China is changing the way it procures drugs in its major cities. The result: Prices are set to tumble. According to some media reports, the declines for some drugs could be as much as 90 percent. The reaction: Chinese drug stocks plunged the most in a decade on Dec. 6.

What exactly is China doing?

Eleven major cities — including Beijing, Shanghai and Guangzhou — are banding together to bulk buy drugs through a tender process. In what the government calls a pilot exercise, pharmaceutical firms were invited last month to bid for contracts to supply 31 drugs — ranging from allergy and high-blood pressure treatments to cholesterol and cancer medication. 

Here’s the thing: There’ll be just one winner for each of the drugs. The victor would then solely supply that medication to the hospitals in all 11 cities.

Why’s China doing this?

The government is overhauling its healthcare system to provide better access to quality drugs and treatment for its population. While it has already begun to import more foreign drugs and make more of them reimbursable through its national insurance plan, it also wants to contain costs. 

Since its greatest bargaining chip is the sheer volume of demand from its massive population, China has asked cities to combine drug procurement in order to glean the best prices from drug makers.

So this is bad news for pharmaceutical companies?

Yes. Both Chinese and multinational companies oppose the plan, not least because the highly competitive tender process will inevitably slash drug prices and hurt their bottom lines. Another objection: By handing the supply of a drug almost entirely to one company, the government risks quality and supply chain issues, according to Sanofi’s China country chair Jean-Christophe Pointeau. 

The majority of Chinese drugmakers rely on the cheap production of generic medications to drive revenue, which means their profit margins are already slimmer than global pharmaceuticals with research and development capabilities. Chinese healthcare stocks have gone into deep sell-offs every time new information about the plan has emerged.

Are multinational pharmaceuticals also in trouble?

Yes and no. Global drugmakers are less impacted because they rely for revenue on their pipeline of novel drugs, which have not yet been matched by generics or are still on patent. No novel drugs are in the list of 31. However, in a Chinese market quirk, foreign pharmaceuticals still do big business with Chinese hospitals on their blockbuster drugs, like Pfizer Inc.’s cholesterol medication Lipitor — even though these drugs have gone off patent. 

According to Bocom International analysts led by Kelvin Chen, Pfizer supplied 74 percent of Atorvastatin, the generic name for Lipitor, to Chinese hospitals prior to the bidding — even though other Chinese makers produce generics of it. Pfizer also still supplied 84 percent of its blood pressure medication Amlodipine to hospitals, and Novartis AG provided 81 percent of cancer treatment Imatinib.

What’s going on?

Domestic generic manufacturers are generally unable to match foreign makers on quality. That means overseas pharmaceuticals still win the lion’s share of individual hospital tenders, despite higher prices. This business is likely to disappear, though, after the tender results are announced, as the foreign pharmaceuticals are unlikely to bid low enough. 

But it’s not all bad news for Big Pharma: The Chinese government has reformed its drug approval process. That’s allowing novel drugs of multinationals in at a rapid pace — sometimes faster than in the U.S. — and creating vast new revenue streams.