GlaxoSmithKline in China: more pharma than good?

Will Hodges breaks down the GSK bribery scandal in China

It sucks to be a pharmaceutical company right now. In July 2013 GlaxoSmithKline, the UK's biggest drug manufacturer, was accused of bribery and corruption by the Chinese government following a long-running investigation into the firm's practices in China. The incident brought further scrutiny on the pharmaceutical industry, which has rarely been out of the headlines over the past few years.

The company, which reported revenues of £26 billion in 2012 and has 97,000 employees worldwide, is alleged to have paid out as much as Rmb3bn (£320m) in kickbacks to doctors, hospitals and government officials in return for prescribing the company's products. Chinese police claim to have elicited confessions from four senior Glaxo executives, one of whom confessed publically to wrongdoing on Chinese state television.

The race for riches

Even by emerging markets standards, China represents an extremely lucrative opportunity for Western pharmaceutical firms. Valued at £53 billion, China's drug industry is the third largest in the world, behind only the US and Japan, and has plenty of room to grow. The country's per capita spending on medical services remains far below Western levels and, at just £215 per person per year, is the second lowest within the leading group of emerging economies - Brazil, Russia, India, Mexico and Turkey. What's more, China's own pharmaceutical industry remains in the early stage of development, meaning foreign drugmakers account for the majority of medicines sold. To plug the gap, China relies heavily on pharmaceutical supplies from abroad, importing £6.5 billion worth of medicines in 2011.

Growing demand has created a happy hunting ground for western drug manufacturers. In the first quarter of 2013, five leading international drug companies - AstraZeneca, Merck & Co, Novo Nordisk, Sanofi and Daiichi Sankyo - all reported sales growth of more than 20% in the country, according to research firm Business Monitor International. With rewards such as these on offer drugmakers are likely to do whatever it takes to gain an edge, explains Jamie Davies, head of pharmaceutical research at the firm:

"Pharmaceutical companies will be reassessing their corporate practices in emerging markets. Nevertheless, instances of corrupt practices will still take place. It is deeply ingrained in the highly competitive industry", he says. "Glaxo's main concern now is to repair the damage done to its image in developing markets, which it will look to do primarily through corporate social responsibility initiatives."

The impact back home

Repairing its reputation will not come cheap, however. Glaxo's Chinese transgressions have already seen the company invest heavily in legal and other professional services to try and resolve the matter. Ropes & Gray - an international law firm with offices in the US, London and Asia - has been hired to carry out an independent investigation into the alleged corruption and will work alongside Beijing law firm Jun He. In addition, Glaxo has also recruited professional services firm EY to carry out an independent audit of the company's Chinese operations. The audit will examine the company's financial records and business transactions for any wrongdoings.

The financial repercussions of the Glaxo's Chinese operations look set to reverberate far beyond the Far East. With the investigation ongoing, Glaxo's standing with the financial community has come under scrutiny. Ratings agency Moody's downgraded its credit outlook for the company from 'stable' to 'negative' in the wake of the bribery scandal. While the company's first and second quarter 2013 financial results were good, analysts expect the scandal to exert pressure on the firm's bottom line in the second half of the year.

Glaxo's Chinese involvement has come at a price. Yet, given the potential spoils on offer, the short-term fall-out of the affair is unlikely to dissuade the company from continuing its foray into China, or any other developing economy for that matter. It clearly still pays to be a pharmaceutical company.