GlaxoSmithKline PLC CEO Andrew Witty was fairly mum about the company’s alleged bribery charges in China during the company’s earnings call July 24. The CEO held a call with media to discuss China specifically, ahead of the company’s normal call, presumably to fend off China questions in advance.

Not surprisingly, journalists and analysts grilled him throughout both events, with some asking if the turn of events called into question his leadership capability, and some asking if he would forego a bonus this year.

Witty stayed close to prepared talking points on the investigation, stressing, “From what we understand from the authorities, it appears that certain senior executives in the Chinese business have acted outside of our processes and our controls to both defraud the company and the Chinese health care system. To see these allegations made about people working for GSK is, as we have said, shameful. For me personally, they are deeply disappointing.”

China’s Ministry Of Public Security issued a statement on its website July 11 that said it had gathered sufficient evidence in a preliminary investigation against high-level executives at GSK China allegedly involved in commercial bribery and tax-related crimes in China.

According to the statement, the public security ministry recently investigated GSK facilities in Changsha, Shanghai and Zhengzhou. The ministry took “criminal compulsory measures” to arrest suspects. After an initial interrogation, the suspects confessed to the crimes, according to the ministry ([A#28130710009]).

“We support the efforts of the Chinese government to reform the medical sector, and we are open to looking at all ideas to improve affordability of and access to our medicines, including change in our own business model in China” - GSK CEO Andrew Witty

“To be crystal clear, we have zero tolerance for this kind of behavior,” Witty said during the call with media. “I can assure you that we are absolutely committed to rooting out corruption and we are absolutely committed to getting to the bottom of what has happened here.”

Witty said GSK has added resources to the investigation and is conducting an independent review. He said the company would “learn from this and make changes.”

When pressed about why he has not gone to China himself, Witty told reporters that GSK’s European and Emerging Markets Head Abbas Hussain is leading the company’s day-to-day response to Chinese authorities ([A#28130721005]).

“In the meantime,” he said, “let me say that we continue to be highly committed to China. We support the efforts of the Chinese government to reform the medical sector, and we are open to looking at all ideas to improve affordability of and access to our medicines, including change in our own business model in China. We have a long history and a very large footprint in China, and we continue to see the country as a key place for further investment. We also continue to believe that, in a country that is facing significant health care challenges and with critical needs in areas such as hepatitis B, respiratory disease and diabetes, GSK has many important medicines and vaccines that can potentially benefit the people of China.”

China At Inflection Point?

When asked what that change in its business model might entail, Witty said that China was at “an inflection point,” and noted that a tiered pricing approach might be an option. He said the company also would look at other “evolutions” to make sure it remains in step with China.

Witty may have been referring to the health care infrastructure in China in which most hospitals are run by the government, but funding is not enough to support hospital operations, and doctors are paid significantly less than Western peers. In response, hospitals and doctors have turned to prescription drug sales as a major source of income. Hospital pharmacies traditionally have charged a 15% markup, which encourages overprescribing of more expensive drugs, and kickbacks to doctors are often paid by distributors and pharmaceutical companies ([A#28130717019]).

Moreover, lowering prices in China actually can boost volume significantly and increase sales. That was certainly the case with Sanofi’s Plavix after the National Development and Reform Commission imposed mandatory price cuts earlier this year ([A#28130109007]).

The CEO also said the China investigation is focused on “a number of senior managers,” but that there were no allegations against Mark Reilly, SVP and GM China/HK Pharmaceuticals and Vaccines, and Steve Nechelput, VP Finance China/Hong Kong.

Regarding whistleblowers, Witty said the company encourages “people in the organization to speak up if they have concerns. We had a series of complaints earlier in the year and we investigated those fully, and those have been fairly widely reported in the press. We involved personnel from outside of China in those investigations as well as personnel from inside China in those investigations. We explored all of the various allegations and we were unable to find any evidence of systemic abuse or any evidence or material concern from those allegations.”

Witty is no stranger to Asia. The top GSK executive previously was based in Singapore and led the group’s Asia Pacific operations as its senior vice president before his accession to become the president of GSK Europe, and a member of the company executive leadership team in 2003.

Q2 2013 Group Turnover By Geographic Region
Region	Sales	Growth (constant currency)
U.S.	£2.15 billion	5%
Europe	£1.89 billion	-1%
Emerging markets, Asia Pacific (EMAP)	£1.74 billion	3%
Japan	£435 million	-3%
Other	£393 million	-3%
Source: GSK Q2 2013 press release

“As the leader of a major organization, my role is clearly to try to make sure that we build a culture and the values of the company which protect us from this kind of thing, and then also to have in place the right controls. It has been very clear to anybody who has watched or seen GSK over the last several years that that has been an absolute and unrelenting focus of this organization,” Witty said.

“However, just as we see in all large organizations – and, remember, we have over 100,000 employees – there is unfortunately a risk that individuals can sometimes do inappropriate things.”

Indeed, China has now overtaken the U.S. in terms of the number of pharma sales reps employed by MNCs. How to manage such a large sales team in a high-turnover environment with fast-rising costs and declining productivity is a major challenge for Big Pharma. The top 10 multinational companies increased their sales reps from 5,500 in 2005 to 25,000 in 2011, a more than four-fold increase.

In a recent report, McKinsey acknowledges that the current Big Pharma model in China, which relies on detailing to large hospitals where most prescriptions are written and dispensed, has been a success. The top 10 pharma MNCs added more than $7 billion in China sales in six years, reaching $9.7 billion in 2011, the consultancy said ([A#28121205007]).

Those sales have been fueled by a single-line sales force model, where each product often receives its own sales force, leading to a rapid expansion of sales teams in China. For example, Pfizer Inc., the largest pharma company in China, now employs more than 4,000 sales reps in China.

During the larger Q2 review with analysts, GSK said it does not plan on spinning out its Established Products Division. Witty said the company is reviewing its portfolio to choose the right solution for various blocks of businesses ([A#28130428005]).

“Most of the established products business is ex-U.S. and consists of many brands and many SKUs. They are looking at a variety of options that will maximize savings and improve operating margins – for example tender opportunities and streamlined manufacturing,” wrote Bernstein analyst Tim Anderson in a same-day note.

Emerging Markets Group Sales See 7% Growth

For the numbers, group sales grew 2% in Q2, with the U.S. pharma and vaccines business growing 5% and 7% in Emerging Markets and Asia Pacific (EMAP) for pharmaceuticals. EMs represented more than 25% of revenues. Vaccines sales declined 13%, reflecting the timing of vaccine tender shipments. Sales were flat in Europe during the quarter and Japan sales were down 5%, largely due to continued erosion of Paxil sales.

“GlaxoSmithKline reported 2Q core basic EPS of 26.3p (4% CER, 1% GBP) below our estimate of 27.2 but in-line with consensus,” Anderson wrote. “Revenues of £6,618M (2% CER, 2% GBP) were in-line [with] our figure of £6,619M but slightly above consensus of £6,597M.

“We rate GSK as Market-Perform. GSK fell out of favor in 2H 2012 due to it walking down numbers twice during the year, partly because of austerity and partly because of various one-offs, as well as weaker Advair/Seretide sales. This led to a “crisis in confidence” in GSK’s ability to deliver on margin expansion and a return to growth as it has previously guided for,” Anderson said.

In China, GSK was at No. 8 among Big Pharma in terms of sales at the end of 2012, and roughly at No. 13 among all pharma companies in China. It’s biggest selling drug in China is respiratory drug Seretide, with sales of RMB 831,425,034 ($135.44 million) at the end of 2012, according to IMS Health.

Seretide saw group total sales in Q2 of £1.35 billion, with £708 million coming from the U.S. (8% growth CER) £376 million coming from Europe (-1% growth CER) and £117 million coming from EMAP with 14% growth.

EMAP Pharmaceuticals and Vaccines turnover for Q2 grew 5% to £2.324 billion, with particular contributions from the Middle East/Africa and China. Pharmaceuticals sales grew 7%, led by antibacterial Augmentin, up 18% to £202 million, and Seretide up 11% to £223 million. Vaccines sales fell 5% to £472 million, largely reflecting the phasing of tender deliveries, particularly of Synflorix.

Japan Pharmaceuticals and Vaccines turnover fell 6% to £830 million, as a 4% growth in pharmaceutical sales was offset by the 80% decline in vaccine sales.

“As far as Japan is concerned, we've clearly seen a slowdown in the HPV marketplace and over the last year, we’ve seen a significant share decline for Cervarix,” Witty said during the analyst call. “I don’t think we're going to see anything very dramatically change in that scenario. Rotarix is a rotavirus and much more positive situation where we continue to hold very substantial share, despite new entrants. I think rotavirus is likely to develop into a continued positive story. I think on the HPV side, less so.

GSK CEO Andrew Witty Under Fire About China During Q2 Call

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