China corruption probe takes a turn into domestic drug distribution business

A probe by Chinese authorities into alleged corruption in its pharma industry initially focused on drug manufacturers, and Western companies at that. But with the announcement that the former vice president of China's largest drug distributor has been detained, it has moved down the supply chain and firmly into its domestic industry. It also involves a company in a piece of the industry that is key to foreign drugmakers and one that has been tricky for them to navigate.

Actually, two people from Sinopharm Group are being investigated, according to Bloomberg. The company said in a statement that Shi Jinming, a former vice president, was detained last week after stepping down. Xu Yizhong, an ex-general manager of the Sinopharm distribution unit, is also involved in the investigation. A whistleblower accused the two of secreting money in personal accounts. Sinopharm's parent is China National Pharmaceutical Group, a state-controlled operation.

The corruption probe started last summer with allegations that GlaxoSmithKline ($GSK) was using travel accounts to pay off doctors and officials to sell more drugs. It has since expanded, with many of the largest pharma  companies at least being questioned. But with the latest disclosures, it takes a turn into drug distribution, an entirely different part of the industry.

While drugmakers have been expanding rapidly in China, the government has kept a tight control over distribution, requiring companies to create partnerships or use domestic distributors, with mixed results. In 2012, Pfizer ($PFE) won a court battle with a long-time distribution partner, Ruibangyonghe Trading Co. It had cut off supplies to the company after learning it was competing against Pfizer by selling at prices below prices set in their contract. Ruibangyonghe sued, but a court finally sided with Pfizer.

With a growing economy and rising demand for Western drugs, China has huge potential for drugmakers. But its protective laws make the mathematics of Western pricing less applicable, and so keeping on top of costs is essential. Eli Lilly ($LLY) CEO John Lechleiter in 2012 announced that his company was seeking to invest in Chinese distribution companies to better control supply chain costs. At the time, Frank Guo of Ipsos explained the difficulties it was up against. "So far, China's pharmaceutical distribution network has been dominated by a group of domestic large companies, such as Shanghai Pharmaceuticals and China National Pharmaceutical Group, whose profit margins exceed 10%, while in developed markets, such as the United States and Europe, it's usually no more than 1%," the research director said.

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