Notes on a Scandal: Lessons from GlaxoSmithKline’s Chinese Challenge.
In January, an anonymous individual contacted U.K. pharmaceutical company GlaxoSmithKline’s senior executives to notify them of systemic abuses in the company’s Chinese operations. In mid-June, Chinese authorities officially accused Glaxo of bribing doctors to sell more of the company’s medicine. The company responded by launching an internal review, along with a promise to fully cooperate with the authorities. A month later, Chinese authorities had apprehended ten individuals in connection with the scandal, and GlaxoSmithKline International president Abbas Hossain admitted that “certain senior executives of GSK China [...] appear to have acted outside our processes and controls which breaches Chinese law.”
The story stands out for a few reasons. It’s an unsurprising illustration of how vulnerable China’s health system is to corruption. It is also an example of how serious the Xi administration appears to be about enforcing good corporate governance and fighting corruption, and of the risks for multinationals of expanding into China’s domestic market.
According to Chinese authorities, Glaxo is responsible for spending three billion CNY (about $500m USD) over the past three years on bribes to encourage doctors and hospital administrators to sell more Glaxo-made drugs to patients. Often, the incentives were funneled through travel agencies, who would send doctors on international trips and provide them with luxuries. Other times payments were made in cash, and at least one Glaxo employee allegedly entered doctors’ offices “to meet their sexual desires,” according to Xinhua, China’s state news service.
A crooked history
Three factors enabled the Glaxo scandal. Two of these are fairly specific to GlaxoSmithKline. First, the company has a history of greasing physician’s palms in order to raise sales. Despite being one of the world’s largest drug companies, Glaxo’s corporate reputation was sullied well before the most recent scandal. Last year, Glaxo was fined a record $3bn for bad practices in the United States, where the company offered psychiatrists incentives to prescribe the anti-depressant drug Paxil to children, despite the fact that at that time, Paxil was only approved for adult use by America’s Food and Drug Administration.
Second, the company’s profit goals in China were over-ambitious: one of Glaxo’s local Chinese sales representatives claimed that the company had set a goal of increasing sales in China by 30% over two years – a goal that may have been impossible to obtain without some backdoor dealings. The company invested in expanding its Chinese sales staff to over 4,000 employees, and saw profits rise an impressive 20% last year. While sales were increasing on paper, however, senior executives in the U.K. had little motivation to inquire too much into the activities of their Chinese employees and even if they had they may have been told that the issue was simply an example of the importance of guanxi, or the Chinese culture of personal connections, gifts, and favours that permeates the nation’s economy and politics. Often the line between business-as-usual and illegal backroom dealing can be ill-defined or seemingly nonexistent, especially between executives in Europe or America and their local Chinese managers.
Glaxo’s eventual fall made a mockery of the company’s own system of internal checks and balances. Mere days before Hossain’s admission of Glaxo’s guilt, the company claimed it had conducted its own investigation and “found no evidence of bribery or corruption of doctors.” The complete reversal shortly afterward was a moment of unprecedented humiliation, even for a company with a record of ignoring the law. That a multinational corporation could be so swiftly brought to its knees by the Chinese government is a stern and intentional warning from the Xi administration to those who would capitalize too readily on the often-chaotic conditions of China’s domestic markets.
China’s broken health system
The final factor in understanding why the Glaxo scandal happened is the vulnerability of China’s health system to bribery. Be it from large pharmaceutical companies or from individuals, the semi-private national health system relies on backdoor enticements and tainted money. Doctors and nurses simply aren’t paid enough, and hospitals are routinely underfunded. As a result, families of sick individuals often have to pay hongbao, or red gift envelopes full of cash, to ensure that their relatives receive adequate care.
Such conditions were ripe for abuse from GlaxoSmithKline’s opportunistic sales teams, who worked through many channels to encourage doctors to prescribe more Glaxo-brand drugs. For a well-trained but poorly paid Chinese doctor, an international trip, or a lump sum of cash were welcome lifestyle enhancements in return for the relatively low effort and risk of prescribing more Glaxo medicine.
A propaganda coup for the government
The decision of the Chinese government to act against Glaxo is likely motivated by a desire to make a strategic example of an international pharma company in China. A subsequent inquiry into other big pharma companies, including Roche and AstraZeneca, has led to the quiet cancellation of medical conferences in China. In particular, AZ was linked to the same Shanghai-based travel agency, and one of their employees taken into custody for questioning. It may be that rather than punishing the whole pack, the government has chosen to make an example of Glaxo as a warning to the others.
Both the state-run domestic press and international media organizations have followed the story of Glaxo’s wrongdoing with avid interest. The narrative has been almost entirely in favour of the Xi administration: a big international company is caught breaking the rules at the expense of China’s population.
Domestically, the new government polishes its image, both as an administration dedicated to improving the health care system, and as a defender of the Chinese people against avaricious foreigners. China’s population is ageing, and consuming growing amounts of Western medicines. The cost of pharmaceuticals seriously limits the access of average Chinese citizens to effective medical care, and breaking up GlaxoSmithKline’s scheme will deter other companies from doing similar things in the future, but will probably have little overall effect on the nation’s deficient health system.
Internationally, the narrative helps define Xi as a leader who is committed to fair, rules-based markets, reflected in a sternly worded Xinhua article that accused Glaxo of “disrupting market order.” It may damage investor confidence in the short term as Glaxo is put through the wringer for its kickback scheme, but it also may advertise the government’s commitment to make business in domestic markets more regulated and predictable.
At best, however, punishing Glaxo is a symbolic move. As some commentators have pointed out, the biggest corporate offenders in China are Chinese companies themselves. The “melamine-milk” scandal of 2008, when a toxic mineral in domestically produced baby milk poisoned hundreds of thousands of small children, stands out in recent memory as an example of China’s gross lack of responsible corporate governance. And while hospital administrators were jailed in a separate recent government inquiry into pharmaceutical kickbacks, the domestic suppliers of drugs involved appeared immune to punishment. But symbolic actions play an important role in China’s government, and hopefully the Xi administration will try to bring more of the domestic economy under the umbrella of consistent regulation.
A warning to multinationals
The Glaxo case illustrates the danger of reckless expansion in the Chinese domestic market. Even firms with better corporate reputations than GlaxoSmithKline should take heed: entering the Chinese market without watertight checks-and-balances and well-defined rules for dealing with guanxi and the local ‘cost of doing business’ may result in distasteful situations. As corruption specialist Peter J. Henning pointed out in the New York Times, the handling of white-collar crime in China is brutal compared to the kid-glove treatment that the U.K.’s Serious Fraud Office or the U.S. Justice Department uses in its investigations. Long periods of detainment or limited movement are routine, as a few of Glaxo’s American and British employees in China are now discovering. Companies who want to reap the rewards of expanding in China’s fertile domestic market would do well to take heed of Glaxo’s costly mistakes.