Xu Jiaxi of Industrial Securities: Two-Invoice Policy May Drive Higher Concentration in China's Pharmaceutical Industry
Recent discussions about the "Two-Invoice System" potentially costing many pharmaceutical representatives and pharmaceutical distribution companies their jobs continue to gain momentum. Many professionals in the pharmaceutical industry are deeply concerned about the Two-Invoice System, believing it will have a significant impact on the industry and could lead to a major reshuffling.
Against this backdrop, VCBeat (WeChat ID: vcbeat) interviewed Xu Jiaxi, Chief Pharmaceutical Industry Analyst at Industrial Securities, on issues related to the Two-Invoice System and healthcare investment. He provided a comprehensive analysis ranging from the core logic of healthcare reform to how pharmaceutical manufacturers and distributors can respond to the Two-Invoice System reform.
According to Xu Jiaxi, against the backdrop of the VAT reform and the “Two-Invoice System,” pharmaceutical manufacturers, pharmaceutical circulation enterprises, and pharmaceutical distributors will undergo significant changes in their business operations. This is particularly true for pharmaceutical circulation enterprises, which operate through multiple channel tiers under the existing multi-invoice system. Although the Two-Invoice System has not yet been mandatorily implemented nationwide, starting from the pilot program in Fujian Province, it already covers more than 60%—or even a larger share—of the national healthcare market, encompassing 11 pilot provinces and 200 pilot cities engaged in healthcare reform. It is expected that the system will be fully rolled out across China by 2018, marking a major trend.
First, the replacement of business tax with value-added tax (VAT) has led to stricter tax supervision, making it more difficult to obtain invoices for offsetting purposes. This ensures the integrity of the industry’s VAT deduction chain and allows companies with standardized tax practices to fully demonstrate their competitiveness.
Another key factor is the “Two-Invoice System.” Based on relevant policies issued in Fujian, Anhui, Shaanxi, Sichuan, and Chongqing, there are certain requirements for the scale and operational capabilities of distribution enterprises. Taking Shaanxi Province as an example, regulations stipulate minimum premises area, adequate warehousing facilities, and satisfactory historical business records, effectively excluding many small-scale distributors from the supply channels of public hospitals.
Data shows that there are more than 13,000 pharmaceutical wholesale enterprises in China. The main business revenue of the top 100 pharmaceutical wholesalers accounts for 80% of the total size of the national pharmaceutical market during the same period, indicating that market concentration is already very high. Based on the current drug market size of RMB 2 trillion, the average annual sales volume of a small-scale pharmaceutical distribution enterprise is only around RMB 20 million, yet their impact on drug prices is critically significant.
If drug prices decline, there is in fact a spillover effect, namely the issue of healthcare insurance cost containment. The Report on the Development of China’s Healthcare Sector predicted that the basic medical insurance fund for urban employees would face a deficit in 2017. To avoid the risk of fund exhaustion, controlling healthcare insurance expenditures has become one of the core tasks of healthcare reform. Where to start? Controlling drug prices naturally becomes the focal point.
“Therefore, healthcare reform aims to achieve the so-called ‘tri-medical linkage’ among medical insurance, pharmaceuticals, and medical services. Under payment pressure, medical insurance must adopt multiple approaches for precise cost control; the pharmaceutical sector needs standardization and a restructuring of its value chain; and medical services must improve efficiency and return to the essence of healthcare,” said Xu Jiaxi.
“Looking back at pharmaceutical distribution companies, we see that the trend toward consolidation is becoming increasingly clear, driven by upstream forces and downstream tendering requirements. Small regional distributors are likely to be gradually phased out; many may simply shut down, while others may seek partnerships with leading regional or national commercial enterprises,” said Xu Jiaxi.
Xu Jiaxi also noted that for pharmaceutical manufacturers, the Two-Invoice System may lead to a shift toward higher invoicing prices, which will have certain implications for how these companies handle their internal projects. This is particularly true for manufacturers relying on agency sales, as they will face significant tax pressures and issues related to the standardization of financial processes.
However, the circumstances faced by different pharmaceutical manufacturers may vary. If a company’s products are popular in the market and it holds relatively strong bargaining power over distributors, the impact on the company will be relatively limited. Conversely, if its products are primarily generic drugs, the impact will be more significant.
“We believe that the Two-Invoice System is a major trend, but its implementation will not be one-size-fits-all; it will depend on the local industrial competitive landscape, whether in terms of commercial or manufacturing structures. Overall, however, it remains favorable for large-scale commercial enterprises, namely national leaders and regional leaders,” said Xu Jiaxi.
Capital will be the key driver of industry transformation, with sources including industry-specific capital, industrial capital, financial capital, and internet capital. According to statistics from Industrial Securities, as of early December, four listed chain pharmacy companies had announced 21 mergers and acquisitions (M&A) this year; listed pharmaceutical commerce companies had announced 62 M&A deals; and numerous other pharmaceutical companies are in the process of going public.
Xu Jiaxi said, “Capital actually plays a directional guiding role, as capital markets tend to be more forward-looking. While it may not contribute to profits immediately in the short term, its medium- to long-term direction is generally accurate.”
“In certain sectors that currently show no profitability, it is hard to imagine how internet healthcare and precision medicine could gain traction or secure funding without the involvement of capital. These enterprises are unlikely to generate profits, or will only yield modest profits if any, over a fairly predictable period, possibly the next several years. However, they do drive user traffic. The influx of capital has played a leading role, creating industry hotspots, on the basis of which several major companies may emerge in the future,” explained Xu Jiaxi in detail.
However, the capital market is becoming increasingly selective, exercising greater caution in project evaluation and showing a preference for companies that have already been validated by the market. Taking “Healthcare + Internet” as an example, several characteristics of this year’s market cannot be overlooked: first, pharmaceutical e-commerce has begun to operate on thin margins; second, the concept of internet hospitals in the pharmaceutical sector has gained significant traction; and third, the pharmaceutical O2O (Online-to-Offline) sector has seen some players exit while others continue to expand. Our previous statistical data show that financing and investment in the pharmaceutical e-commerce sector alone approached RMB 2 billion this year, with most recipients being companies beyond Series A funding rounds. The investment amounts were relatively large, far exceeding the scale of previous years.
In this regard, Xu Jiaxi believes that the integration of healthcare and the Internet holds long-term value and will give rise to a number of industry leaders, although each player must address its own unique challenges. Given that healthcare consumption is low-frequency, companies need to explore effective strategies to enhance user stickiness and engagement.
The reporter noted that B2B pharmaceutical e-commerce is developing rapidly, with a promising market size. How can B2B pharmaceutical e-commerce platforms facilitate the functional transition required by the Two-Invoice System, and what impact will this have on pharmaceutical distribution?
Xu Jiaxi stated that future B2B pharmaceutical e-commerce may adopt two models: asset-light and asset-heavy. The asset-light model functions solely as an information platform without handling physical goods. The asset-heavy model can be undertaken by large pharmaceutical distributors and manufacturers, requiring a robust logistics and warehousing-distribution system for support. Currently, the volume of pharmaceuticals distributed through online channels remains relatively small. Whether the future will favor an asset-light approach or a hybrid model combining both asset-light and asset-heavy elements remains to be seen.