On 30 December 2018, China's State Administration for Market Regulation (SAMR) issued an infringement decision imposing a total fine of CNY 10.04 million on Hunan Er-Kang Medical Operation (Hunan Er-Kang) and Henan Jiushi Pharmaceutical (Henan Jiushi) for abusing their dominance in the supply of chlorpheniramine active pharmaceutical ingredients (API) in China. Hunan Er-Kang's illegal profits of CNY 2.39 million were also confiscated.

This decision highlights that companies without a significant market share in a concentrated market may still be considered collectively dominant, and therefore be prohibited from charging unfair prices under China's Anti-Monopoly Law (AML). It also provides important guidance on the approach that the SAMR adopts to decide if prices are unfairly set.

Relevant Market

The SAMR concluded that the relevant market was the market for the supply of chlorpheniramine API in China.

Drug makers require APIs as raw materials for their drugs, and chlorpheniramine is widely used as an API to produce more than 2,000 types of common cold and allergy drugs, including common medicines like rhinitis tablets (鼻炎片) and vitamin C tablets (维C银翘片). From a demand-sided perspective, strict Chinese drug regulations stipulate that chlorpheniramine cannot be substituted by any other API or other substances. From a supply-sided perspective, domestic producers of chlorpheniramine API are required to obtain manufacturing and other approvals, while foreign suppliers are required to have the necessary approvals before being allowed to import chlorpheniramine API into China. Further, the facilities for manufacturing chlorpheniramine API cannot be used to produce other APIs. Accordingly, the SAMR found that there was limited demand and supply sided substitutability for chlorpheniramine API, and concluded that chlorpheniramine API formed its own distinct product market.

The SAMR considered the relevant geographical market was China. Although there may be other suppliers of chlorpheniramine API outside China, the SAMR noted that strict regulatory requirements resulted in only one foreign supplier (India-based Supriya Lifescience) being qualified to import chlorpheniramine API into China. Accordingly, foreign suppliers did not present a significant competitive constraint, and the relevant geographical market was limited to China.

Dominance

Interestingly, the SAMR found Hunan Er-Kang and Henan Jiushi to be collectively dominant in the relevant market.

Hunan Er-Kang and Henan Jiushi were presumed to be dominant based on Article 19 of the AML, which contains a rebuttable presumption that two business operators with a combined share of two-thirds of the market are dominant (the Article 19 Dominance Presumption). Hunan Er-Kang and Henan Jiushi had a combined market share of 96.38 percent in 2017, and 88.55 percent market share from January to July 2018.

Apart from market shares, the SAMR also considered other market factors. In particular, it noted that the market for chlorpheniramine API was highly concentrated with only three active suppliers. Downstream manufacturers were highly dependent on, and unable to constrain the parties by exercising countervailing market power, as the downstream market had many market players and competition was intense. Barriers to entry were also high given the strict regulatory requirements and the need for drug manufacturers to obtain fresh approval for their drugs if they switched to other APIs. Hunan Er-Kang was also found to have had close ties with, and had a certain level of control over Henan Jiushi.

This case is a reminder that business operators may find themselves jointly dominant in a concentrated market, even if they might not individually have significant market shares. If the combined market shares of the top two or three market players are sufficiently large, dominance may still be found.

Having concluded that the parties were dominant, the SAMR proceeded to find that they had abused their dominance by engaging in unfair pricing, refusal to supply, and tying conduct.

Abuse – Unfair Pricing

Hunan Er-Kang was found to have violated Article 17(1) of the AML which prohibited selling goods at unfairly high prices, because while Hunan Er-Kang did not face any major changes to drug production and procurement costs, it sold chlorpheniramine API in July 2018 at a price of CNY 2,940 / kg, which was three to four times of the average cost to procure the same. Downstream drug manufacturers had to accept these prices as there were no alternatives and the parties controlled prices in the market.

It is instructive to note the method used by the SAMR to determine unfair pricing. In this case, it made reference to the costs incurred by the dominant entity, and decided that a mark-up of three to four times above cost was excessive. A slightly different approach was taken in the Second Pharma/Tianjin Handewei decision in July 2017, where the regulator determined unfair prices by comparing current prices with prices in the preceding year. Second Pharma was found to have increased its prices by 3.52 times, while Tianjin Handewei had increased prices by 19 times.

The methods used in Hunan Er-Kang/Henan Jiushi and Pharma/Tianjin Handewei are consistent with the approach in the Price Behaviour Guidelines on Operators of Active Pharmaceutical Ingredients and Drugs Prone to Shortages (Drug Pricing Behaviour Guidelines) published by the National Development and Reform Commission (NDRC), which indicates that unfairly high prices of drugs can be identified by either:1

  1. comparing it with the prices of the same type of drugs sold by other business operators;
  2. where the market is stable and where costs are not significantly affected, examining to see if price increases exceed the usual range (as was done in Hunan Er-Kang/Henan Jiushi);
  3. comparing to see if the increase in drug price is significantly higher than the increase in costs; or
  4. comparing the price difference in the same market over time, or comparing the price difference between different markets during the same period of time (as was done in Second Pharma/Tianjin Handewei).

The above approaches suggest that it may be easier for the SAMR to find unfair pricing abuses compared to regulators in some other jurisdictions. For example, while the Chinese approach allows for a focus on the difference between cost and prices as the sole basis for unfair pricing, the UK Competition Appeal Tribunal (CAT) recently indicated in Flynn Pharma v. Competition and Markets Authority that solely comparing costs and prices is insufficient to find unfair prices for certain drugs. To determine excessiveness, it would be important to also compare the prices to benchmark prices that would have existed in conditions of normal competition. In the EU and UK, apart from examining the difference between cost and price, the regulators and courts would generally also look at whether the prices were unfair (e.g. by comparing it to comparable products), and whether they had any reasonable relation to the economic value of the products in question.

As another example, while it was sufficient in Second Pharma/Tianjin Handewei for unfair prices to be based on a comparison of the price differences between the companies' current prices and historical prices, Flynn Pharma v. Competition and Markets Authority considered that such price comparison over time may not be sufficient by itself to serve as a test for unfair pricing. In particular, the CAT noted that many factors could influence the 'before' prices (e.g. regulatory price controls) which may not allow these prices to be used as suitable points of comparison.

Accordingly, it appears that the risk of infringing unfair pricing prohibitions in China is higher than in the UK and EU, as a lower bar is applied to determining what constitutes unfair pricing.

Abuse - Refusal to Supply

The parties were also found to have refused to supply chlorpheniramine API to downstream drug manufacturers on the false excuse that they had no stock. Alternatively, they had required drug manufacturers to pay excessive deposit amounts, increase the prices of the final drug products, and make commission payments. The SAMR found that the downstream drug suppliers had no way of accepting these additional conditions, and held that the imposition of these conditions constituted a refusal to supply chlorpheniramine API. This conduct tightened the supply of chlorpheniramine API in the market and raised prices, resulting in some downstream drug manufacturers having to cut production as they were unable to purchase chlorpheniramine API. The parties conduct therefore restricted competition in the market, and was in breach of Article 17(3) of the AML, which prohibits a dominant business operator from refusing to trade without a justified reason.

It is noteworthy that a refusal to supply was found even though the parties had no presence in the downstream market. Refusal to supply resulting in vertical foreclosure typically arises in situations where the dominant undertaking competes on the downstream market. The dominant undertaking would typically leverage on its market power in the upstream market to foreclose competitors and gain an unfair advantage downstream. In this case however, neither Hunan Er-Kang nor Henan Jiushi were identified as being active in the downstream market, and any competitor foreclosure from the refusal to supply would not have advantaged either of the parties in the downstream market.2

Abuse - Tying

The parties were also found to have engaged in abusive tying by requiring downstream purchasers of chlorpheniramine API to also purchase starch capsules (淀粉胶囊), medicinal cane sugar (药用蔗糖) and other medical supplements. The use of these medical supplements had no direct relation with the use of chlorpheniramine API, and purchasers typically bought them separately depending on their needs. The parties' tying conduct restricted purchasers' choices in the market, and also allowed the parties to extend their dominance in the chlorpheniramine API to the market for such medicinal supplements. The parties therefore breached Article 17(5) of the AML for imposing tying requirements without objective reasons.

Conclusion

While drug prices used to be price controlled in China, the NDRC has removed price controls on most drugs since mid-2015. However, drug prices are still subject to provisions of the AML and the Price Law, and the NDRC had also issued the Drug Pricing Behaviour Guidelines in November 2017.

The pharmaceutical sector continues to be actively monitored by the regulators. Apart from the unfair pricing cases mentioned above, there have been infringements involving cartel conduct, refusal to deal, and resale price maintenance. It is likely that such assertive enforcement will continue going forward.


1 See also Article 11 of NDRC's Provisions against Price Fixing (反价格垄断规定) (2010)

2 While uncommon for a refusal to supply leading to vertical foreclosure to be abusive where the dominant undertaking is not present in the downstream market, such a theory of harm is not unheard of, see e.g. Arriva the Shires Ltd v. London Luton Airport Operations Ltd [2014] EWHC 64 (Ch).

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