Three Take-Home Messages From China’s Glaxo Verdict

The investigation of GlaxoSmithKline’s corruption scandal ended last Friday with China fining the British drug maker nearly $500 million. The verdict revealed three important messages that multinational pharmaceuticals do not want to miss.

First, the cost of relying on giving bribes and other illicit tactics to increase product sales in China can be quite high.  It is an open secret that multinational pharmaceuticals operating in China are caught in an inherent dilemma. Under the pressure of fierce competition, big pharma may be left with no choice but to bribe government officials, hospital administrators, and doctors in order to boost sales and expand market share.  But doing this would violate not only the company’s governance and compliance procedures, but also, more troublingly, the laws of its home and host countries. As a middle-ground alternative, many choose the indirect, seemingly legal means of funneling money to third parties (e.g., travel agencies) who can then pay bribes to doctors and regulators in China.  Excessive use of this approach by its local executives made Glaxo the lightning rod for China’s massive government anti-corruption campaign. The fine (three billion yuan, or nearly $500 million), allegedly the exact amount that the firm paid as bribes, was the biggest fine ever imposed by a Chinese court. Indeed, based on the Chinese courts’ previous verdicts in similar cases, a European investment bank predicted that Glaxo would only pay a $5-10 million fine.

Furthermore, the scandal has caused a serious setback for Glaxo’s market expansion strategy in China. As the government probe continued, competitors grabbed its market share. Glaxo’s  product sales in China slumped earlier this year, resulting in a 25 percent decline from the previous year.  In addition, since Glaxo has admitted to its wrongdoing in China, its overseas practices face investigations by U.S. and British authorities, which potentially will lead to further stiffer penalties. Glaxo has already been slapped with hefty fines in the United States—in 2012, it paid $3 billion for fraud settlement.

Second, in a country where rule of law is still good only in theory, multinationals too can be victims of the capricious and arbitrary Chinese politics. Glaxo’s bribery practices, while serious, would not automatically trigger the high-profile government investigations. After all, Chinese pharmaceutical firms are more brazen than their multinational counterparts in using bribes and other illegal tactics for commercial gains. Also, despite the rise of economic nationalism, Chinese leaders, driven by development and stability considerations, still have incentives to attract and keep pharmaceutical-related foreign direct investment.

People close to the situation attributed the scandal to an internal control problem within GSK China. As reported by The Sunday Times last year, an anonymous email was sent to several Glaxo top executives, which not only made allegations about GSK China’s commercial bribery practice, but also included a sex tape of the company’s top China manager, which was shot in his bedroom without his knowledge. Viewing this as a serious security breach, the company authorized an investigation, which reportedly had focused on a well-connected businesswoman who previously headed GSK China’s department of government relations. But in a statement of apology issued last week by GSK, the company apologized for “the harm caused to individuals who were illegally investigated by GSKCI.” In a strange twist of events that underscores the murkiness and danger in the officialdom, the lead investigator was arrested by Chinese police and later sentenced to 2.5 years in prison for acquiring personal information about Chinese citizens. That, according to The Sunday Times, led to the beginning of a formal probe into Glaxo in July.

Third, Chinese healthcare reform is now in a critical juncture where almost all the low hanging fruits have been picked. It has been more than five years since China kicked off its “new” round of healthcare reform.  The reform led to increased state commitment to healthcare and expanded health insurance coverage.  But these efforts were not joined by significant measures to reform the public hospitals, which still provide 90 percent of healthcare services in China.  Chinese scholars have suggested that vested interests of public hospitals and health bureaucrats are to blame for the lack of progress on this front.  Premier Li Keqiang seemed to be keenly aware of the challenge when he said “stirring vested interests may be more difficult than stirring the soul”.  In absence of meaningful public hospital reform, hospital workers continue to follow the hidden rules to take bribes and illegal kickbacks from pharmaceutical companies. The cost of corruption (estimated 20-30 percent of the drug prices) has not only sustained the overreliance on drug sales for revenues in China’s healthcare sector, but also made it next to impossible to bring the healthcare cost under control.

The GSK corruption scandal, according to a Chinese scholar, provided an excellent opportunity for China to rectify its chaotic pharmaceutical market. While the government verdict serves as a warning to other pharmaceutical companies, it also signals the lack of further progress in China’s healthcare reform. The failure to kick off critical reform measures means that Chinese regulators have no other choice, but to rely on extraordinary measures to force big pharma to cooperate in the healthcare reform. It is noteworthy that GSK in its statement of apology promised to “establish itself as a model for reform in China’s healthcare industry” and “increase access to its products…through greater expansion of production and through price flexibility.”

One year ago, when the scandal came to light, I noted that big pharma’s go-go years in China were over.  The verdict last week further highlighted the risk of them doing business in China.  Successful operation in the country requires lower expectations and improved management, but it is equally important for top pharmaceutical executives to have the political acumen to swim with the political tide, not against it.