HONG KONG – China has launched a two-invoice system for drug procurement as part of a change that underscores an ongoing reshuffle of the health care industry in the country. By limiting the number of invoices allowed in the drug distribution chain, the system aims to eliminate middlemen, avoid unnecessary invoicing that may facilitate corruption and increase transparency in drug pricing.

The State Council Healthcare Reform Office, the National Health and Family Planning Commission (NHFPC) and six other departments jointly promulgated the "Circular on Carrying Out the Two-Invoice System for Drug Procurement Among Public Medical Institutions (for Trial Implementation)" on Jan. 9.

As the name suggests, the system limits the number of invoice cycles between drugmakers and hospitals to a maximum of two. The first invoice facilitates sales from a manufacturer to a distributor and the second allows for sales from the distributor to the medical service provider.

By checking the two invoices, hospitals and other patient-facing health care providers will be able to verify that there is only one markup linked to any drug purchases. Authorities hope the approach will make drug prices more transparent and traceable.

"We are currently studying the issue of drug prices, which can be very different depending on the manufacturers and time. But I can assure you that for some drugs, the inflated prices were largely caused by issues in the [distribution] process, which was also emphasized in our reform plan. To cut prices and benefit the people is the future direction for us," said Liang Wannian, deputy head at the State Council Medical Reform Office.

Pharmaceutical manufacturers and distributors are facing many changes to their marketing methods and the handling of finance and taxation.

The two-invoice system was tested in several provinces and cities before a formal nationwide launch. Test pilots were carried out in Jiangsu, Anhui, Qinghai and Fujian provinces and in more than 200 cities.

The approach has already led to rapid destocking of inventory in distributors and drop in drug sales.

The system is also putting pressure on pharmaceutical companies, especially on companies that engage in indirect sales, such as Sihuan Pharmaceutical Holdings Group Ltd., CSPC Pharmaceutical Group Ltd. and Shanghai Fosun Pharmaceutical (Group) Co. Ltd.

Hong Kong-listed Sihuan noted in its 2016 interim report that "the aforementioned factors led to the group's first negative growth in history with revenue and profit decreasing by 21.8 percent and 49.3 percent year-on-year."

"Overall, regulations in health care sectors are much stricter. It might be short-term pain, but will upgrade the industry in the long term," Zhu Min, a partner at Han Kun Law Offices told BioWorld Today. Zhu likened the push to "cleansing toxins."

Industry observers say that local Chinese pharmaceutical manufacturers and distributors should think about how to avoid the risk of using falsified invoices to obtain tax deductions and how to allocate tax costs.

Currently in China, drugmakers sell their drugs at a relatively low price to distributors. The margin retained in the distribution channel is used to cover the promotion, marketing and sales-related services provided by the distributors.

Under this model, the drugs are sold through multiple distributors before being sold to the medical service provider at a much higher price.

"Due to the implementation of the new system, [this] model will be phased out as there will only be one distributor allowed in the value chain," noted a KPMG report.

The advisory service provider forecasts that the two-invoice system will be more popular in China. Manufacturers will sell their drugs at a higher price to one single distributor and the distributor will earn a limited margin for the distribution services provided. The promotion, marketing and sales-related services provided by a third party will be compensated via commission fees paid by the manufacturer.

"It is expected that more and more service providers will become specialised contract sales organisations," noted the report.

Small and medium drug distributors will therefore be gradually forced out of the market, and only provincial A-level distributors would survive.

Among the current 13,000 drug wholesalers in China, about 10,000 would be screened out, said Li Guoqing, head of the CFDA drug supervision department. The ideal situation is to have 3,000 such companies in the market.

According to the circular, the two-invoice system will be initially implemented in a further 11 comprehensive health care pilot reform provinces and 200 public medical institutions in as many cities and will be expanded nationwide in 2018.