Brighter outlook for China's grey market?

(by David Rowtey)

With the first Australia-China Complementary Health Products Expo soon underway in Melbourne, David Rowtey looks at the crippled Chinese health landscape, demand for Australian exports in the face of significant legislative change and whether opportunities for community pharmacy are still there.

At the end of June, Melbourne plays host to the largest number of Chinese pharmacy owners Australia has seen.

The Australia-China Complementary Health Products Expo 2016 expects to host more than 800 Chinese delegates representing 3000 members of retail pharmacy chains, 240,000 pharmacy retail outlets and up to 80% of medicine sales in China over the two-day event.

Some of them are coming here to look at selling Chinese complementary medicine in Australia. But most of them are coming here to buy.

Why? They are all catering to a domestic market whose health system is near breaking point - and the demand for high-quality health products is high.

Michael Woodhead, a journalist who writes for Australian Doctor and has his own blog, China Medical News, calls China's health system the "triple whammy" of bad combinations.

Hospitals are state-owned by the central government but administered by the 19 regions, which leave them largely to their own financial devices.

The lack of a primary care model leaves urban hospitals swamped by massive queues (often with their own waiting-list ticket scalpers). Overservicing and expensive overprescribing is common, and community pharmacy is patchy, according to Woodhead.

Patients have, until recently, been compelled to fill prescriptions at the hospitals' pharmacies - known as "gold mines" - which generate up to 40-50% of hospital revenue. Scripts have a short life - they need to be dispensed in three days. We're not in Kansas anymore.

Add to this unenviable scenario the now deep-seated Chinese scepticism about locally produced health products and the perception that anything Australian is associated with quality, the Chinese market has emerged as an ideal opportunity for Australian companies working in health.

Australian Self Medication Industry (ASMI) strategy manager for complementary medicines Brenda Davy says Australian scan data from February 2016 in pharmacy and grocery which predate recent restrictive legislative changes - show the majority of growth is in pharmacy.

This is presumably driven by the informal grey market, or personal shoppers for China, she says, and is believed to be sourced primarily from pharmacies.

"Grocery grew 6% and while pharmacy was up 37%, the pharmacy share of total category sales went to 81% versus 76% a year ago.

"The category 'total herbals', the biggest individual category, far outshone other segments, growing 53% in 12 months and most of that was driven by pharmacy, which grew by 60%.

A closer look at the data shows the strongest growth was in products such as evening primrose oil, milk thistle, glucosamine, cranberry supplements and grape seed oil, all of which seem to have high demand in China, she says.

The opportunity for Australian companies to capitalise on the ailing Chinese healthcare system is nothing new. The well-publicised Chinese baby formula scandal dates back to 2008 when products from many different suppliers were found to be adulterated with the chemical melamine.

Six babies died, tens of thousands were hospitalised and up to 300,000 were estimated to be affected in some way.

That was just the first of many health scandals. One of the most recent involved the reselling of out-of-date or close-to-expiry vaccines to hospitals and clinics around the country.

Allegedly masterminded by a pharmacist and his daughter, the 2 million faulty vaccines, which were transported without regard to the cold chain, are believed to have been sold for around A$120 million. Twenty-nine pharmaceutical companies and 16 health departments were implicated.

The government response was glacially slow until media pressure finally forced an official inquiry in late March which, most observers say, has been a whitewash anyway.

There have also been many high-profile media 'exposures' about shonky health products and services being promoted through paid search engine results on Baidu, China's Google equivalent.

All these contribute to what Woodhead describes as a huge healthcare trust deficit, which has since expanded to far-reaching criticism of the healthcare system, hospitals and administration of medications.

But the scandal has had a silver lining for Australia, driving huge demand for powdered milk and an export bonanza. The grey market has received widespread media coverage with tales of whole suburbs emptied of the most popular infant products, usually baby formula and milk powder, headed for China.

Many thought the China-Australia Free Trade Agreement, which came into effect in December 2015, would smooth the way for continued trading and supply. But changes to Chinese postal tax and import tariffs introduced in April this year are affecting the grey market and mainstream suppliers equally.

In response, share prices dropped sharply for companies that had directly benefited from the exports: Blackmores, Bellamy's Organic and a2 Milk.

Later that month, Chinese news agency Xinhua said the Chinese government was directing prescription drug sales away from hospital pharmacies and into retail to reduce hospital reliance on drug sales for revenue.

It said the government was also considering allowing prescription drugs to be sold online, giving ecommerce firms such as Alibaba and JD.com the opportunity to get involved in the lucrative prescription drug business (though at the time of print, Reuters reported this may have changed).

Though the long-term effects of the postal and tariff reforms/changes to medicinal or health-related exports to China are not clear, players at a grassroots level, as well as the larger companies, have taken a hit.

Consider Wayne, a 28-year-old well-paid banker who is a daigou on the side. 'Daigou' are the middlemen in the grey market; independent business people who buy products straight off retail shelves, or buy in bulk from wholesalers, repackage, and send to contacts in China by post.

Wayne came to Australia when he was three months old and speaks Mandarin. By his own admission, Wayne is a "small to medium-sized" player. For him, the grey economy market peaked in early 2015 and he's immediately felt the effects of not only the recent tariff changes but also the direct incursion of Australian players.

He says Chemist Warehouse's establishment of a Chinese online operation last year has seen his vitamin/complementary market collapse.

For him, now the big opportunity is still milk powder but even that's been hit hard by the changing regulatory landscape.

"Back in the day, you could send two boxes - around 12 cans - by post, then that was reduced to six, then three cans per package. Now there's talk of that being reduced to one. That's huge. If the Chinese government tightens up on that even more, we're screwed," he says.

"We were doing around three grand profit per week, now we're down to only about $1500.".

But in teched-up, celebrity-obsessed China, it takes only one celebrity deliberately or accidently endorsing a product for it to "take off", he says.

The export "hits" for him remain pretty stable - milk powder, cranberry high-strength supplement by Swisse, goat's milk soap and papaw ointment which, though some Australian media have recently been reporting a spike in demand, he says is not that "hot" now. And in among it all, ugg boots.

On a broader level, ASMI's Brenda Davy says people who know the market in detail don't think the 11.9% tariff on complementary medicines is going to have that much effect.

"Given they're already paying prices significantly higher than the RRP in Australia, another few dollars on top of that will not break the bank," she says.

But other observers note there's been more hesitancy and caution since the tariff changes, and maybe even signs some of the key players may have overestimated Chinese demand.

"A couple of key brands seem to be doing a lot of Australian promotion, which suggests an overstock of goods previously bound for China through the personal shopping front," says one insider.

"Supply was such an issue for so many months, how can there be deep price promotions unless there's been a pullback in Chinese demand?" Just before PN went to press, Sigma subsidiary Amcal announced its first step into the Chinese market, with an Australian-hosted website that may sidestep some of the piracy issues other entrants into the market are claimed to have suffered.

"We haven't rushed into the market - it was a very deliberate strategy," says a Sigma spokesman, confirming the Chinese portal was linked back to their Australian site "to protect the brand".

But on top of all of this is the tantalising "elephant in the waiting room" of Chinese prescriptions opening up to online players. What would it mean for international players wanting to get into the market, if anything?

With endless regulatory hoops to jump through, it wouldn't be easy - but with the right partners with the right connections and prominent Australian branding, who knows?

At this stage the government initiative is so new, with apparent sudden regulation changes, that nobody is prepared to speculate.

But the Sigma spokesman confirms: "We're aware of it. Yes, we're aware of it and, whatever we do, we're not going to rush it."