Porter (2008) points out that positioning downstream is under the threat of substitution. In China’s pharmaceutical industry, competition from substitute products mainly happens in the public hospitals. “Advances in technology create new substitutes or shift price-performance comparisons” (Porter, 2008, p. 25). Adding an injection device for anti-cancer chemical drugs or changing drugs forms from TCMs tablet to granules were adapted to create “new” drugs as substitutes (See Section 4.5.2). Those substitutes obtain a higher price under DCBP within a short time. At the same time, guanxi acts as competitive advantage to compete with substitutes (See Figure 4.9).
This section looks at how government policy is an important force to influence the power of substitutes. DCBP policy is the main factor that facilitates the replacement of substitutes. All the interviewees emphasized the significance and far-reaching impact of the DCBP policy. It has been developed alongside Medical Reform for 2009. Winning tender purchase is a key goal for strategy implementation. Because of lack of national standardization, its non-transparency and its uncertainty (Geng, 2010; He and Li, 2011), this policy is mainly adopted in centralized provincial regulations. Therefore, every province has different regulations and entry thresholds but the directive has the same purpose of cutting drug prices. The policy directly influences the product’s price and profits. The sales director of Company B said:
We have to deal with different provincial standard of DCBP. It strongly influence our strategy implementation. Winning higher drugs tender bidding price is important. But drugs price cut is the trend this year (2014). Balancing national price system is strategy for SMPCs.
In the words of the sales director of Company A:
This tendering bidding price cut cannot be changed. It is becoming a direct threat for prescription drugs and, since 2014, this policy has been getting stricter. Local government’s purpose is directly to reduce medical costs. The union of local medical organizations directly negotiate price with SMPCs. Under this context, guanxi has less chance to influence this policy regulation any more.
DCBP policy is provincial government-oriented. In the face of the trend of drugs price cutting, the two companies’ decision-making process is the same. Two sales directors described the process and their decision making. The author compiled and summarized the findings (See Figure 4.12). This policy influences strategy implementation and business performance.
Figure 4.12 The DCBP Policy Influences SMPCs’ Strategy Decisions
As discussed in Section 2.4.3, DCBP is also a barrier for SMPCs entering the hospitals market. Every drugs producer wants to win the DCBP. Regarding generic drugs, rivals utilized low price strategy to compete in the existing competitive market (Porter, 2008). But since 2013, DCBP price has been reduced by provincial governments. Low DCBP price determines low profitability so that did not inspire local agents. And then the goal of sales performance could not be
achieved. At this time, SMPCs were facing two completely different decisions. If SMPCs accepted the DCBP prices formulated by provincial governments, they maintained existing market but obtained low profitability. If SMPCs did not accept the DCBP prices, they lost existing market. And then substitutes would enter the existing market. The sales director of Company B also emphasized the price of raw materials issue which inevitably influences SMPCs’ profitability. The cost of raw materials has been increasing. But the DCBP policy still utilizes a lower drugs price strategy. Cost and DCBP price have obvious conflicts in the industry.
Due to the uncertainty and differentiation of local tendering rules, Company A had misjudged the situation and lost the Fujian province market with the sales director of Company A noting that:
Products with lower bidding prices have to be withdrawn generally from the market. From 2009 to 2014, regarding generic drugs, many SMPCs had failed in the bidding pricing system in the countrywide market.
The disequilibrium of the bidding price system directly affects SMPCs’ sales model and company profits. In contrast, patented products listed in the reimbursement scheme, with higher bidding prices, support and stimulate the marketing model of prescription-based commission (Hu, Chen and Zhao, 2012; Peng, et al., 2013). “Discriminatory drug pricing and reimbursement policy and partial policy failures and drugs abuse in public hospitals cause the disequilibrium of revenue and expenditure in medical insurance” (BMI, 2014, p. 10). In the end, local provincial government has adopted a compulsory execution policy to constantly cut drug prices and a policy of drug prices negotiation to reduce patented drugs and exclusive TCMs expenses.
Although this policy can be criticized, it is still the main policy to reveal the drugs’ real and practical costs so that the government can formulate and calculate
a drugs pricing strategy for the pharmaceutical industry. Up to the present, the price system of the policy is still significant to manufacturing sectors. Stringent price controls and “continued price cuts” (BMI, 2014, p. 10) heavily influences SMPCs’ price system. Based on this stringent situation, SMPCs have to adjust their strategy too. Then, policy is a central force, but so too is guanxi in particular contexts as they seek to influence markets.
It is obvious, then, that not only did government policies directly impact SMPCs’ strategy formulation and implementation in China, but also more generally that different provincial DCBP policies directly influence SMPCs’ profitability. When the drug price cut is the main policy in 2015, price negotiation policy will be issued for patented drugs and new drugs. The secondary pricing policy is critical (Li and Huang, 2013; Wang, Fu and Li, 2015) to SMPCs too. Up to now, Hubei provincial or Gaozhou city governments (in Guangdong province) have permitted local hospitals directly to negotiate drug price with medicine suppliers. However, those policies will accelerate the collapse of small companies in the local market if the local government supports the secondary pricing policy. Hence, it seems that these two companies’ strategy may be difficult to execute. More specifically, for the two case studies (See Appendix 22), strategy formulation has been one of continual adjusting based on the policies changing since 2009. Both companies’ strategy formulation and implementation has been dynamically adjusted from 2009 to 2014. Their industry environment encompasses policy making during this Chinese economic transitional period (Wei and Luo, 2013) as well as guanxi. While the two case studies utilized focus on strategy or combination of focus on and differentiation strategy of Porter’s generic strategy, their strategy has been notably influenced by government policies and guanxi, the two additional key ‘forces’.
In summary, this chapter noted that the four major policies – New GMP, NBMIL, NEDL, and DCBP – are very important to our two SMPCs. The New GMP policy is a mandatory policy at national level and it directly influences SMPCs entry. NBMIL and NEDL and their sub-lists for provinces are related to SMPCs strategy formulation (See Section 4.4.1); the two medical insurance schemes decide market share rate and coverage with government policy formulation at provincial level being uniquely influenced by guanxi. While both the literature and seven of the nine interviewees expressed criticism of DCBP, since it is a complex system lacking coordination and consistency (Geng, 2010; He and Li, 2011), they still considered it to be important enough to influence their own strategy work formulation and implementation. This inherently included an assessment of guanxi – that is, its strength and where it resides within their networks. In other words, the guanxi givers and receivers.