GSK Becomes Poster Child For Healthcare Clean-Up

Beijing regulators are making an example out of GlaxoSmithKline (GSK) （London: GSK) by accusing the British drug giant of massive bribery related to its aggressive sales tactics, spotlighting one of the major risks that foreign firms face when doing business in China.

While many of the allegations against GSK may well be true, the timing and high-profile nature of the probe against such a well-known and trusted western name look like a warning to all drug companies to stop this kind of behavior as China overhauls its healthcare system. Unfortunately for GSK, the company’s reputation and business in China will be severely damaged by the scandal. Many employees have already been fired since the scandal began, and some could even end up in jail for practices that are quite common not only in China but also in many western countries.

The GSK scandal comes as China is overhauling its healthcare system during the country’s transformation from a socialist to a market economy. As part of that shift, most of the state-owned hospitals and clinics where people used to receive care through their local work units have been closed. They have been replaced by a new generation of privately-run facilities that mostly earn their own money and receive far fewer subsidies than their older predecessors.

GSK and others have exploited the transformation by channeling money to underfunded hospitals and their underpaid doctors and other professionals. While most of these drug makers should be strongly censured for taking advantage of the situation, the current investigation and criminal charges seem a bit extreme, and unfairly single out GSK for practices that occur throughout the industry.

GSK first got into trouble in mid-July when it was named as one of a half dozen pharmaceutical firms being probed for selling its drugs at high prices. This initial investigation looked strange to me, as it didn’t accuse the companies of any particular crime such as anti-competitive behavior but simply targeted them for charging high prices.
Those firms were able to charge such higher prices for the simple reason that they enjoyed a better reputation than their local Chinese rivals, who are generally less trusted due to frequent quality problems. That’s how things work in a market economy: If you make a better product, consumers will trust you more and you can charge higher prices for your premium reputation.

The original drug scandal was only a week old when GSK landed at the center of the bigger scandal focused exclusively on the company. As that scandal unfolded, details emerged that GSK was being investigated for allegedly channeling up to 3 billion yuan ($480 million) through third parties like travel agencies since 2007 to bribe doctors and other healthcare professionals to buy and prescribe its drugs.

GSK’s global chief has called such practices “shameful” and the company has promised to cooperate in the investigation. But many of the practices at the heart of the GSK investigation are hardly unique to China. One of my good friends who is a doctor in the US expressed surprise at some of the allegations, informing me that this kind of hard-selling by pharmaceutical firms is quite common and considered normal in America.

Drug firms frequently invite doctors to dinners at expensive restaurants and take them on vacations to exotic locations where they attend lectures on the companies’ their latest medicines. These firms also hire attractive young men and women to sell their products, adding a sexual element to the hard sell. While no actual bribery occurs, the drug companies also pay handsome fees to western doctors to give lectures on and endorse their products.

Of course the goal in all of this is to get doctors to prescribe more of their drugs, helping to boost sales. Doctors in Taiwan and Hong Kong engage in similar practices, often selling unnecessary drugs to patients for simple ailments like a colds or sore throats. In those cases the doctors can actually profit directly from the drug sales, which are paid for by the patient’s insurer.

In the case with GSK in China, the company is being accused not only of lavishing doctors with gifts and vacations, but also of bribing them directly. But such bribery, while certainly unethical, is also a fact of life in China, and is so embedded in the business culture that companies that don’t participate put themselves at a major competitive disadvantage.
One friend recently told me about the son of a government official who brazenly called a businessman and demanded expensive gifts in exchange for his father’s assistance. In another case, a friend told me about a well-known Shanghai obstetrician who said she could get as much as 40,000 yuan in “gift money” for a single operation, helping her to earn hundreds of thousands of yuan in extra income each year.

Beijing leaders are finding themselves in a difficult position as they try to clean up this kind of rampant corruption, especially in transitioning sectors like healthcare where industry patterns and practices still are being established. Against that backdrop, big companies like GSK look like easy targets. That’s partly because they’re so well known and trusted by Chinese consumers, and also because they lack the government guanxi  that often help to shield local companies from such negative attacks.

GSK is hardly alone in the recent wave of negative publicity against high-profile multinationals. Foreign dairy product makers also came under recent attack for their high prices, and McDonalds (NYSE: MCD) and KFC (NYSE: YUM) were also the subject of a recent media investigation into high bacteria levels in their ice cubes.

GSK’s case is more extreme than most, since it involves allegations of criminal behavior and is likely to end with a court trial and jailing of former company employees. This kind of high-profile action seems designed to send a message to both domestic and foreign drug companies, telling them to stop this kind of behavior and to keep drug prices affordable.

But while the other firms will have a chance to quietly clean up their acts, GSK will inevitably suffer a long, drawn-out process of negative publicity as the case evolves and employees go on trial and are jailed for bribery. That process will result in damage to the company’s reputation that could take years to repair, costing GSK billions of dollars in lost sales.