China's e-pharmacy eyes prescription drug for full-bloom growth

China's e-commerce giants are getting a hand in pharmaceuticals as the government directs prescription drug sales away from hospitals and into retail.

China's online pharmacy business has grown from virtually nothing five years ago to more than 7 billion yuan (1.1 billion U.S. dollars) in 2014, accounting for 3 percent of all retail sales of medicine in the country, Boston Consulting Group (BCG) said in a report Thursday.

But analysts say the boom in online medicine sales is only a preview of explosive growth to come, provided that authorities allow online pharmacies to sell prescription drugs. So far online pharmacy sales consist mostly of over-the-counter medicine, which contributes very little to margins.

One of the key themes in China's ongoing medical reform is to reduce hospital reliance on drug sales for revenue. Over the long term this will enable patients to choose between hospitals and retail pharmacies for prescription drug purchases.

Authorities also consider allowing prescription drugs to be sold online, giving e-commerce firms such as Alibaba and JD.com the opportunities to get involved in the lucrative prescription drug business.

"E-Pharmacy business is changing very quickly in China with new regulations and different competitors entering the space. Each one is trying to grab a piece of the business," said John Wong, a partner for BCG's pharmaceutical practice.

While regulations are ushering more prescription drug sales toward retail channels, including online pharmacies, the pace of that transition remains uncertain.

Such uncertainties have forced Alibaba to scrap last week a plan to inject its online pharmacy business into its health subsidiary. Its plan to operate in the country's medical tracking system also drew backlash from brick-and-mortar pharmacies.

Online pharmacies are working with hospitals and local governments on separate trial programs to allow patients to buy drugs online with a doctor's prescriptions.

Access to prescriptions is the key for online pharmacies to get into prescription drug sales. Some local trials have managed to extend medical insurance coverage to online medicine purchases, an important incentive for patients to buy online.

But analysts are cautiously optimistic about potential nationwide trials, given that China's social security system is still managed by fragmented jurisdictions, creating discrepancies in coverage policies across the country.

Another challenge, says another BCG partner Magen Xia, is for authorities to figure out a way to cap expenditure online. Under the current scheme, the cap for insurance coverage has been maintained by hospitals that prescribe these drugs.

Regulatory challenge aside, Xia said online pharmacy cannot thrive in the prescription drug sale business alone. Given the importance of access to doctor's prescription, retailers need to penetrate upstream.

"Pharmacies can't just limit themselves to selling drug online. They have to either extend to consultations and diagnosis or find upstream partners that can refer prescriptions to them," Xia said.

Unlike the United States where brick-and-mortar pharmacies like CVS and Walgreens holds dominance in retail prescription drug sales, the lack of nationwide pharmacy chains in China puts them in a much weaker position. This creates opportunity for e-commerce to consolidate the fragmented national market through online platforms. And once they gain access to prescription, they can ask local pharmacies to become a distribution channel for prescription drugs.

"China's online pharmacy will grow, but whether it grows faster or slower depends on regulation on the separation between drug prescribing and dispensing," Wong said.

"Right now hospital still wants money from drugs but as soon as the government says 'stop' you will see the industry rapidly, rapidly transform," Wong said.