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Sales of pharmaceuticals in China are already the third highest in the world, and China is likely to become the world’s second largest drug market within the next year. Multinational pharmaceutical corporations cannot afford to underperform in China if they want to achieve global prominence. But as significant policy and market changes rock the basis of competition, incremental adjustments to the current commercial model will be insufficient to maintain a growth trajectory.

The Chinese government’s commitment to improved health care access is creating millions of new pharmaceutical customers. However, the government’s need to contain costs has increased pricing pressure on drugs, which now threatens the profits that multinational producers of “originator” drugs have long enjoyed. (Originator drugs are branded pharmaceutical products made by the company owning the initial patent for the underlying compound, after the patent’s expiration.)

Merely tweaking the existing commercial model will not be enough to manage the inevitable price decline. Without changing the current business model, Bain & Co. analysis shows a doomsday scenario in which the current existing originator model goes “un-economical” within five to seven years. (See exhibit.)

Success will require a fundamental reinvention of the commercial model. For multinational corporations (MNCs) to stay competitive with increasingly savvy local producers, they will need to introduce innovative products tailored to Chinese health needs, accompanied by continued expansion of established products to meet more basic demands. The best way to support this fit-for-local business will be to restructure the sales function, apply a more sophisticated approach to market access that involves stronger relationships with payors and patients, and promote a smarter use of digital technology. A strategically coherent and integrated commercial model can ease the pain of price reductions and protect the bottom line.

China's current health care system has created an addiction to drugs by Chinese hospitals and physicians. Until now, pharmaceutical sales have constituted 40% or more of the revenue - and almost all of the profit - of Chinese hospitals. The government policy has been to alter the incentive system with a zero percent drug markup policy in hospitals across the country by 2015, although the implementation of this policy has been uneven. Nevertheless, the commitment is firm, and the result has been a stripping away of the near-autonomous power of prescription from physicians, as well as a potential erosion of their income.

Since 2011, Zhejiang province, one of China's richest, has been implementing zero percent markup for hospitals within its jurisdiction, with Hangzhou City the final and most recent target of reform. The government plans to offset that loss of drug-related revenue by increasing the fiscal subsidy to hospitals and adjusting medical services charges, but it's not yet clear how that will unfold.

All of this is happening against the backdrop of an ethical compliance crisis that has the capacity to accelerate the changes. No longer can hospitals thrive primarily on drug revenues. No longer can physicians use drug sales to reinforce their income. And no longer can pharmaceutical companies engage physicians in the same way without incurring more stringent scrutiny.

As if all these systemic changes were not sufficient to raise business concerns, the disease burden in China, especially in non-communicable diseases such as diabetes, cancer, and heart disease, is growing significantly. Patients too often have to pay a major portion of medical costs, and as they learn more about the effectiveness of non-reimbursable drugs, they are likely to demand better access to them.

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Philip Leung is a partner with Bain & Co.’s Shanghai office and leads Bain’s Greater China Healthcare practice. Grace Shieh is a partner based in Bain’s Los Angeles and Shanghai offices. Ellon Xu is a principal based in Bain’s Shanghai office.