Man buys medicine with the help of a pharmacy sales person in Chongqing municipality, Southwest China, July 21, 2014. [Photo/IC]

BEIJING - China's e-commerce businesses are expanding into pharmaceuticals as the government directs prescription drug sales away from hospitals and into retail outlets.

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

The boom may be only a prelude to explosive growth to come, provided that authorities allow online pharmacies to sell prescription drugs. Thus far, sales consist mainly of over-the-counter medicine, with very slim margins.

One of the key themes of the ongoing reform of the medical system is to wean hospitals off the revenue that comes from drug sales, allowing patients to choose between hospitals and retail pharmacies. If online sales of prescription drugs are permitted, firms such as Alibaba and JD.com are sure to get involved.

"The e-pharmacy business is changing very quickly in China with new regulations and different competitors entering the space," said John Wong, a BCG partner, but whether that pace continues is far from certain.

Last week, Alibaba scrapped a plan to merge its online pharmacy business with its health subsidiary. Its plan to operate the country's medical tracking system also drew the wrath of brick-and-mortar pharmacies.

Access to prescriptions is the key. Online pharmacies are working with hospitals and local governments on trial programs to allow patients to buy drugs online with doctors' prescriptions. Some trials extend medical insurance to online purchases, an important incentive for patients to buy online. Analysts are cautiously optimistic, given that China's social security system is still a set of fragmented jurisdictions, creating discrepancies in policies across the country.

Another obstacle, according to BCG partner Magen Xia, is figuring out a way to cap expenditure online. Under the current scheme, the cap for insurance coverage has been maintained by the hospitals that prescribe the drugs.

Regulatory challenges aside, online pharmacies cannot live by the prescription drug business alone. They need to move upstream.

"Pharmacies can't limit themselves. 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 dominate retail prescription drug sales, a lack of nationwide pharmacy chains in China puts them in a much weaker position. This creates opportunity for e-commerce to consolidate the fragmented market and, once they gain access to prescriptions, they can ask local pharmacies to become distribution channels.

"Online pharmacies will grow, but how fast depends on regulations on separation between prescribing and dispensing," Wong said. "Right now hospitals still want the money from drugs but as soon as the government says 'stop' you will see the industry rapidly, rapidly transform."

In late March, the government of Zibo City in east China's Shandong Province became the latest to link e-pharmacies with government hospitals, tasking JD.com and Shandong Xinhua Pharmaceutical, a pharmacy listed on the Shenzhen Stock Exchange, to operate an out-of-hospital platform synchronized with in-hospital prescriptions. Hospitals were asked to share information with the platform allowing patients to purchase drugs easily.

Chinese patients traditionally purchase medicines where they seek treatment, and these hospitals are mostly state-owned and receive directions from local governments.

Enabling patients to purchase drugs elsewhere fits right into the current government agenda, but without in-depth knowledge of where, what and how much medicine is needed, e-pharmacies are unable to supply them efficiently.

By supplying data on hospital demand to market players, the pricing and delivery of medicine could be revolutionized, just like other goods and services widely marketed online.