (payment system): An R&D process with high returns and risks. A bargaining and payment system that favors innovation outcomes, we think, could encourage pharmaceutical companies to invest in cutting-edge fields. Best in class (BIC) and first in class (FIC) products usually have high value and higher R&D risks, placing higher requirements on product commercialization expectations. As the commercialization of new drugs typically begins in the domestic market, we think improving the payment system's capacity for fund raising, clarifying its guidance of clinical value, and paying innovation premiums for high-risk innovations can encourage pharmaceutical companies to invest in the cutting edge.

15.2 China Enters the Global Outsourcing Business; the Hardware Supply Chain is Gradually Replacing Imports

15.2.1 R&D Process Benefits From Outsourcing; China Has an Engineer Dividend

Outsourcing accelerates pharmaceutical R&D. R&D outsourcing undertaken by a contract X organization (CXO) includes service-focused contract research organizations (CRO) and manufacturing-focused contract manufacture organizations (CMO). CRO and CMO are customized outsourcing systems that provide innovative drug developers with research support and production and supply services, which can substantially improve R&D efficiency. CRO accelerate the laboratory and hospital clinical trial processes. On a contract basis, they provide all or part of the activities involved in the drug development process to assist pharmaceutical companies in scientific or medical research. Their main services include drug discovery, safety evaluation, pharmacokinetics, pharmacology and toxicology, as well as other preclinical studies, clinical data management, and new drug registration applications. CMO accelerate factory production with a focus on drug production, providing manufacturing and packaging services for intermediates, active pharmaceutical ingredients (APIs), and preparations in the form of contract customization. Contract development and manufacturing organizations (CDMO) also provide R&D and innovation services for production processes.

Chinese CXOs have become a critical component of the global pharmaceutical R&D outsourcing system. Around the year 2000, China moved to enter the global R&D outsourcing system, offering chemical synthesis services, ahead of the joining the World Trade Organization (WTO) in 2001. Also, around the year 2000, the first batch of Chinese CXO companies emerged, e.g., WuXi AppTec and Pharmaron Beijing. These firms offered front-end entrusted processing services with low barriers to entry, such as chemical synthesis, and expanded into the pharmaceutical outsourcing supply chain. Following China’s accession to the WTO, Chinese companies have gradually built trust with large overseas pharmaceutical companies and secured overseas orders by leveraging their labor and production capacity cost advantages. In 2015, the State Council issued Opinions on Reforming the Review and Approval System for Drugs and Medical Devices, outlining the direction of domestic pharmaceutical companies’ innovation and transformation, and domestic demand for new drug R&D began to rise. Since joining the International Council for Harmonisation of Technical Requirements for Pharmaceuticals for Human Use (ICH) in 2017, China’s approval system has adopted international standards, allowing domestic CXO companies to receive more back-end, high-value-added orders, including international multi-center clinical trials and preparation production. Leading CRO and CDMO companies have accumulated extensive experience after more than 20 years of development, and overseas revenue accounts for more than 70% of their total revenue on average (excluding clinical CRO Tigermed). They are part of a global system.

Chinese CROs have become globally competitive, supported by the engineer dividend.¹ Since 2000, the number of science and technology graduates in China has increased notably, and there is a large pool of high-quality professionals. China has comparatively low labor costs and a distinct engineer dividend in preclinical trials and production, resulting in cost and efficiency advantages. With global demand growing steadily, Chinese CXOs continue to benefit from demand shifting from overseas markets to China. Due to biological information security, the clinical business cannot achieve global value chain transfer and division of labor due to localized value chain management, making it difficult to expand overseas in the short term.

China’s CMO contract manufacturing volume and high-value-added businesses are increasing as the manufacturing industry matures. Innovative drug production involves basic chemicals, starting materials, non-GMP intermediates, GMP intermediates, APIs, and preparations. The later it is in the production process, the higher the added value. Previously, China and major developed countries adopted different drug policies and regulations. China followed WHO standards, while major developed countries adhered to ICH standards. Innovative drugs launched overseas had to be re-registered when entering the China market, resulting in a time lag of several years. This, to some extent, resulted in a return of high-end innovative drug (including preparations) market demand to developed countries.

Meanwhile, the regulatory framework in China’s pharmaceutical market was not as comprehensive in the past, resulting in limited production capacity to meet the requirements of highly regulated markets. Therefore, domestic CDMO have mostly provided intermediates used in API production, which have low added value. The market for a single product is also small. European and US companies focus on high-value-added downstream businesses such as API and preparation production and development and application of new drug dose technologies. With increasing collaboration between domestic CXOs and overseas pharmaceutical companies, and China’s adaptation to the international system after joining the ICH in 2017, the production and sales in the same region have accelerated the shift of high-end market demand to China. Chinese companies have begun to gain exposure to the API and preparation markets with high added value in the later stages of large-scale production.

CMOs and CDMOs are expanding their global presence to deal with decentralized risk. Leading CDMOs, including WuXi AppTec and WuXi Biologics, have begun a global capacity expansion cycle. In July 2022, WuXi AppTec announced plans to build an R&D and production base in Singapore, with a total investment of SGD2bn (US$1.43bn) over the following 10 years. WuXi Biologics announced a plan in 2022 to invest US$1.4bn over 10 years to build an integrated service center in Singapore that will expand its capacity and biological drug discovery, and development and large-scale production of bulk and preparations. The firm estimates it will add about 120,000 L of biopharmaceutical production capacity by 2026. As end-product manufacturing needs to be geographically close to the consumer market, most overseas pharmaceutical companies need to produce preparations overseas. Meanwhile, pharmaceutical companies have focused on expanding production capacity across multiple regions, mainly to maintain stable supply in the face of headwinds from the COVID-19 pandemic. Leading CDMOs have seized the opportunity presented by drugmakers seeking to manufacture outside of China by expanding their overseas capacity, focusing on the high-value back-end preparation business and creating synergies with the low-cost front-end business.

15.2.2 The Supply Chain for Hardware is Partly Constrained by Overseas Markets in the Near Term; Substitution is not Insurmountable

The hardware required for manufacturing is not a permanent restraint on industry development; it will take some time required for Chinese companies to gain market share. Hardware for the pharmaceutical R&D supply chain system includes scientific research equipment and reagents, factory manufacturing equipment, and consumables. Most hardware is imported since domestic innovative pharmaceutical industries are emerging and due to the requirements on outsourced orders. The reliance on imported equipment has also hampered the growth of domestic hardware suppliers. However, the COVID-19 pandemic disrupted domestic and overseas supply chains, accelerating the development of domestic hardware. Also, there was a rapid period of development in the domestic CDMO industry after 2018, with urgent demand for factory construction. In the upstream pharmaceutical equipment industry, due to unstable overseas supply during the COVID-19 outbreak, there was accelerated adoption of made-in-China equipment, with product offerings from leading domestic pharmaceutical equipment companies such as Tofflon and Truking. In the near term, products for domestic high-precision machinery manufacturing such as scientific research equipment and manufacturing equipment will lag their overseas peers. Replacing foreign products with those made in China may increase R&D difficulties and production costs. Over the long term, hardware is not a hard barrier to entry, and in time, development of Chinese products may be supported by demand, in our view.

Scientific research equipment sub-products are under development; supply of mass spectrometers and other products may be limited in the short term. R&D of life science research equipment in China is in its infancy. Localization rates have increased notably in fields with low technological barriers, such as direct digital radiography and blood diagnosis. However, the localization rate remains low for high-end research equipment such as mass spectrometers, chromatographs, endoscopes, and gene sequencing devices. Foreign brands dominate the manufacturing of some devices, and many analytical instruments used by pharmaceutical companies are in limited supply.

Localization may be achieved for scientific research reagents. The biological reagent industry has largely matured in developed markets such as the US and Europe, and the competitive landscape is relatively stable. Leading companies have gained economies of scale through M&A, among others, and market share. The industry is thus more concentrated, and firms with global influence have emerged, such as Thermo Fisher. In China, the biological reagent industry started relatively late. Chinese biological reagent companies have competitive disadvantages in business scale, financing channels, and their relatively short period of development. They also tend to lag overseas companies in key raw material technologies, production processes, product variety, and product quality. The COVID-19 pandemic disrupted global supply chains, accelerating the replacement of imported goods with Chinese-made reagents. For example, in 2020, the overseas supply of upstream raw materials required for nucleic acid PCR test kits was in short supply, and domestic demand for nucleic acid tests accelerated the use of domestic raw materials. This accelerated the development of companies in the life research reagent industry such as Vazyme, ACROBiosystems, and Sino Biological. As demand for biological reagents is relatively customized and fragmented, the likelihood of any interruption to the production of core products from fluctuating overseas supply is relatively low.

Imported pharmaceutical equipment dominates the Chinese mainland market; domestic products gaining market share. Chinese companies lag foreign leaders in equipment technology and performance. However, as the pharmaceutical equipment industry is still emerging, as technology develops and accumulates, pharmaceutical equipment companies with strong R&D and competitiveness, such as Tofflon and Truking, have gradually emerged. As domestic demand grows, we expect Chinese brands to gain market share and outperform imported brands.

15.3 Software Construction in the Pharmaceutical Ecosystem Has a Long Way to Go

The core of drug supply lies in the development and marketing of new drug molecules. The value of pharmaceuticals lies in the development of new drugs to address clinical needs rather than the construction of manufacturing capacity. In other words, compared with R&D services and suppliers, the product end, with higher GM and revenue, is at the top of the value chain. Blockbuster drugs with both clinical value and innovation perform strongly in commercialization. A single blockbuster drug can drive rapid growth of pharmaceutical companies. Sales of the world's top 10 drugs combined exceed US$100bn, with sales of three of these drugs each exceeding US$10bn in 2020. Most of these blockbuster molecules are products from European and US pharmaceutical companies.

The US is the world’s major developer of drugs and market for new molecules and commercialized products. We believe the competitive landscape of the US drug market has remained stable, largely due to the patent system and strict regulatory requirements, which ensures the commercialization potential of drugs, drives ongoing R&D investment from the capital market and the pharmaceutical industry, and directs the development and iteration of the R&D system for new drugs. In 2020, US pharmaceutical companies contributed 51% of new drug molecules, and nine of the world's top 10 best-selling drugs were introduced to the market by US pharmaceutical companies. US firms accounted for 46% of global biotech companies in 2019. In 2020, nine of the world’s top 20 pharmaceutical companies were headquartered in the US. Strong end-market demand and payment system are solid drivers of R&D at pharmaceutical companies.

Globally, a large proportion of high-value new drugs come from European and US multinational pharmaceutical companies. Due to the high R&D cost of new drugs, a division of labor has formed in mature markets in Europe and the US. After completing proof of concept, small- and mid-size enterprises often cooperate with large multinational pharmaceutical companies with cash on hand, mature clinical and commercialization platforms, and a need to expand their pipelines through co-development, licensing, or sales. This division of labor has resulted in European and US multinational pharmaceutical companies gaining a majority share of new drug molecule development (Fig. 15.3).

Fig. 15.3

Source Pharmacodia, CICC Research

The number of new approved drugs by region. Note Data as of August 2022.

Chinese pharmaceutical companies are transforming and catching up with foreign companies; Chinese firms and products are not yet globally competitive. China’s pharmaceutical industry is comparatively young, and the domestic drug market is fragmented. The most profitable comprehensive pharmaceutical companies tend to focus on generic drugs, while their new drug businesses are undergoing transformation and following innovations from overseas, and most of their products are not yet globally competitive. Pharmaceutical and biotech companies that have grown rapidly in recent years and focus on innovative drugs are growing (Fig. 15.4).

Fig. 15.4

Source Company announcements, CICC Research

Comparison of revenue and GM of key global pharmaceutical companies. Note The size of the bubble is the relative size of revenue of the top 10 companies in each region in 2021. IVD = in vitro diagnostics.

Pharmaceutical innovation in China is catching up to global peers; innovation capability developing. R&D of new drugs in China has accelerated since 2015. In recent years, early entrants to the market have begun to generate income. However, the increasing number of clinical trials for the same drug targets is creating homogeneous competition. Most domestic innovative drug companies adopt a “me-too” or “fast-follow” strategy,² which has a higher success rate. Based on their understanding of their European and US peers, Chinese companies have leveraged the advantages in being a late-mover to catch up with international best practice. For some targets, the progress of Chinese companies has already reached the same level as global leaders. However, excessive competition is inevitable as most limited development and clinical resources are allocated to popular, highly homogeneous targets. In 2019, the number of targets undergoing clinical trials was 550 in the US vs. 160 in China, implying smaller coverage of targets. Furthermore, clinical trials for targets are more homogeneous in China. In the US, 70% of clinical resources are allocated to the top 30% of targets. In China, 70% of clinical assets are used to support the top 21% of targets, according to Pharmaproject, which suggests a waste of clinical resources (Fig. 15.5, Fig. 15.6).

Fig. 15.5

Source Deloitte, CICC Research

Homogeneity has increased in China’s drug R&D (2017–2020).

China has established a pharmaceutical R&D ecosystem, and its regulatory system is improving to a stage of adopting more international standards. However, basic scientific research, the capital market, and the payment system have room for improvement. Since the 2015 drug approval and medical insurance reforms,³ institutional standards and the investment focus of the drug companies have become clearer, with progress being made overall. However, there are gaps in the STEM-based disciplines, especially in chemistry, biology, and pharmacology. We believe the construction of discipline and talent systems could be improved. Furthermore, current incentives for innovation investment are insufficient, financing arrangements are inefficient, and payment capability from the market has not been fully exploited.

Fig. 15.6

Source Pharmaproject, CICC Research

The number of targets corresponding to clinical resource utilization (2019).

15.3.1 Regulatory System: Breakthroughs in Reforms of Drug Review; Modern Approval System Improving

The 2015 drug review and approval reforms clarified the therapeutic value of innovative drugs in clinical trials. Since the review, a series of mechanism innovation reforms have since begun. The Chinese pharmaceutical industry’s innovation ecosystem has gradually improved, and the industrial structure has been optimized, providing the necessary conditions for growth of the domestic innovative drug industry.

• Optimizing processes to accelerate the review and approval of new drugs while reducing system and regulatory costs. To ensure safety, regulators can grant more rights to enterprises, institutions, and markets, allowing them to take on more responsibility. The National Medical Products Administration (NMPA) system for clinical trial applications has shifted from being approvals based to expiration based. The NMPA has a system for authenticating the qualifications of institutions to reduce the approval time for clinical trials and to improve the ability of and incentive for medical institutions to take part in trials. The 2020 Provisions for Drug Registration provides four channels that accelerate the launch of new drugs: Conditional approval, breakthrough therapy designation, priority review, and special review. On the supply side, review capabilities might also be improved. The Center for Drug Evaluation (CDE) increases the number of reviewers and improves efficiency of review.

• China’s regulatory system continues to adopt international standards. The NMPA joined the ICH in 2017 and was elected to its management committee in 2018. The highest international technical standards and guidelines are being introduced, pushing the scientific development of drug registration standards, and accelerating coordination and unification of technical requirements for drug registration with international requirements. China is integrating further into the international innovation system in all aspects of new drug R&D, incorporating its drug regulatory system into the international framework and gradually entering the global pharmaceutical market

• Clarifying the significance of intellectual property protection in encouraging pharmaceutical innovation. After the passing of the Patent Law of the People's Republic of China (2020 Amendment), China implemented a drug patent term compensation system that adopted international standards, providing appropriate patent term compensation for time to market for innovative drugs occupied by review and approval and establishing drug patent linkage. Drug regulators and patent departments jointly develop measures to resolve patent disputes in drug marketing approval and licensing applications, establishing an early resolution mechanism for drug patent disputes. This process can also improve the protection of drug test data.

• Improving reviews and approvals guide the industry to BIC and FIC innovative drug development; raising barriers to entry has led to low-quality capacity exiting the industry; guiding the industry to reduce competition and duplicated and inefficient use of R&D resources; guiding companies to achieve healthy accumulation in the newer direction with higher clinical value. The CDE released Guiding Principles for Clinical Value-Oriented Clinical R&D of Antitumor Drugs in November 2021. The document emphasizes the quality requirements for clinical research design of new drugs from the policy end, echoing international guidelines from organizations such as the FDA and ICH and imposing high requirements for innovation quality.

15.3.2 Scientific Research System: Basic Science Emerging; Efficiency of Results Transformation Needs to Be Enhanced

Reforms to the drug review process have unlocked the impetus for innovation in the pharmaceutical industry, in our view. The skilled worker system for clinical trials and manufacturing in China’s innovation system has also improved greatly in the past few years, but there is still much room for improvement in the development of basic and translational science and skilled worker systems. Over 2015–2019, the average citation frequency of US theses in biology and medicine was 2.5× and 4× that of China, and the journal impact factor of papers in the life sciences in the US was 12,185 in 2019, much higher than China's 2,722. There are currently few academic leaders capable of breakthroughs in innovations, in our view. We believe the absolute amount of published high-level academic articles is increasing, but the industry lacks achievements that are successfully translated into new drugs in pipelines or in markets.

There is room to improve the efficiency and mechanisms to commercialize scientific and technological achievement. The concept of “from labs to hospital beds” was proposed in 1992, and encapsulates the rapid and effective translation of basic research in medical biology into theories, technologies, methods, and drugs that can be applied in clinical practice. The US National Institutes of Health (NIH) formally proposed and formulated a roadmap for translational medicine in 2003. It established a clinical and translational science fund in 2006 and the National Center for Advancing Translational Science in 2012. It has built a national network of academic medical centers, and there many professionals that bridge the gap between basic research and clinical practice. More recently, China has established a basic system for technology transfer, but translational medicine is still in its infancy. Most of China's scientific and technological achievements come from research institutes rather than corporates, resulting in a substantial disconnect between scientific and technological achievements, and industrial integration. We believe some alliances aimed at commercializing scientific and technological results are relatively loose, and they find it difficult to form synergies.

15.3.3 Investment System: Investment Volume Rising Rapidly; Specialized Basic Research and Structure Still Need to Be Optimized

Investment in basic research is low in China, accounting for around 5.5% of total R&D investment in 2018 (vs. 16.6% in the US, 12.6% in Japan, 18.3% in the UK, and 22.8% in France). Most R&D funds are spent on experimental development, and the amount spent on basic research has notable upside potential. Most developed countries have established a biomedical research management system to ensure the direction of basic medical research investment across different specialties and multiple projects. For example, the NIH uses 80% of the nearly US$40bn it manages to support non-hospital research institutions via 24 research institutes in sub-disciplines, helping to fund US research in cutting-edge areas of medicine. In 2019, China’s public sector spent more than Rmb20bn on medical specialties such as biochemistry, physiology, microbiology, anatomy, pathology, and pharmacology medicine. Funding mainly comes from the Ministry of Science and Technology, the National Health Commission, the NMPA, the National Natural Science Foundation of China, and medical universities.

The established pharmaceutical capital market in the US improves capital utilization efficiency, and tiered funds improve innovative R&D risk identification and resilience. As the birthplace of venture capital, the US has a relatively professional pool of investors and a mature pricing and valuation system for the pharmaceutical industry. Together with a well-built technology transfer system, this allows the US to better leverage the capital market and share the risk in commercializing cutting-edge innovations. Meanwhile, secondary markets such as the Nasdaq offer an exit route for venture and equity investment, reducing the cost of exit. We think the US experience sets an important example for China. Tolerance of project failure can be increased through the stratification of innovative financing and conventional financing, and raising the barriers to entry for innovative financing. Investment institutions are stratified, and investments are made in professional projects. This can improve the identification of innovative projects and the NMPA's ability to supervise new projects. Exploring the financial derivatives business can also dilute the impact of the failure of specific innovative drug projects.

China's financing system is improving, but further specialization is required. Since 2014, the accelerated growth of investment in the medical industry has been a major driver of growth in drug innovation. The introduction of Chapter 18A listings, which is mainly relevant to biotechnology companies, and the SSE STAR Market have provided a channel for the listing of biotech companies in China, and the improved capital exit mechanism is attracting substantial investment. Data from VBDATA.cn shows that domestic investment and financing in the biopharmaceutical sector rose 26.0% YoY to Rmb111.36bn in 2021, and financing events increased by 53.1% YoY to 522. However, the quality of investment targets varies. Funds have flowed to areas with repeated construction, and valuations of some bids have been too high.

15.3.4 Payment System: Lack of Commercial Insurance Payers; High-Risk, High-Reward Incentive Mechanism Needs to Improve

The US is the world’s largest drug market, with most consumer spending on pharmaceuticals flowing to innovative drugs with clinical value. According to the Institute for Clinical and Economic Review, willingness to pay among US patients is US$100,000–150,000/quality-adjusted life year.⁴ Annual sales in the US drug market reached US$555bn in 2021, ranked No.1 globally and accounting for 47% of global market sales. The US patent, regulatory, and pricing systems focus on the innovative and clinical value of drugs, which increases pharmaceutical companies’ pricing power for new drugs. The US payment system can pay a premium for innovation. According to the Pharmaceutical Research and Manufacturers of America (PhRMA) and IQVIA, original, patent-protected drugs accounted for 9% of prescriptions in the US in 2020⁵ but 80% of sales, and the market share of original drugs whose patents have not expired accounted for 66% of prescription drugs in 2018, with the majority spent on new drugs.

Fig. 15.7

Source Statista, Atradius, IQVIA, CICC Research

Breakdown of the global drug sales market (2021).

China has a large drug market in absolute terms, but per capita spending is low. China’s population is large and its drug market is second only to the US in terms of absolute size. Per capita spending on drugs, however, is low. According to the 2019 China Health Statistical Yearbook and OECD data, China's per capita healthcare expenditure in 2019 was around US$700, accounting for 6.67% of GDP, and per capita drug spending was about US$260. In the same period, per capita healthcare spending in the US was around US$12,000, about 17.6% of GDP, and the per capita prescription drug spending (excluding over the counter [OTC]) was US$1,128 (Fig. 15.7, Fig. 15.8).

Fig. 15.8

Source CMS, Ministry of Commerce, National Bureau of Statistics, CICC Research

Comparison of per capita drug spending in China and the US (2019).

The potential revenue from the Chinese market has yet to be fully realized, and market structure is not yet mature. Since the drug review and medical insurance system reforms of 2015, China's pharmaceutical market has undergone substantial structural changes. However, generic drugs, TCM injections, and adjuvant drugs account for a large share of China’s drug market, reducing room for payment for innovation outcomes. The efficiency of fund utilization needs to improve as well, in our view.

NHSA reform efforts are yielding results, creating scope for innovations in payment. Since 2016, government departments and commissions, as well as the NHSA, have launched reforms to the list of drugs to be monitored, normalization of centralized procurement of generic drugs, optimizing of the adjustment mechanism for the medical insurance drug list, increasing the frequency of updating the medical insurance drug list, and reducing the time for participating in negotiations on the access of new drugs. Through these processes, the number of drugs included in the medical insurance program has risen each year, and the increase in medical insurance negotiations has greatly reduced the institutional cost of introducing innovative drugs for treatment covered by medical insurance and accelerated the realization of the commercial value of new drugs. Meanwhile, the market for drugs and generics with unclear clinical value has shrunk, with a greater proportion of funds from medical insurance paying for innovative drugs, forcing pharmaceutical companies to shift their product strategies towards innovative drugs.

The payment system requires guidance; should seek to maximize multi-level payments. China’s national medical insurance program, China Healthcare Security, is the largest payer in the pharmaceutical market, and, in our view, should work to prioritize coverage of broader medical needs and drug accessibility. The program has a simple financing system and payment policy, with the strength to bargain on prices. These factors, as well as China’s competitive landscape and ongoing economic development, drive China's innovative drug market to lower prices. New drugs such as PD-1 monoclonal antibodies are much cheaper in China. Meanwhile, drugs paid for out-of-pocket account for a large proportion of all pharmaceutical sales in China, and the payment system has not fully met the needs of patients and their willingness to pay. Commercial insurance dominates the US payment system, and its government-led basic medical insurance primarily covers vulnerable groups. Specifically, commercial insurance companies mainly target the working-age population and offer customized products to meet the needs of various groups. They explore different groups of people's differing medical needs and willingness to pay and maximize multi-pillar payment capabilities.

However, for insurance names in China, obtaining the usage data of medical terminals is crucial to their product design, total expenditure control, and risk control. At present, commercial health insurance mainly targets individual policyholders, and their data is mainly unstructured data provided by policyholders. The lack of data in the healthcare system, especially among public hospitals, hinders commercial insurance companies from planning and designing insurance products. Lack of data transparency also makes risk control more difficult for underwriting and claim settlement, and there is a serious problem of information asymmetry between agents and users in the insurance market. We expect the establishment of the hospital drug data system to accelerate the introduction of commercial insurance and exploration of commercial insurance payment, introducing incremental capital to the payment system in China’s pharmaceutical industry and easing the long-term burden on the national medical insurance program.

15.4 Thoughts and Implications: Policy Guides Improvement of Software Ecosystem; Marketization to Incubate Strong Pharmaceutical Companies

15.4.1 A New National System That Creates a Favorable Environment for Pharmaceutical Innovation and Development

Increase investment in basic and translational science, driving the industrialization of research results. The scientific research system can use public sector funds and policies to continue to attract high-level skilled workers. It can improve infrastructure construction for technology transfer and commercialization of scientific research output, and give play to the guiding role of government funds to support commercialization and exploration in high-risk areas.

The regulatory system can further optimize the approval system and encourage cutting-edge innovations. We think regulators can remove policy barriers in cutting-edge fields and improve patent and data protection systems. Regulators can create a socialized incentive mechanism to guide innovation, increase the efficiency of preclinical and clinical resource allocation, and encourage innovation. They can also expand the regulatory system, launching systematic training programs and capacity development system construction that meet global innovation standards, improving regulatory institutions’ professional capabilities, and creating an approval and review system for independent R&D of innovative drugs.

Investment system: Fund stratification improves risk identification and resilience of innovative R&D while stimulating the vitality of social capital. The stratification of innovative and conventional financing can raise the barriers to entry for innovative financing, increase tolerance for project failure, and help establish a healthy investment system. Investment institutions should be set into different categories to support professionals investing in projects in areas of their expertise, so as to improve the authenticity of innovative projects. Financial derivatives investments might be explored. ETFs, for example, can help investors dilute the impact of a specific innovative drug project's failure, and customized products can meet the needs of investors with varying risk appetites.

Payment system: Building a diversified payment system to introduce incremental volume to pay a reasonable premium for innovation. The market can build an integrated hospital medication data system, accelerate the entry of commercial insurance, and explore the potential of commercial insurance payment to introduce incremental volume to the pharmaceutical industry's payment system and ease the burden of forward payment in the national medical insurance program. The market might further reduce the entry cost of new drugs into the insurance system, improve the drug evaluation system and drug management system, and use medical insurance funds rationally and efficiently based on clinical value and patient benefits. The market should support the pricing system for original and innovative products. The high-risk, high-reward mechanism may accelerate the stratification of financing and boost high-risk original drug innovation.

15.4.2 Localization of Upstream Hardware is an Imperative; Localizing Key Supply Chains Can Solidify Ecosystem

The rise of Chinese companies is imperative upstream; localizing key supply chains could solidify the ecosystem. The number of domestic companies in the life science research equipment value chain is relatively low. To make technological breakthroughs, China faces high barriers to entry in R&D and innovation in products. Furthermore, from core components to machine integration, equipment products involve a wide range of disciplines, requiring skilled workers with diverse backgrounds. Aside from breakthroughs in product R&D and product performance comparison, downstream commercial customers highly recognize foreign brands’ derivative services such as maintenance and replacement. There is scope for breakthroughs in commercializing upstream domestic life research equipment, in our view.

With China's continuous support for skilled worker training and policy catalysts, we expect Chinese companies to gradually accumulate the underlying technical knowledge involved in product R&D, facilitating breakthroughs in innovative technologies. Meanwhile, as the business ecosystem changes and domestic brands focus more on customer needs, the overall proportion of Chinese companies upstream and downstream will likely increase further, stabilizing the domestic life science research supply chain ecosystem.