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Offshoring in the Pharmaceutical Industry

Mridula Pore, Yu Pu, Lakshman Pernenkil, and Charles L. Cooney

Department of Chemical Engineering

Massachusetts Institute of Technology

EXECUTIVE SUMMARY

A pharmaceutical company’s competitive advantage is based on its reliance on basic science to create and develop new products. Increasing costs along the pharmaceutical value chain and an industry-wide decline in R&D productivity has placed considerable pressure on the industry to explore options for improving performance by reducing cost, increasing research productivity, and extending market penetration. Among the options are tactics for operating beyond the boundaries of companies’ home countries for research, manufacturing, and sales.

A framework has been developed for investigating and assessing strategies associated with offshoring different segments of the value chain in the U.S. pharmaceutical industry. Cost, access to human capital, time to market, and market entry potential are the main drivers for offshoring. A large and expanding trained talent pool in India and China and growing infrastructure are enablers that attract multinational pharmaceutical companies to set up operations in these countries. Although government support, improvements in patent law, and growing capital markets in these countries will ultimately be the sustainers of the offshoring phenomenon in the pharmaceutical industry, the poor quality of talent, strict regulatory barriers, and cultural and economic barriers will have to be overcome for companies to maintain a competitive advantage via offshoring. The impact of offshoring on U.S. employment in the pharmaceutical industry is predicted to be minimal, and higher value-added services in the United States are expected to increase.

An interesting trend is the emergence of reverse offshoring. With the increasing success of manufacturing and research, Indian and Chinese firms are looking westward to acquire access to discovery in basic science and profitable markets by partnering or acquiring assets in the United States and Europe.

INTRODUCTION

Competitive advantage in the pharmaceutical industry first requires excellence in translating basic research and development (R&D) into new products, and then efficient manufacturing and distribution to high-margin markets in the United States, Western Europe, and Japan. Thus the traditional business model for multinational pharmaceutical companies (MNPCs) is R&D intensive, and the business is fully integrated to service key markets. R&D costs, as a percentage of sales, range from 15 to 17 percent, higher than for any other global industry. So-called “innovator” companies have invested in in-house R&D with the goal of developing a strong proprietary pipeline for new drugs. These companies, which are vertically integrated (Figure 1), are involved in everything from early-stage platform research, drug discovery, and regulatory development to the manufacturing, marketing, and distribution of their products.

In the last 10 years, MNPCs have been faced with a declining pipeline of new products, expiring patents, rising R&D costs, declining productivity, and pressure on drug pricing. From 2002 to 2004, only 58 new drugs received marketing approval from the FDA, a 47 percent drop from the peak of 110 new drugs in 1996 to 1998. In contrast, R&D spending rose from $2 billion in 1980 to $39 billion in 2006. Historically, only three out of 10 marketed drugs have produced revenues that matched or exceeded average



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offshoring in the Pharmaceutical industry mridula Pore, Yu Pu, Lakshman Pernenkil, and Charles L. Cooney Department of Chemical Engineering Massachusetts Institute of Technology eXeCUtiVe sUmmArY research, Indian and Chinese firms are looking westward to acquire access to discovery in basic science and profitable A pharmaceutical company’s competitive advantage is markets by partnering or acquiring assets in the United States based on its reliance on basic science to create and develop and Europe. new products. Increasing costs along the pharmaceutical value chain and an industry-wide decline in R&D produc- introDUCtion tivity has placed considerable pressure on the industry to explore options for improving performance by reducing cost, Competitive advantage in the pharmaceutical industry increasing research productivity, and extending market pen- first requires excellence in translating basic research and etration. Among the options are tactics for operating beyond development (R&D) into new products, and then efficient the boundaries of companies’ home countries for research, manufacturing and distribution to high-margin markets in manufacturing, and sales. the United States, Western Europe, and Japan. Thus the A framework has been developed for investigating and traditional business model for multinational pharmaceutical assessing strategies associated with offshoring different seg- companies (MNPCs) is R&D intensive, and the business is ments of the value chain in the U.S. pharmaceutical industry. fully integrated to service key markets. R&D costs, as a per- Cost, access to human capital, time to market, and market centage of sales, range from 15 to 17 percent, higher than for entry potential are the main drivers for offshoring. A large any other global industry. So-called “innovator” companies and expanding trained talent pool in India and China and have invested in in-house R&D with the goal of developing a growing infrastructure are enablers that attract multinational strong proprietary pipeline for new drugs. These companies, pharmaceutical companies to set up operations in these coun- which are vertically integrated (Figure 1), are involved in ev- tries. Although government support, improvements in patent erything from early-stage platform research, drug discovery, law, and growing capital markets in these countries will and regulatory development to the manufacturing, market- ultimately be the sustainers of the offshoring phenomenon in ing, and distribution of their products. the pharmaceutical industry, the poor quality of talent, strict In the last 10 years, MNPCs have been faced with a regulatory barriers, and cultural and economic barriers will declining pipeline of new products, expiring patents, rising have to be overcome for companies to maintain a competitive R&D costs, declining productivity, and pressure on drug advantage via offshoring. The impact of offshoring on U.S. pricing. From 2002 to 2004, only 58 new drugs received employment in the pharmaceutical industry is predicted to marketing approval from the FDA, a 47 percent drop from be minimal, and higher value-added services in the United the peak of 110 new drugs in 1996 to 1998. In contrast, States are expected to increase. R&D spending rose from $2 billion in 1980 to $39 billion An interesting trend is the emergence of reverse off- in 2006. Historically, only three out of 10 marketed drugs shoring. With the increasing success of manufacturing and have produced revenues that matched or exceeded average 103

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104 THE OFFSHORING OF ENGINEERING Target identification Discovery Lead discovery Preclinical - Lead optimization Development Development Phase I Clinical Trials Phase II Active ingredient Phase III Manufacturing Manufacturing Final dosage Marketing & Distribution FIguRE 1 Value chain for innovator companies. R&D costs, and it has become increasingly difficult to de- product, plus R&D occupy 44 percent of the workforce (Fig- velop blockbuster drugs, such as Pfizer’s Lipitor, which was ure 2). Because these are the activities that require engineer- introduced almost a decade ago in 1997. At the same time, Cooney Figure 1 expertise, they are the areas of focus in this ing and science the patents of many drug products are expiring, opening the paper. Because the industry is highly integrated throughout market to competition from manufacturers of generic ver- the value chain, these activities include engineering, such as sions. The generic share of prescription drug units rose to chemical engineering, mechanical engineering, bioengineer- 72 percent in just 18 months after generic substitutes were ing, and materials science and engineering, as well as sci- approved. [1] These pressures have convinced companies ence, such as chemistry and biology. Furthermore, we are not to consider offshoring parts of the value chain as a tactic to aware of specific data that show the extent of involvement create competitive advantage. of each engineering and science discipline in pharmaceutical This paper focuses on U.S. and European pharmaceutical manufacturing and R&D. companies that engage in offshore activities. Biopharmaceu- tical companies only recently have begun to embrace the off- framework of Analysis shoring paradigm because of complexity in the technology, their small size, and the regulatory environment surrounding How and where a company chooses to operate its offshore their products. These factors are addressed further in later activities depends on company-specific factors as well as sections. location. Company-specific factors include the attitude of senior management and a company’s regional capabilities and growth strategy. Location-specific factors fall into four global employment in the Pharmaceutical sector categories: cost structure, business environment, workforce, Global employment in the pharmaceutical industry is and the local market. In our framework, we divide location- estimated to account for 1.7 million full-time equivalents specific factors into drivers, enablers, sustainers, and barriers (FTEs). The industry is dominated by the top 20 global to offshoring activities at different stages of the value chain MNPCs, which account for 59 percent of employment. The (Figure 3). We consider how these factors change over time United States, Europe, and Japan dominate the global phar- and their impact on the global pharmaceutical industry. maceutical industry, and the United States has the largest sin- The Merriam-Webster Dictionary defines offshoring gle workforce by region (41% of the global workforce). [2] as “The action or practice of moving or basing a business Using data from the McKinsey Global Institute [2], one operation abroad.” [7] The McKinsey Global Institute can see that manufacturing of the active pharmaceutical in- prefers the term “global resourcing,” which has a more spe- gredient (API), or drug substance, and final dosage, or drug cific definition: “Decision of a company to have a location-

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105 OFFSHORING IN THE PHARMACEUTICAL INDUSTRY FIguRE 2 Global pharmaceutical employment, by function. insensitive job performed in a demand market (market company offshoring some of its activities. The spectrum where the product is sold), in a border zone (near shore), image operating models by which a company may operate of fixed or remotely (offshore).” [2] We believe it is important to Figure 2 is presented in Figure 4. Cooney offshore explain the difference between offshoring and outsourc- ing. Outsourcing is defined as “procuring (as with some Choice of offshore Location goods or services needed by a business or organization) under contract with an outside supplier.” [8] International According to the AT Kearney Offshore Location Attrac- outsourcing is indeed one possible business model for a tiveness Index survey in 2004, India and China are currently FIguRE 3 Framework of analysis.

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106 THE OFFSHORING OF ENGINEERING Greenfield investment Foreign Direct Investment Increasing Mergers and acquisitions capital and Increasing human- dependence resource on third- Joint Ventures/ commitment. party Strategic Partnerships Increasing provider. “micro” risk Increasing —corporate IP risks, governance, potential Contract Services safety, etc. competition. (International Increasing IP Outsourcing) control. FIguRE 4 Offshoring business models. Cooney Figure 4 offshoring in PhArmACeUtiCAL the two most popular offshoring locations for a broad range reseArCh AnD DeVeLoPment of industry sectors because of their cost advantages and their depth and breadth of offshoring experience and people Overall, offshoring of R&D in pharmaceuticals is not very skills. [3] Malaysia, Singapore, and the Philippines also rank common but has been growing at a rapid pace in recent years. in the top 10, confirming the strength of Asian economies Outsourcing of drug-discovery services, such as chemistry, in offshoring competition. China and India are also ranked first and second in both the AT Kearney FDI Attractiveness Index and the Country Attractiveness Index for Clinical TABLE 1 The Top Multinational and Domestic Trials. [4] Both countries have hosted offshoring activity in Pharmaceutical Companies by Market Share in China and manufacturing and R&D in the pharmaceutical sector for India [5, 6] several years, and this sector is still evolving and growing China India and is expected to have a considerable impact on the global Multinational Pfizer Inc. GlaxoSmithKline industry. For these reasons, we focus mainly on offshore Companies AstraZeneca plc Pharma Ltd. activities in these two countries. Roche AG Pfizer Inc. Both China and India are net exporters of drug products. Novartis AG Sanofi-Aventis Indian exports of pharmaceuticals have been growing at a GSK plc Abbott compound annual growth rate of 17 percent. China’s exports Bayer AG Novartis AG Wyeth are growing at a rate of 25 percent, to $5.7 billion in 2005. [5] Merck As these economies develop, their domestic markets are also Astra Zeneca plc growing, involving both multinational and domestic compa- Janssen-Cilag nies. The largest players in each market are summarized in Infar India Table 1. Domestic Shanghai Pharmaceutical Ranbaxy Laboratories The exports are almost exclusively generic products, Companies Group Co. Ltd. Cipla Ltd and the market is becoming increasingly competitive. As a Guangzhou Pharmaceutical Dr Reddy’s Laboratories consequence, only firms that can meet demanding pressures Holdings Ltd. Ltd. Tianjin Pharmaceuticals Wockhardt Ltd. on manufacturing cost can compete, and margin pressure Group Corp. Nicholas Piramal India continues to erode profits. An important competitive at- Yangtze River Pharmaceutical Ltd. tribute of these firms is their ability to continually improve Group Sun Pharmaceuticals manufacturing to reduce costs. Harbin Pharmaceutical Group India Ltd. In the next two sections, we consider motivations for Co. Ltd. Lupin Ltd. Shijiahzhuang Pharmaceutical Aurobindo Pharma Ltd. offshoring in the context of drivers, enablers, sustainers, Group Co. Ltd. Cadila Healthcare Ltd. and barriers associated with both China and India for R&D North China Pharmaceutical and manufacturing. Following this assessment, we address Group Corp. the impact of offshoring by U.S. companies to China and Beijing Double-Crane India and the effects on the U.S. pharmaceutical industry of Pharmaceutical Co. Ltd. Northeast Pharmaceutical a growing and increasingly aggressive domestic industry in Group Co. Ltd. India.

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107 OFFSHORING IN THE PHARMACEUTICAL INDUSTRY offshore research and Development in China biology, screening, and lead-optimization, accounted for $4.1 billion in 2005, and is expected to approach $7.2 bil- Traditionally, foreign firms have shied away from invest- lion by 2009. [1] Starting with comparatively high-volume, ing in R&D in China because of the widespread prevalence low-value work, offshoring related to drug discovery has there of generic brands and counterfeit drugs, inadequate IP moved up the value chain to services ranging from preclini- protection, and Chinese consumers’ inability and unwilling- cal chemistry to large clinical trials. Companies in India and ness to pay for expensive medicines. Even today, according China provide manually intensive but highly skilled out- to a recent report from Ernst & Young, only about 20 percent sourcing services that include nucleotide sequencing and of the world’s leading pharmaceutical companies have plans synthesis, protein expression, and library construction. A few to invest in R&D in China. [10] According to Kalorama In- firms even provide chemical services in molecular biology formation, global pharmaceutical firms will outsource about and bioinformatics. In places with an established hospital $3.5 billion in research in 2006, but less than 5 percent of infrastructure and support activities such as India, clinical that is earmarked for China. [11] trails with good supporting analytical work are becoming China’s current pharma R&D environment (Figure 5) is increasingly common, not only because of cost, but also reasonably advanced in clinical trials and lower complexity because of access to skilled workers, treatment-naïve, and chemistry but less so in preclinical and biology-based drug well stratified patient populations and the prospect of reduc- discovery. [9] Although MNPCs have been cautious about ing development time. FIguRE 5 China’s current environment for pharmaceutical R&D. Reprinted with permission of ©The Boston Consulting Group. All rights reserved. [9]

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108 THE OFFSHORING OF ENGINEERING offshoring R&D to China, the scope and scale of these activi- Other large MNPCs, such as Servier, Novartis, and ties have risen. Today, almost all of the top 20 MNPCs are Sanofi-Aventis, are also planning to support research in doing some form of chemistry-based work in China. Prior China on compounds from traditional Chinese medicines as to 2001, 40 percent of Chinese medical enterprises had co- a basis for drug discovery. Novartis has announced its inten- operative projects with foreign firms. [12] tion to make captive research investments (i.e., establish its A few leading MNPCs have built their own R&D centers own facilities) in China. in China. Novo Nordisk, the first MNPC to establish its own R&D center in China, set up a $10 million center in 1997 to offshore research and Development in india conduct research in industrial biology and pharmaceuticals focused on natural products. After spinning off its industrial- A 2004 survey of 104 senior executives in a wide range enzymes divisions in 2000, the new Novo Nordisk desig- of industries, including eight pharmaceutical companies, nated China as its global center for competency in microbial ranked India among the top three countries where they protein expression. The company plans to double the staff planned to spend R&D dollars in the next three years. [65] in the next two to three years to 60 scientists and gradually With some of the top technical universities in Asia, a large transition from a highly skilled biotechnology provider to an community of entrepreneurs, Western-trained graduates, innovator in target identification for cancer and inflammatory resourceful managers, and researchers who are at ease with diseases. [9] the English language, India has a welcoming business envi- GlaxoSmithKline (GSK) has worked with Chinese ronment for global collaboration in R&D. [18] scientific and research groups on several occasions. At Global R&D companies, such as U.S.-based AMRI and the beginning of the 1990s, the company cooperated with Nektar, Switzerland-based Evolva, and Germany-based Ta- Shanghai Institute of Material Medica (SIMM) in evaluat- ros, have already opened research facilities there. In 2002, ing approximately 10,000 herbal medicines and undertook about 40 global trials were conducted in India, and in 2005, collaborative projects worth $7 million. Since the merger, the number rose to about 200. [18] Many leading MNPCs GlaxoSmithKline has invested more than $10 million in have invested in R&D work in India (Figure 6). For example, R&D projects in China. [13] Pfizer doubled its investment in clinical research in India to Roche invested more than $10 million in a new R&D roughly $13 million and plans to invest another $30 million center in Shanghai’s Zhangjiang High-Tech Park at the end in the next five years. [19] AstraZeneca made an early invest- of 2004. Currently, the center has 40 scientists working on ment in the late 1980s in a captive R&D center in Bangalore, basic chemical synthesis. The center plans to begin research where its new candidate drug molecule for tuberculosis in traditional Chinese medicine and is expected to gradually is under final development. In addition, the company has develop more comprehensive R&D capabilities. [9] forged a partnership with Torren Pharmaceuticals to work Twenty percent of Lilly’s chemistry work is being done on a drug for hypertension. [18] in China, where costs are one-quarter of what they are in the Novartis has entered an agreement with Syngene Inter- United States or Western Europe. Lilly helped start a labo- national, a biopharmaceutical company based in Bangalore, ratory, Chem-Explorer, in Shanghai in 2003. The start-up to carry out R&D to support new drug development. The company works exclusively for Lilly and has a staff of 230 research teams in Syngene, with skills in synthetic chemis- chemists, 20 to 25 percent of whom have Ph.D.s. In addition, try and molecular biology, also conduct high-value R&D in Lilly does about 50 percent of its clinical research outside early-stage drug discovery for other global clients. [20] the United States, mostly in Western Europe. However, it Compared with China, India has a relatively well devel- has been predicted that Lilly will do 20 to 30 percent of its oped R&D environment in clinical trials and basic chemistry, testing in China and India in the next few years. [14] in contrast to biology and preclinical work (Figure 7). [21] AstraZeneca was one of the first MNPCs to set up clinical However, China is more advanced in the field of proteomics trials in China in 2002. [15] In December 2003, the company and molecular biology for target identification, while India announced a $374,000 three-year partnership with Peking is better at clinical data management and lead optimization University’s Guanghua School of Management to fund work. [22] Thus different areas of the R&D value chain are programs at the China Centre for Pharmacoeconomics and being conducted in China and India, but neither country has Outcomes Research to support reform of China’s health care an environment that supports end-to-end R&D. system. [16] Pfizer, one of the largest foreign pharmaceutical enter- DriVers, enABLers, BArriers, AnD sUstAiners prises in China, has more than 1,500 employees in four for reseArCh AnD DeVeLoPment state-of-the-art plants throughout the country, as well as a management center and a trade company. Pfizer China Drivers located an R&D center in Shanghai, following the lead of AstraZeneca and Roche. Part of the Shanghai center’s stra- There are multiple complex reasons that MNPCs are off- tegic plan is R&D on biometrics, which would support the shoring R&D work to India and China. According to a study development of new drugs. [17] by Thursby of R&D intensive firms, the drivers for offshoring

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109 OFFSHORING IN THE PHARMACEUTICAL INDUSTRY FIguRE 6 R&D activities by MNPCs in India. © 2004, A.T. Kearney, Inc. Reprinted with permission. [19] Most common service offerings Less common service offerings Emerging service offerings Research–Biology Research–Chemistry Clinical development Preclinical Target Target Compound Lead development Screening Phases I–IV identification validation generation optimization Key Genetic research Functional Analog preparation Pharmacology Clinical management Compound Assay execution activities genomics synthesis • Building • Safety • Protocol design and Proteomics SAR evaluation blocks • Efficacy • Patient recruitment technologies Protein HTS and UHTS • Protein • Reference • Trial management and biochemistry expression and Medicinal compounds monitoring PKDM purification chemistry Assay • Bioanalysis Disease models • Central lab development • Protein structural Synthesis • In vitro ADME • Report writing analysis Cell-based • Focus library Genetically • In vivo ADME models for • Protein-to-protein • Combinatorial modified mice Data management efficacy interaction chemistry Toxicology • Clinical data Bioimaging • Natural management Chemoinformatics • General compound • Biostatistics • Reproductive extraction Bioinformatics • Genotoxicology Regulatory Drug design • Immunotoxicology Expression profiling • Drug registration • Computer • Carcinogenicity • Regulatory consulting aided Basic molecular- Animal model for • Structural biology technologies efficacy based • Gene sequencing • DNA and RNA Structural preparation chemistry • mRNA library • NMR • X-ray crystallography Analytical chemistry FIguRE 7 Various opportunities along the value chain. Reprinted with permission of ©The Boston Consulting Group. All rights re- served. [21] Cooney Figure 7.eps

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110 THE OFFSHORING OF ENGINEERING include low cost, market factors, the quality of R&D person- In addition, offshore R&D brings companies closer to nel, and collaboration with university scientists. [66] the demand and dynamics of the local market. In China, for example, the lifestyle is increasingly influenced by Western culture, leading to changes in the disease profile. As living Cost and Time standards rise, particularly in the cities, a number of formerly The cost of bringing a drug to market is more than $800 common diseases and conditions associated with poverty million and can take 8 to 12 years. Of every 5,000 drugs have been almost entirely eliminated. At the same time, tested, only about five reach the clinical trial stage, and only higher incomes, new diet patterns, less physical exercise, one is approved by the FDA. [23] This high “failure” ratio and more work-related stress, including a recent decline in adds significant risk to pharmaceutical R&D, forcing major job security, have combined to increase the incidence of dis- pharmaceutical companies to focus on fewer projects to eases new to China but common in Western countries, such address increasingly specific indications. Cost advantage is as diabetes, cardiovascular disease, and other stress-related one of the driving forces for offshoring of R&D. In general, disorders. [25] In addition, the aging population in China is direct cost savings can be as high as 60 percent, or even 80 growing as life expectancy increases annually, and the birth percent, on salaries in the drug-discovery phase, and 60 to rate is declining. People over 60 now account for 10 percent 70 percent per patient in clinical trials. [18] of the total population, and this number is expected to rise Biologists in China are paid 20 to 33 percent of what simi- to 30 percent within five decades. [25] By 2020, people 65 larly qualified biologists are paid in the United States. The or older will account for 16 percent of China’s population. average annual salary of a full-time employee with a Ph.D. These trends point toward a larger, more diversified in an MNPC in Shanghai is about $12,500, approximately market demand for drugs in the future. As per capita GDP one-fifth the salary in the United States. Because clinical tri- rises, purchasing power will also rise, enabling sales in the als account for 40 to 75 percent of drug-development costs, pharmaceutical market to increase by 6 to 8 percent annu- savings in this phase of R&D can be significant. ally. In addition, Western pharmaceuticals and diagnostics In India, clinical trials cost as little as 40 percent of are increasingly believed to be more effective than domestic those conducted in Western countries. [24] For example, in versions or traditional Chinese medicines. a clinical data-management center established by GSK in Bangalore, the combined salaries were barely one-third of A Large Talent Pool salaries for an equivalent center in the United States; GSK had an annual cost saving of $30,000 per employee. Staff of Finding qualified scientists, engineers, and physicians is the center has been expanded from four 10 years ago to 300 essential to offshoring R&D. China and India, which have today. large talent pools, make it possible for R&D work to be car- Along with the lower costs, drug development time is ried out at lower cost. However, there are still questions about much shorter. In low-cost countries, Phase III clinical trials quality, such as whether there are enough well qualified re- can be completed six to seven months faster than in domestic searchers to maintain or even improve the quality of research. markets because of faster patient enrollment and higher pa- In a study conducted by Gary Gereffi and Vivek Wadhwa at tient concentration. [18] For example, the German manufac- Duke University [69], the numbers of engineering bachelor’s turer Mucos Pharma asked SIRO Clinpharm in India to find degrees and associate degrees awarded annually by India 750 patients to test a drug for head and neck cancer. Within were reported to be 112,000 and 103,000, respectively. For 18 months, the company had recruited enough volunteers in China the numbers were 351,537 and 292,569, respectively, five hospitals. In Europe, it took twice as long to find just about 2.5 to 3.5 times higher than in the United States. In 100 volunteers in 22 hospitals. [24] addition, in China the number of doctorates in domestic Another advantage of offshoring R&D is multi-shift work science and engineering has increased rapidly. From 1975 across multiple time zones. For instance, scientists in the to 2005, China’s global share of science and engineering United States can focus on more complex processes while (S&E) doctorates increased from near zero to 11 percent; at offshore staffs perform the repetitive tasks. In this way, the same time, U.S. global share fell from half to roughly 22 MNPCs gain flexibility in their pipeline management. percent. [70] Another component of the talent pools in China and India is doctorates earned overseas. In 2001, the number of Chi- Market Potential nese S&E doctorates earned in Japan, United Kingdom, and MNPCs with offshore activities and investments in China United States equaled 72 percent of the total S&E doctorates and India often seek access to the domestic markets as part earned by American citizens and permanent residents. [70] of their global market strategy. (Market growth in both coun- From 1986 to 1998, of all S&E doctorates earned in U.S. tries is described later.) Offshore R&D allows companies to universities, Chinese students accounted for 8.4 percent build close relationships with local governments, research in biological and agricultural science and 9.1 percent in institutes, and hospitals that can help secure their positions engineering. [71] From 1993 to 2000, the total number of in the local market. engineering doctorates awarded in U.S. universities fell

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111 OFFSHORING IN THE PHARMACEUTICAL INDUSTRY slightly, from 2,228 to 2,206; however, doctoral awards in 16,000 hospitals provide a broad infrastructure for offshor- engineering to Chinese citizens increased 30 percent from ing clinical R&D. [27] Six laboratories in India have secured 543 to 711 in the same period. [72] GLP certification, and a dozen more are about to. In addition, In recent years, with the booming economies in China more than 20 CROs in India now handle Phase II through and India, more and more Chinese and Indian scientists and Phase IV trials. engineers, especially in high-tech fields such as biomedical studies, have chosen to leave the United States for home sustainers and have taken their technical skills with them. According to China’s Bureau of Education, since 1978, about 700,000 Government Support Chinese college graduates and scholars have gone abroad for advanced degrees, and about 170,000, or 24 percent, have According to the director of the Pharmaceutical Depart- returned. A high portion of the graduates earned degrees in ment, which is overseen by the State Economic and Trade chemistry and life sciences. Currently, 40 to 60 percent of Commission of China, the Chinese government encourages postdoctoral students in the United States are from China and foreign pharmaceutical companies to expand their businesses Taiwan. Within 10 years, there may well be a reverse brain from just manufacturing to include R&D. They promise drain in U.S. biotechnology. [9] that foreign-funded research centers will be exempt from The scientific disciplines most relevant to the pharma- import tariffs and custom taxes. In addition, companies that ceutical industry are chemistry and biology. Graduates in transfer technology to China will be exempt from business chemistry in both China and India outnumber their U.S. taxes. [28] counterparts by more than fivefold at the bachelor’s level and The list of key focus areas in the current Five-Year Plan more than threefold at the master’s level. [18] Even correct- includes biotechnology and innovative drug discovery. ing for variations in quality, these large numbers provide an Funding in some areas of biomedicine and biotechnol- impetus for moving higher value work offshore. ogy—most notably genetics—has increased rapidly in the past few years. [29] From 2000 to 2005, an average of $600 million in public funds went to China’s biotechnology sec- enablers tor. India’s Department of Biotechnology has funded more than 1,800 R&D projects, helped to develop 12 vaccines, and Resources transferred 54 technologies to the biotechnology industry, 17 Another important factor driving MNPCs to offshore of which have been commercialized. [18] their R&D work to China is that valuable resources might Many life-science parks, such as Shanghai Zhangjiang be discovered from traditional Chinese medicine (TCMs), Life Science Park, have been established to encourage for- 12,807 medicinal materials derived from natural sources, eign investment in the pharmaceutical and biological sectors. about 5,000 of which may have some proven clinical efficacy. These parks, which are focal points for the clustering of TCMs’ share of the global market in herbal medicines ($60 similar companies, offer MNPCs basic amenities and fiscal billion in 2002) is expected to rise to $5 trillion by 2050. [18] and regulatory incentives. A good example is the Beijing The expected advantages of TCMs for MNPCs is that they Economic and Technological Development Zone, in which may provide drug-discovery leads and diversify an MNPC’s both domestic and foreign companies are exempt from taxes pipeline. for two years after they start making profits. For the next In addition, both China and India offer access to the broad three years, they are taxed at half the normal rate. [30] By the human gene pool and patient population. Data on differ- end of 2005, there were 60 such parks in China and five fully ent populations is becoming increasingly important as the operational parks in India and 17 more at various stages of industry shifts from developing blockbuster drugs to drugs planning or construction. [18] These special economic zones targeted at patient populations with specific genetic poly- attract foreign direct investment (FDI) in knowledge- and morphisms. [26] The large patient pool (and large number of manufacturing-based businesses, and thus attract offshoring treatment-naïve patients) makes it easier and faster to enroll by foreign firms. patients in clinical trials. Improvements in Patent Protection Infrastructure Sustainable development of offshore pharmaceutical China has 185 bio-related institutes and research labora- R&D requires a well regulated business environment and a tories, 1.4 million doctors, more than 1 million nurses, and well established legal system to protect MNPCs from mis- 20 facilities with GLP (Good Laboratory Practices) certifica- appropriations and infringements of patents and from coun- tion. As many as 300 contract research organizations (CROs) terfeit drug makers. A new law in China, the New Medicine now offer support for clinical trials, which also provides Examining Statute, encourages innovation by controlling an infrastructure to support the offshoring of R&D work. prices and protecting intellectual property. First, it extends In India, half a million doctors, 171 medical colleges, and the protection period for new medicines, in some cases from

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11 THE OFFSHORING OF ENGINEERING eight years to 12 years. During the protected period, only li- skills will accelerate wage inflation and erode some of the censed companies can produce the drug in question. Second, cost advantages of offshoring. profit margins for new medicines can be higher than for other Another problem for MNPCs is that, although the poten- products, so manufacturers can recoup the costs of R&D tial supply of talent in low-wage countries is large and grow- more quickly. Third, the government is reducing bureaucratic ing rapidly, only a fraction of potential job candidates are red tape by contracting out the licensing of new medicines qualified to work for foreign companies. The reasons for the and production plants. All of these measures will stimulate lack of suitability are inadequate language skills, poor qual- investment, improve R&D, and cut the time-to-market for ity of education, and limited practical experience. Another new medicines. [31] problem is cultural differences, which are especially apparent In September 2003, the Chinese government also passed in interpersonal skills and attitudes toward teamwork and a regulation for implementing the Law on Drug Administra- flexible working hours. [1] tion. The regulation defines new drugs as “drugs that have According to Wadhwa and Gereffi’s survey results, not appeared in the domestic market,” a stricter standard than multinational and local technology companies in China the old rules that defined new drugs as “drugs produced in felt comfortable hiring graduates from only 10 to 15 elite China for the first time.” The new standard has unnerved universities across the country and complained that the sup- many domestic pharmaceutical research institutions, whose ply of these graduates was limited. [73] Interviews with 83 main products are imitations of sophisticated foreign drugs. human-resource managers in multinational companies reveal According to the old rules, these drugs could be patented as that, on average, only 17 percent of engineers and 14 percent new drugs only if foreign drug makers had not manufactured of researchers in the life sciences were suitable for hiring by the originals in China. [32] Although the trend appears to foreign companies. Among all candidates, only 10 percent be toward greater protection of IP, it will take some years in China and 25 percent in India would be suitable for off- for sufficient case law to establish how the government will shore R&D by MNPCs. As McKinsey reports, only 2.8 to actively protect the IP rights of foreign firms. 3.9 million—or 8 to 12 percent—of young professionals in low-wage countries are suitable for hire by export-oriented services companies, compared to 8.8 million in the sample Barriers of high-wage countries. [1] The scarcity of experienced and skilled middle-management-level workers for offshoring Regulatory Barriers companies is even more serious. Even though the business environments of China and In- In China, for cultural and historical reasons, students are dia have improved in recent years, some regulatory barriers not encouraged to think innovatively. However, innovative still impede MNPCs’ offshore R&D activities. For example, thinking is the quality that pharma R&D thrives on. The in India, new chemical entities discovered outside the coun- ratio of graduate students to professors in China can be as try must undergo initial Phase I trials outside the country; high as 20 to 1, compared with a 3-to-1 ratio in the United only then can a Phase I trial be conducted in India. [18] This States. Physicists, chemists, and engineers dominate the tal- delays the time-to-market for new drugs. ent pool in China. Although the output in applied biology In China, slow approval time (usually 9 to 12 months) has increased rapidly over the past decade, the percentage is a serious problem. The process of registering a drug and of biotechnology- and biology-related fields in China is obtaining production and sales permits involves numerous still modest. Furthermore, it is estimated that just half the central, provincial, and local authorities and can take several potential talent pool in China is geographically accessible years. [26] In India 3 to 4 months is the norm. to multinational companies. Supply of High-Quality Talent Protection of Intellectual Property The large pool of scientists and engineers in China and As discussed earlier, R&D work conducted in developing India is one of the attractions for offshore R&D. However, countries is fragmented and concentrated mostly in relatively with the rapid growth of offshore activities and competi- lower value-added areas of chemical synthesis and routine tion from the growing number of domestic companies, the analysis. MNPCs tend not to offshore their most proprietary demand for qualified engineers is increasing. For example, R&D activities because of uncertainties about the protection in India, the share of global clinical trials is expected to rise of intellectual property. [67] These same uncertainties may from the current level of 1.5 percent to 15 percent by 2011. encourage MNPCs to pursue only fragmented work offshore In addition, the number of global trials is increasing by 10 and not to work across the entire value chain. percent per year. At current training levels, India will turn out only one-tenth the required numbers of clinical research Venture-Capital Funding assistants. [18] Thus early movers in offshoring of clinical trials will have an advantage; later entrants will have to work Besides establishing fully owned subsidiaries in China and harder to find trained staff. In addition, this competition for India, MNPCs can offshore R&D work to CROs and through

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113 OFFSHORING IN THE PHARMACEUTICAL INDUSTRY partnerships with local firms. Establishing a high-technology stance. This is followed by secondary manufacturing, which company, such as a pharmaceutical research firm, is capital involves drug-product formulation; in this stage the drug is intensive, and there may not be a short path to profitability. produced in its final dosage form. The last stage involves For such firms to be established, funding sources and legal the filling, finishing, and packaging of drug products for and business infrastructure must be available. Therefore, the distribution to patients. These stages are often performed at current lack of established venture capital (VC) firms and different sites and may be broken down into further steps. For funds in China and India represents a barrier to offshoring example, in API manufacturing, it is common for chemical activity. intermediates to be supplied by one company to another. The The VC industry is at an early stage in both China and technical and regulatory requirements for the manufacturing India, where most funding has traditionally come from gov- facility depend on whether the drug is a chemical or a bio- ernment, financial institutions, and individuals. Currently, logical product. High-potency drugs and biologics typically most VC funding is from foreign firms, although domestic require more containment, hence more infrastructure and VC companies are emerging. As wealth accumulates in stricter maintenance procedures. The volume of the drug China and India, private-equity funding may play a larger depends on its potency and the frequency of dosing. Low- role. Government policy toward the regulation of finance and potency drugs that require frequent dosing are produced in investment will certainly influence the extent of domestic large volumes. High-potency drugs that are used sparingly and foreign investment. are produced in low volumes. Thus there is a continuum in In India, returning expatriates, particularly from Silicon the size and scale of manufacturing facilities. Valley, have encouraged the establishment of a regulated VC industry. [33] The Securities and Exchange Board of manufacturing of Active Pharmaceutical ingredients India (SEBI), which regulates the stock market, is now also responsible for regulating VC funds. The first regulations, Manufacturing of the API is frequently offshored by out- issued in 1996, offer tax benefits similar to those of U.S. sourcing to a third party. The primary motivation is cost ef- limited partnerships. There are currently 84 VC funds and ficiency. Because FDA approval is required for facilities and 54 foreign VC funds registered with SEBI, and many other processes in the United States or abroad that supply product funds are still unregistered. [34] Although the goal is to to the United States, the quality of the API is guaranteed. In promote an exit strategy, the mechanism by which venture China, the world’s largest producer of APIs, sales are ex- capitalists recoup their investments through an initial public pected to increase by 17.6 percent in the next few years, from offering (IPO), most investment exits are currently realized $4.4 billion in 2005 to $9.9 billion in 2010. In India, the third through mergers and acquisitions. The barriers to VC funding largest global manufacturer (after Italy), sales are expected in India include the reluctance of businesses to give up their to increase by 19.3 percent per year, from $2 billion in 2005 majority stake to an investor, the lack of fund-management to $4.8 billion by 2010, according to a study conducted by experience, and the lack of infrastructure to provide legal Italy’s Chemical Pharmaceutical Generic Association. [38] and business support. However, the presence of domestic APIs accounted for 60 percent of pharmaceutical exports stock exchanges, a history of domestically managed mutual from India in 2001. [39] funds, and a growing entrepreneurial spirit are contributing The APIs manufactured in offshore facilities are almost to confidence in VC investments. [33, 35] all generic, and thus off-patent products, the point at which In China, VC funding has been growing rapidly, from just cost savings on manufacturing provides a competitive ad- $418 million in 2002 to $1.27 billion in 2004 [36], and the vantage. Patent protection for these products has expired Chinese Venture Capital Association (CVCA) has become and non-infringing processes can be developed and used for an umbrella organization to promote the industry. [37] Exits manufacturing them, thus lowering IP concerns. The expan- from venture investing are predominantly in the form of IPOs sion of the generics market is expected to continue, both in on foreign exchanges; some are realized through mergers and absolute terms ($2 billion growth between 2000 and 2002) acquisitions. [36, 37] The main concerns about VC funding and as a percentage of contract manufacturing in India (ex- in China are the lack of a domestic exchange for IPOs, the pected to increase from 20 percent in 2000 to 62 percent in lack of experienced fund management and legal capability, 2010). [5] and, given the weak IP regime, the inability of companies to An interesting change may be in the wind, however. retain value from technology. Dishman Pharmaceuticals and Chemicals (Ahmedabad, Gujarat, India) recently announced that it is the first Indian firm selected by an MNPC as primary manufacturer of an offshoring in PhArmACeUtiCAL API for a brand new drug. [40] With this business model, the mAnUfACtUring innovator firm can leverage low-cost production before the Pharmaceutical manufacturing encompasses a variety of drug has generic status. Success will depend on protection process technologies on different scales. Primary manufac- of IP for the product and process. turing involves synthesis of the drug substance, also called Indian companies are becoming more sophisticated. the active pharmaceutical ingredient (API) or bulk drug sub- Companies that started as contract manufacturers for inter-

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114 THE OFFSHORING OF ENGINEERING manufacturing of Biologics mediates, and then APIs, are becoming vertically integrated and moving into drug-product formulation. This is possible Although both India and China have substantial and because of improvements in R&D skills, which have enabled growing biopharmaceutical industries, offshoring of bio- them to challenge patents and adopt an aggressive acquisi- pharmaceuticals manufacturing is still small by global tion, IP-based approach to expansion into regulated markets. standards because of the nature of these products and pro- For example, Ranbaxy USA has submitted more than 20 cesses, the lack of regulatory clarification, and the relative abbreviated new-drug applications (ANDAs) to the FDA immaturity of the industry. Patents on the first generation for review of generic products. The Ranbaxy group acquired of biopharmaceuticals are beginning to expire, but the FDA OHM Laboratories (USA) manufacturing facilities in 1995 has not yet issued clear guidelines for how bio-similar or and European generics, including Bayer AG, RPG (Aven- follow-on biologic products should be assessed for safety tis), Terapia SA, and Ethimed NV. [41] Nicholas Piramal and efficacy as generic-like substitutes. Such products can acquired Avecia and Pfizer’s manufacturing site in Morpeth, enter the marketplace but only after clinical trials have been U.K. [42] completed. The rise of the Indian pharmaceutical industry, with ex- Thus the concept of generics does not apply to biological pertise in reverse engineering and patent challenging, could products as it does to chemical drugs. Biological therapeu- have a significant impact on the global generics market. In tics cannot be as easily characterized by physico-chemical effect, these firms are practicing reverse offshoring by reach- methods or bioassays; hence their safety and efficacy depend ing back to U.S. and Western European firms for skills to fill more strongly on the manufacturing process. Thus it can be out the value chain. difficult to transfer a product to a different manufacturing Indian and Chinese companies are increasingly interact- site, which may require clinical evaluation. ing with each other to leverage their unique strengths. For However, the technology for characterizing biologicals example, India has emerged as a preferred trading partner is evolving rapidly. There is a continuum of molecular com- with China; India’s imports of pharmaceutical products from plexity in biologicals reflected in the molecular weight and China increased by 172 percent in 2004 to $303 million in extent of post-translational modification of the molecule 2005. China is also the leading pharma export market for during synthesis. Some smaller molecules, such as insulin, India. In 2005, imports from India were valued at $58 mil- which have been manufactured for a long time, are suf- lion. By contrast, U.S. drug product exports to China were ficiently well characterized that injectable insulin can be valued at $29.5 million. [43] manufactured by numerous companies. [44] The European Medicine Evaluation Agency has published guidelines, in- manufacturing of final-Dosage Products cluding comparison guidelines, for products manufactured at multiple sites. [45] However, the lack of clarification The growth in offshore secondary manufacturing appears by the FDA poses a barrier for companies interested in to be driven by a combination of both low-cost manufactur- producing bio-similar or outsourced products for the U.S. ing structures and the growth of domestic pharmaceuticals market. markets. Low-cost manufacturing in China and India enable companies to sell pharmaceuticals at prices affordable to DriVers, enABLers, BArriers, AnD the local population. Low-cost manufacturing also enables sUstAiners for offshore mAnUfACtUring penetration into other developing markets where the costs of pharmaceuticals are prohibitive, such as in Southeast Asia Drivers and Africa. Final-dosage manufacturing in India and China is done The primary drivers for offshore manufacturing are low- by a mix of third-party outsourcing and foreign direct in- cost operations and access to rapidly growing pharmaceutical vestment in manufacturing facilities run by Indian subsid- markets in India and China. If a company can manufacture iaries of MNPCs. The company websites of GSK, Pfizer, and produce at a cost low enough to be competitive in emerg- Wyeth, Aventis, and Abbott (five of the top six MNPCs by ing markets and still be in compliance with FDA require- domestic sales in India) [36] indicate that they have estab- ments, then that company can expect to be cost competitive lished manufacturing sites in India to cater to the Indian in regulated markets. In the future, as the efficiencies of market and for exports, mainly to Middle Eastern and Asian manufacturing processes by emerging Chinese and Indian markets. They also provide some external manufacturing companies improve, MNPCs will have more opportunities to services, including API manufacture, but the focus of these offshore their non-core manufacturing activities. In addition, operations is on secondary manufacturing. It stands to rea- as Indian and Chinese companies become more innovative, son that, if they can meet the tough cost demands for local competition to supply the global market will increase, driv- sales, they can also leverage higher margins on sales in the ing improvements in both cost and technology. regulated markets.

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115 OFFSHORING IN THE PHARMACEUTICAL INDUSTRY Low Cost Structure science and engineering of pharmaceuticals. This talent pool for MNPCs makes it possible for domestic companies to be Both India and China have lower capital, labor, and innovative in designing non-patent-infringing processes. raw-material costs than manufacturers in Western Europe There is also considerable manufacturing infrastructure al- or the United States. The largest savings (approximately ready in place, such as manufacturing plants and equipment 60 percent) for these companies is in labor costs. Total cost vendors to supply the industry. savings are estimated to be $10,000 per million tablets. [46] Arthur D. Little Benelux estimates annual per-person labor Consolidation and Standardization costs at $3,000 in India and $4,000 to $6,000 in China. The cost in Western Europe is well over $50,000. Outlays per Medium-sized industries in both China and India are con- installed cubic meter of reactor capacity are at least 40 per- solidating, and many smaller manufacturing units are closing cent lower than in the West and can be as much as 90 percent down. The top 20 companies in India increased their market lower. [42] share from 29 percent to 56 percent in 2004, reflecting this trend. [5] As a result of these consolidations, the remaining Growing Markets facilities are increasingly able to meet international oper- ating standards, which is likely to increase confidence in The value of Chinese and Indian pharmaceutical markets India as a global supplier. The Drug and Cosmetics Act of is considerably less than the value of the market in the United 1940 was modified to encourage the standardization of drug States. However, with an expanding, increasingly affluent manufacturing. [43] Many plants in India are also approved middle class willing to pay out of pocket for treatment, the by regulatory bodies, such as FDA, EMEA, MCA-UK, and markets in India and China are growing. Increased sales of TGA-Australia. In fact, India has the largest number of existing drugs at low prices and a wider range of new prod- FDA-approved facilities outside the United States. Ernst and ucts in the market are reflective of the growing number of Young predict that in the future Indian companies will fall people who can afford more therapies and are demanding into one of three categories: world-class treatment. Thus opportunities abound for phar- maceutical companies to expand their operations. • global companies that offer both generic and brand- India’s pharmaceutical market, which was estimated to be name drugs and co-promotion deals worth $4.5 billion to $4.9 billion in 2004, has grown steadily • medium-sized and large companies resulting from for the past 15 years. It is estimated that value will rise from the consolidation of equally sized small to medium $5.3 billion in 2005 to $16 billion in 2015. [18] companies In China, the pharmaceutical industry is one of the fast- • companies that have reduced their scope of operations est developing sectors, driven by the medical needs of the and specialize in a niche activity country’s 1.6 billion people. During the 9th Five-Year Plan (1996–2000), the average annual growth rate of the pharma- In China, the number of pharmaceutical manufacturers is ceutical industry was 17 percent. For comparison, the rate decreasing, but the productivity and scale of manufacturing is worldwide is 13 percent. Biotech-based pharmaceuticals in increasing. It is estimated that there are 3,000 GMP-certified China were worth about 20 billion RMB in 2002, or about 6 manufacturing facilities in China today. [43] percent of the total value of the pharmaceutical industry. This share is predicted to rise to 12 percent in 2006. [47] Estimates Skilled Workforce of the Chinese market vary widely. IMS estimates that the value was $11.7 billion in 2005 and will be the seventh larg- China and India have large and growing numbers of est in the world by 2009. [5] In a BCG report, it is estimated suitably trained graduates in engineering, life sciences, and that China will become the fifth largest drug market, with a pharmaceutical science. However, only a fraction of this value of $37 billion, by 2015. population is suited to working in international companies. Because both countries are large, part of the talent pool may enablers be inaccessible at the desired locations. A McKinsey report that provided data on the supply of engineers and life-science Experience and Existing Manufacturing Infrastructure researchers in China, India, and the United States for 2003 projected the compared annual growth rate for 2003–2009 Domestic chemical and pharmaceutical industries grew (Table 2). [1] rapidly in India following the passage of the 1970 patent law The pharmaceutical-science talent pool in India can be recognizing process patents but not composition-of-matter estimated based on the number of academic institutions. The patents. Similarly, in China companies have developed ex- All India Council for Technical Education has approved 445 pertise in the reverse engineering of drugs available in West- institutes with a combined annual intake of 24,670 students ern markets. As a result, there is now a large, experienced for the diploma or bachelor’s degree in pharmacy. In addi- workforce with considerable knowledge about the process

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116 THE OFFSHORING OF ENGINEERING TABLE 2 Supply of Engineers and Life-Science high-quality engineering students. In addition, the founda- Researchers in China, India, and the United States, 2003 tion of the National Institute for Pharmaceutical Education and Research (NIPER) was established in 1998 to produce Theoretical Maximum Life- graduates and research similar in quality to the standard in Talent Supply Science the pharmaceutical sciences. There is a demand for at least (in thousands) Engineers CAGR Researchers CAGR 10 more NIPER-like institutes. [51] China 1,589 (159) 6% 543 (54) 6% Another accelerating field is biotechnology. The De- India 528 (132) 6% 674 (101) 4% partment of Biotechnology (DBT), established in 1986, is United States 667 (538) 2% 852 (692) –2% responsible for developing a scientific and technical work- Note: Numbers in parentheses are workers suitable for recruitment. force. [52] The focus of NIPER and DBT is (1) to produce Source: Adapted from Das, 2006. [1] more graduates and improve standards and (2) to develop post-graduate education (see Table 3). High-quality workers will not only provide a workforce for MNPCs operating in tion, 132 institutes have been approved for students pursuing India, but will also enable the development of Indian com- master’s degrees in pharmacy; these institutions take in 2,680 panies that can compete on a global level. students annually. [48] Government Trade Policies Health Insurance The government of India is taking several steps to encour- The health-care systems in China and India are largely age the contract manufacturing of pharmaceuticals. Grants market based. In China, employer insurance is mandatory and incentives are offered in the following categories: in urban areas, although the value is capped and the law is not always implemented. Domestic private insurers have • domestic manufacturing for sale in a domestic tariff also emerged. Government primary health-care insurance area (DTA) exists in rural areas, but the coverage is inadequate to meet • domestic manufacturing/service unit for export of most people’s needs. Overall, only 29 percent of people in goods and services less than 100 percent (export ori- China have some form of health insurance, and out-of-pocket ented unit [EOU] or software technology parks of India expenses accounted for 58 percent of health-care spending [STPI] schemes) in 2002. [49] • manufacturing/service activity from a special duty-free In India, almost all expenditures for health care are out enclave (SEZ) of pocket. The easing of regulatory restrictions has allowed • investment in R&D the entry of some multinational insurers into the market. Although life insurance has been available for some time, The concept of a SEZ is modeled on earlier, highly suc- private health insurance schemes are just appearing. One cessful initiatives by the Chinese government to increase example is a Prudential-ICICI product that covers serious FDI. FDI restrictions have been eased so that FDI of up to procedures, such as heart-bypass surgery, organ transplants, 100 percent is now permitted for bulk drugs and their inter- and cancer treatment. [50] It is anticipated that increases in mediates and formulations (including bulk drugs produced private insurance will expand the market, particularly at the using recombinant DNA). [54] In addition, biotechnology high-value end. TABLE 3 Programs in India Supported by the sustainers Department of Biotechnology [53] Supportive policies in host countries are necessary to sus- Number of Annual Intake tain and develop offshoring manufacturing activities. These Universities of Students policies include (1) a commitment to education to ensure the General biotechnology 41 530 supply of high-quality workers and (2) lowering of barriers Agricultural biotechnology 9 110 to international trade to encourage companies to offshore and Medical biotechnology 1 10 to make long-term offshore operations profitable. Marine biotechnology 2 30 Neuroscience 3 25 Industrial biotechnology 1 10 Educational Infrastructure Masters In Technology Biotechnology 9 140 Masters in Veterinary Science 2 15 The Indian government is supporting the development of a Post MD (Doctor of Medicine)/Master of 2 9 growing number of international-class academic institutions Science Certificate Post-graduate diploma 4 56 to support growing industries. The Indian and National In- Totals 74 935 stitutes of Technology are already recognized for producing

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117 OFFSHORING IN THE PHARMACEUTICAL INDUSTRY parks are being set up across the country and the Small Busi- Membership in the World Trade Organization (WTO) ness Innovation Research Initiative (SBIRI) has been set up requires compliance with international intellectual-property to encourage public-private partnerships in the biotechnol- regimes. As soon as China joined the WTO in 2001, the Trade ogy sector. [55] Related Intellectual Property Agreement (TRIPS) went into The government has reduced the costs associated with force (India joined the WTO in 1995 but did not implement international trade to make offshoring more attractive TRIPS until January 2005). [58] Under China’s New Phar- to MNPCs. Exporters are allowed to import inputs on a maceutical Administration Law, which went into effect in duty-free basis for products that will be exported. In ad- December 2001, stronger measures are being taken against dition, excise duties on pharmaceutical products are being counterfeiters. In 2003, 994 manufacturers and distributors lowered. Currently, the excise duty is 16 percent, but since of counterfeit drugs were ordered to cease operations, and January 7, 2005, the excise duty has been levied on only 60 counterfeit drugs and facilities with an estimated market percent of the maximum retail price of the drug. There are value of $60 million were seized. [59] plans to reduce the excise duty from 16 percent to 8 per- However, both in China and India compliance with these cent. [54] laws is a concern. Past enforcement efforts have often been impeded by municipal and provincial authorities that profit from counterfeiting activities. Examples of high-profile Barriers failed patent disputes in China are Prozac (Eli Lilly, 1999); Insufficient protections of intellectual property and price Viagra (Pfizer, 2004); and Avandia (GSK, 2004). However, controls have deterred MNPCs from manufacturing and it is noteworthy that these patents were disputed by the distributing their products in China and India. In addition, manufacturers in a court of law, rather than simply copied, complicated and opaque bureaucracies can also be challeng- as had been done in the past. ing, particularly to new entrants. The quality of infrastructure for utilities, transportation, and communications is also poor Price Controls in some places, particularly away from major cities. The poor quality of infrastructure can pose risks to supply chains in a The price of drugs is controlled by the Chinese and Indian partnership-type offshoring model and may require signifi- governments for the purpose of making them affordable to the cant investment by an MNPC setting up in-house facilities. broad population. However, price controls have been found However, these barriers are not specific to pharmaceutical to delay the introduction of new products because they limit manufacturing and, therefore, are not addressed further profits and create large price disparities between markets, here. which increase the likelihood of arbitrage [68]. Although the number of drugs under price controls has been reduced (Table 4), it is unlikely that price controls will be abolished. Intellectual Property In fact, recommendations by the Indian prime minister’s task In the United States, it commonly costs $800 million and force on drug affordability may further reduce profits. For takes 10 years or more to launch a new drug. It is impossible example, the task force recommended the “de-branding” of for most Chinese drug makers to develop new pharmaceuti- drugs, so that only the manufacturer’s identification and the cal compounds, which cost hundreds of millions of dollars. generic drug name are displayed on packaging. [54] According to the president of Beijing Kevin King Manage- ment Consulting Company Ltd., “In a rather long period of Wage Inflation time, copying foreign drugs after their patent protection is over, or, for some drug makers, seeking legal loopholes in the Labor costs are a major source of cost advantage in patents of foreign drugs to legally produce generic medicines pharmaceutical manufacturing. Low costs are also the basis will be a major development strategy of Chinese drug mak- for competitive advantage for Indian and Chinese firms ers. This may lead to frequent legal disputes.” [56] competing in the global market. Currently, there are large Counterfeiting remains a problem for foreign firms differences in labor costs in the United States and Western in China. According to Chinese law, domestic firms can produce imitations of foreign drugs awaiting administra- tive protection from the State Drug Administration (SDA). TABLE 4 Number of Drugs under Price Controls in India While SDA reviews the application for protection, it makes since 1970 [54] information on the drug available to domestic companies to Year Number of Drugs ensure that the foreign drug is not similar to drugs already be- ing produced in China. In 2000, the China Daily newspaper 1970 Almost all bulk drugs and their formulations reported 50,000 cases of counterfeit or inferior pharmaceuti- 1979 347 bulk drugs 1987 142 bulk drugs cal products in China, which led to the closing down of 1,345 1995 74 bulk drugs factories. [57]

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118 THE OFFSHORING OF ENGINEERING Europe on the one hand and India and China on the other. remotely. Some occupations are more amenable to remote However, with increasing offshore activity, it is likely that employment than others. In the United States today, about 80 there will be wage inflation in the pharmaceutical manufac- percent of workers are employed in services, about 19 percent turing industry as there has been in other industries, such in manufacturing, and only 1 percent in farming. [62] The as business process offshoring and information technology, Bureau of Labor Statistics reports that employment in U.S. which will reduce the cost differential. According to the manufacturing has decreased by two million jobs in the past Culpepper Pay Trend Survey, the base salary increase for 20 years. Over the same period, manufacturing output has technical employees is about 3 to 4 percent in the United increased, meaning that factories have higher productivity States and 6.3 percent in China. India and the Philippines than before, leading to higher national income and a higher project salary increases of 9.2 percent and 11.2 percent, standard of living. Net employment increased by 43 million respectively, which are much higher than in most other jobs in other areas, such as educational and health services, countries. [60] These rates may increase further and thus professional and business services, trade and transportation, diminish the labor cost leverage. government, leisure and hospitality, and financial services (see Figures 8 and 9). [63] Does offshoring of R&D create the risk of a rapid loss Distribution of high-wage jobs and wage suppression? According to the The success of new entrants in the offshoring market McKinsey report, offshoring will have little effect on wage depends not only on their product range and marketing, but levels in developed countries, but local wage inflation will also on their ability to access customers. Both China and probably continue in some offshoring locations as long as India cover vast geographical areas and have large rural companies concentrate demand on a few cities. populations, which can pose challenges. More than 17,000 Over the past 30 years, the United States has experienced distributors were operating in China in 1997, channeling an 11 percent decline in manufacturing jobs, but wages have medicines to hospitals, retail pharmacies, and stores. In remained stable. By comparison, it is estimated that a total India, almost all pharmaceutical sales take place through a of 9 percent of jobs in services in the United States could complicated network of more than 6,000 wholesalers and theoretically be performed offshore. Assuming that half of more than 500,000 independent retailers. [5] these service jobs are actually relocated offshore in the next Foreign firms must use domestic distributors, but, be- 30 years, the resulting job turnover would be around 225,000 cause they are not exclusive agents, the distributors simply jobs per year, or 1 to 2 percent of the 16 million jobs created take orders for hospitals and retailers but do not promote every year in the U.S. economy. The theoretical maximum their products. The large number of intermediaries makes global resourcing of full-time employees in the pharmaceuti- launching products difficult and increases cost pressures. cal industry in 2003 was approximately 200,000, about 13 It also introduces multiple points for the entry of counter- percent of total employment in the industry. The actual off- feit drugs. shore employment in 2003 in low-wage countries was about Some uncertainties remain as to how China’s WTO obli- 10,000. The number is projected to double by 2008, to 21,000 gations will apply to drug distribution. Furthermore, because (see Figure 10). Thus offshoring in the pharmaceutical in- the Chinese government has been slow to reform its health dustry will have a small impact on overall employment. [1] care system, it may be difficult for foreign drugs to get on In research innovation and development, the United States the all-important reimbursement lists; thus they may not be remains the unchallenged leader. Today, almost one-third able to supply the largest Chinese buyer—the state hospital of science and engineering researchers in the world are system. [25] In China, about 85 percent of drugs are sold employed by U.S. firms. Thirty-five percent of the science in hospitals (mostly private); [49] the rest are sold through and engineering research papers are published in the United retail outlets. Because of consolidation in the retail distribu- States, and the United States accounts for 40 percent of tion chain, the top 100 drugstores owned 36,420 outlets in global expenditures for R&D. [74] In addition, in a survey 2005. [61] This will certainly facilitate penetration into the by Duke University of 58 U.S. companies that outsource domestic market. engineering jobs, 61 percent of the respondents said that U.S. engineering employees are equivalent or more productive than offshore engineering employees, and 78 percent said imPACt of offshoring U.S. engineering employees produced equivalent or higher quality work. [73] U.s. employment Although there may not be an imminent threat to Ameri- The slow, evolutionary changes in labor markets in de- can leadership in technology, the number of young profes- veloped economies will continue in response to continued sionals in emerging markets is growing by 5.5 percent annu- offshoring. [1] It is estimated that in 2008, 160 million jobs, ally, while growth in developed countries is only 1 percent. or about 11 percent of the projected 1.46 billion service jobs By 2008, the supply of suitable young engineers is expected in all sectors worldwide, could, in theory, be carried out to be nearly the same in developing and developed coun-

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119 OFFSHORING IN THE PHARMACEUTICAL INDUSTRY 1,000 Professional and business services 500 Information Financial activities Thousands of workers 0 –500 Manufacturing –1,000 –1,500 FIguRE 8 Net annual change in employment for selected sectors in the United States, 1991–2005. [64] Cooney firgure 8 We cannot change the plot lines without redrawing the figure, so we have superimposed new callouts for the lines and also new text on Y axis FIguRE 9 U.S. employment levels in professional and business services, 1996–2005. [64] Cooney Figure 9 tries. [1] The United States must ensure that its workforce is 1. U.S. companies captured more than three-quarters of trained to meet that demand. fixed image the benefits and gained as much as $1.14 in return. The rest of the benefits ($0.33) was captured by the receiving economy (e.g., India) in the form of wages U.s. industry paid to local workers, profits earned by local outsourc- The study by the McKinsey Global Institute shows that, ing providers and their suppliers, and taxes collected far from being a zero-sum game, offshoring is a game of from second- and third-tier suppliers to the outsourcing mutual economic gain. [63] The study found that every dollar firms. of corporate spending outsourced to a low-wage nation had 2. U.S. companies saved $0.58 because of cost advan- the following benefits for the United States: tages in offshore countries.

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10 THE OFFSHORING OF ENGINEERING regulated markets in the United States and Europe, a strategy 1,400 of “reverse offshoring” (see Table 5). As the Indian pharma- Thousands of FTEs in low-wage countries ceutical industry with expertise in reverse engineering and 1,200 2003 patent challenging grows, it could have a significant impact on the global generics market. 2008 (est) 1,000 Indian investor companies use revenue generated by ge- nerics manufacturing to build up their R&D capacity with 800 the goal of becoming innovator firms themselves. Because of the high level of expertise required to develop a new drug 600 and the associated high costs and risks, alliances with West- ern companies have become an effective tactic for develop- 400 ing this capability. This strategy can also be advantageous for MNPCs, because collaborative R&D is one way for 200 companies to diversify the risks in their product pipelines. As Table 6 shows, these alliances cover all stages of the 0 IT services Pharma Total pharmaceutical value chain. One striking example of reverse offshoring is Ranbaxy’s recent decision to license a product FIguRE 10 Offshore employment in IT, pharmaceuticals, and developed in house to the level of Phase I to an American overall analyzed for 2003 and 2008. Adapted from [1]. contract research organization, PDD, for preclinical and clinical development and commercialization. There are no fully integrated Indian or Chinese innova- tor pharmaceutical companies today, so MNPCs do not face 3. Corporate savings invested in new10 Cooney Figure business opportuni- direct competition in this area. However, this situation could ties boosted productivity and created new jobs. Direct change, as offshoring of non-core activities in manufacturing benefits to the United States from corporate savings, and R&D continues, enabling MNPCs to focus on product new exports, and repatriated profits totaled $0.67. development, marketing, and distribution, which may have 4. U.S. consumers benefited from goods and services at the effect of shrinking the workforce based in the United lower prices. States. As long as American and European markets are among the largest and most lucrative in the world, smaller In 2004, U.S. imports of services amounted to $296 bil- pharmaceutical firms or subsidiaries of MNPCs will be at- lion, and exports of services amounted to $343 billion, giving tractive investment targets for growing Indian firms seeking the United States a balance-of-trade surplus of $47 billion a foothold in regulated markets. Hence it is not clear if the in services. In manufacturing in 2005, the United States had net effect will be a decrease in U.S.-based activities, but the a deficit; the U.S. exported $807 billion and imported $1.47 costs of some drugs may fall. trillion. With more than 100 million U.S. workers now work- ing in the services sector, outsourcing is expected to increase fUtUre trenDs at an exponential rate in the next decade, constituting a larger share of the U.S. trade balance and giving the United States Offshoring is an increasingly hot topic that generates a comparative advantage in services. [62] This trend may be controversy about its impact on U.S. employment and the mirrored in the pharmaceutical industry. U.S. economy. Growing interest in offshoring is reflected in the increase in both research papers and articles in the press. Data, however, are often sparse and not well documented and reverse offshoring must be supplemented by anecdotal evidence. The quality of The offshoring of manufacturing has greatly enhanced these data is further compromised by the absence of standard the capabilities of the pharmaceutical industries in India definitions. This was a particular problem in this analysis of and China. Indian companies, in particular, are becoming the offshoring of pharmaceutical research and manufacturing increasingly sophisticated and expanding globally. Compa- because much of the data we found was highly aggregated or nies, such as Ranbaxy and Dr Reddy’s, that started in contract anecdotal. More specific statistical data on employment and manufacturing of intermediates, and then APIs, are becom- the demand for engineering positions broken down by aca- ing integrated by moving into final-dosage formulations and demic majors, degrees, and functions in the industry in both becoming highly skilled in R&D. This has enabled them to the United States and abroad will be necessary to produce a challenge patents in the United States and Europe and to clearer picture of how offshoring will impact the science and follow an aggressive path of acquisition. engineering workforce in the U.S. pharmaceutical industry. Thus many major Indian companies are pursuing acqui- Major European pharmaceutical companies, such as sitions of companies that manufacture generic products for Novartis and GSK, have shifted their R&D centers and

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11 OFFSHORING IN THE PHARMACEUTICAL INDUSTRY TABLE 5 Indian Acquisitions of U.S. and European Pharmaceutical Companies Acquirer Acquirer’s Expertise Target Date Target Activities Reference Reliance Life Biopharmaceuticals GeneMedix Ltd. (UK) 2007 Manufacture of biosimilars The Economic Times, Sciences February 8, 2007 Matrix API and dosage-form manufacturing DocPharma (Belgium) 2005 Manufacture of API and Indian Chapter for Democratic Laboratories dosage-form g Convergence, www.icfdc.com, accessed March 2007 Explora (Switzerland) 2005 API R&D The Hindu Business Line, September 20, 2005 Jubilant Organysys Products and services for global life- Target research (USA) 2005 Contract R&D www.jubl.net, October 2005 Ltd. science industry Malladi Generic API manufacturer Novus Fine Chemicals 2005 Generic API manufacturer PR Newswire, October 5, (USA) 2005 Dr Reddy's Development and manufacture of BMS Laboratories Ltd. 2002 Manufacture and marketing Pharmabiz.com, April 20, Laboratories generic and branded pharmaceuticals (UK) of generics 2006, www.drreddys.com, and bulk pharmaceutical ingredients accessed March 2007 Meridian Healthcare 2002 Marketing and distribution Pharmabiz.com, April 20, Ltd (UK) 2006, www.drreddys.com, accessed March 2007 Betapharma 2006 Generic drug manufacturer The Guardian, February 6, (Germany) 2006 Ranbaxy Research and international generic Terapia (Romania) 2006 Manufacture of generics www.terapia.ro, June 8, 2006 Laboratories manufacturing Allen Generics (GSK, 2006 Manufacture of generics www.ranbaxy.com, accessed Italy) March 2007 RPG (Aventis, France) 2003 Manufacture of generics Basics (Bayer, 2000 Manufacture of generics Germany) Ohm Laboratories 1995 Manufacture of generics (USA) Sun Pharmaceutical API and dosage-form manufacture Caraco Pharmaceutical 1996 Generic dosage www.sunpharma.com, Industries Ltd. Laboratories (USA) manufacturer accessed March 2007 Wockhardt Ltd. Pinewood Laboratories 2006 Manufacture of generics www.wockhardt.com, accessed Ltd. (Ireland) March 2007 Wallis (UK) 1998 Manufacture of generics CP pharmaceuticals 2003 Manufacture and marketing (UK) of generics Esparma (Germany) 2004 Manufacture and marketing of generics Dishman Contract and custom manufacture of Synprotec (UK) 2005 Specialty chemicals www.pharmaceutical- Pharmaceuticals APIs and intermediates technology.com, accessed March 2007 Nicholas Piramal Research and generic manufacturing Pfizer, Morpeth (UK) 2006 Finished-dosage packaging, www.nicholaspiramal.com, India Ltd. supply chain 2006 Aurobindo API and dosage form manufacture Milpharm (UK) 2006 Manufacture of generics www.aurobindo.com, accessed Pharmaceutical March 2007 Pharmacin 2006 Manufacture of generics The Times of India, December (Netherlands) 30, 2006

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1 THE OFFSHORING OF ENGINEERING TABLE 6 R&D Alliances between Indian and Western Pharmaceutical Companies U.S./European Expertise of Expertise of Announcement Party 1 Party 1 Indian Party 2 Party 2 Date Activities Reference Merck (USA) MNPC Advinus Therapeutics Drug 2006 Drug discovery www.merck.com accessed Ltd (Tata group) discovery and clinical March 2007, R.T. Badam, and contract development Associated Press Newswire, services November 16, 2006 Bristol Myers- MNPC Syngene International Research 2007 Research R. Guha, Market Watch by Squibb (USA) Private Ltd Dow Jones, March 14, 2007 (subsidiary of Biocon) PPD Inc (USA) CRO Ranbaxy Laboratories Research and 2007 License to PPD for PR Newswire Europe, Ltd. international development and February 27, 2007 generic commercialization, manufacturing including preclinical and clinical studies GlaxoSmithKline MNPC Ranbaxy Laboratories Research and 2003 R&D and PR Newswire U.S., (UK) Ltd. international (extended in commercialization February 6, 2007 generic 2007) manufacturing Eli Lilly (USA) MNPC Nicholas Piramal Research 2007 Clinical The Times of India, India Ltd. (NPIL) and generic development, January 14, 2007 manufacturing marketing Biovitrum Biopharmaceuticals Orchid Chemicals Custom 2006 Medicinal chemistry A. Krishnan, Global Insight (Sweden) manufacturing Daily Analysis, October 30, 2006 ClinTec (UK) Clinical research Dr Reddy's Research 2006 Clinical Business Standard, Laboratories and generic development and January 13, 2006 manufacturing commercialization Wyeth (USA) MNPC GVK Biosciences Contract 2006 Synthetic chemistry Express Pharma Pulse, research March 17, 2005 AstraZeneca MNPC Torrent Manufacturing 2005 Drug discovery Reuters News, (Sweden, UK) Pharmaceuticals Ltd. February 22, 2005 manufacturing facilities to the United States, which is an markets, trends in R&D productivity, etc. Identifying and interesting trend that is not addressed in this report. If this understanding these factors may be particularly important in trend continues, the basis on which offshoring estimates are assessing the impact of offshoring on the U.S. pharmaceuti- made will be altered. Further work is also necessary to clarify cal industry. the reasons for, and the impact of, the reverse offshoring phe- nomenon, that is, firms in India and China looking to acquire ConCLUsions operations in the United States and Western Europe. Special care must be taken in future studies when data The major leverage points for offshoring pharmaceutical from different sources are compared. For instance, China R&D are cost, time, and access to scientific and engineer- and India have different definitions of “engineering” that ing talent. An additional advantage in moving clinical trials may not be consistent with the definition used in the United offshore may be access to treatment-naïve patients. Not all States. [69] In addition, when assessing the competitive parts of the pharmaceutical value chain are being moved advantages of an engineering workforce, it is important to offshore at the same rate. Thus offshoring activities differ consider the quality, as well as the number of engineers. across the R&D value chain. We could find no examples Standards and criteria in different countries for qualified of an end-to-end offshore R&D model. Operating offshore engineers may vary with the specific job requirements. Thus provides MNPCs with access to innovative human resources, data on the engineering workforce must be specified by skills although the competition for skilled labor is increasing, and and functions. wages are rising above inflation. This report addresses location-specific factors related to Offshoring of pharmaceutical manufacturing provides offshoring that make them attractive destinations (the pull) MNPCs with cost advantages because of the reduced cost for offshoring for specific parts of the overall value chain. of goods sold, and tax leverage, especially if the offshoring The factors that drive a particular company (the push) to location includes a science and engineering zone. Offshoring consider outsourcing should be examined in detail. These also allows flexibility in capacity management. The focus of factors might include the high cost of operations in the offshoring so far has been on generic products, which mini- United States/Europe, the pressures of operating in regulated mizes intellectual property risk. Operating offshore provides

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