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The Offshoring of Engineering: Facts, Unknowns, and Potential Implications 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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The Offshoring of Engineering: Facts, Unknowns, and Potential Implications FIGURE 1 Value chain for innovator companies. R&D costs, and it has become increasingly difficult to develop blockbuster drugs, such as Pfizer’s Lipitor, which was introduced almost a decade ago in 1997. At the same time, the patents of many drug products are expiring, opening the market to competition from manufacturers of generic versions. The generic share of prescription drug units rose to 72 percent in just 18 months after generic substitutes were approved.  These pressures have convinced companies to consider offshoring parts of the value chain as a tactic to create competitive advantage. This paper focuses on U.S. and European pharmaceutical companies that engage in offshore activities. Biopharmaceutical companies only recently have begun to embrace the offshoring paradigm because of complexity in the technology, their small size, and the regulatory environment surrounding their products. These factors are addressed further in later sections. Global Employment in the Pharmaceutical Sector Global employment in the pharmaceutical industry is estimated to account for 1.7 million full-time equivalents (FTEs). The industry is dominated by the top 20 global MNPCs, which account for 59 percent of employment. The United States, Europe, and Japan dominate the global pharmaceutical industry, and the United States has the largest single workforce by region (41% of the global workforce).  Using data from the McKinsey Global Institute , one can see that manufacturing of the active pharmaceutical ingredient (API), or drug substance, and final dosage, or drug product, plus R&D occupy 44 percent of the workforce (Figure 2). Because these are the activities that require engineering and science expertise, they are the areas of focus in this paper. Because the industry is highly integrated throughout the value chain, these activities include engineering, such as chemical engineering, mechanical engineering, bioengineering, and materials science and engineering, as well as science, such as chemistry and biology. Furthermore, we are not aware of specific data that show the extent of involvement of each engineering and science discipline in pharmaceutical manufacturing and R&D. Framework of Analysis How and where a company chooses to operate its offshore activities depends on company-specific factors as well as 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 categories: cost structure, business environment, workforce, and the local market. In our framework, we divide location-specific factors into drivers, enablers, sustainers, and barriers to offshoring activities at different stages of the value chain (Figure 3). We consider how these factors change over time and their impact on the global pharmaceutical industry. The Merriam-Webster Dictionary defines offshoring as “The action or practice of moving or basing a business operation abroad.”  The McKinsey Global Institute prefers the term “global resourcing,” which has a more specific definition: “Decision of a company to have a location-
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The Offshoring of Engineering: Facts, Unknowns, and Potential Implications FIGURE 2 Global pharmaceutical employment, by function. insensitive job performed in a demand market (market where the product is sold), in a border zone (near shore), or remotely (offshore).”  We believe it is important to explain the difference between offshoring and outsourcing. Outsourcing is defined as “procuring (as with some goods or services needed by a business or organization) under contract with an outside supplier.”  International outsourcing is indeed one possible business model for a company offshoring some of its activities. The spectrum of operating models by which a company may operate offshore is presented in Figure 4. Choice of Offshore Location According to the AT Kearney Offshore Location Attractiveness Index survey in 2004, India and China are currently FIGURE 3 Framework of analysis.
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The Offshoring of Engineering: Facts, Unknowns, and Potential Implications FIGURE 4 Offshoring business models. the two most popular offshoring locations for a broad range of industry sectors because of their cost advantages and their depth and breadth of offshoring experience and people skills.  Malaysia, Singapore, and the Philippines also rank in the top 10, confirming the strength of Asian economies 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 Trials.  Both countries have hosted offshoring activity in manufacturing and R&D in the pharmaceutical sector for several years, and this sector is still evolving and growing and is expected to have a considerable impact on the global industry. For these reasons, we focus mainly on offshore activities in these two countries. Both China and India are net exporters of drug products. Indian exports of pharmaceuticals have been growing at a compound annual growth rate of 17 percent. China’s exports are growing at a rate of 25 percent, to $5.7 billion in 2005.  As these economies develop, their domestic markets are also growing, involving both multinational and domestic companies. The largest players in each market are summarized in Table 1. The exports are almost exclusively generic products, and the market is becoming increasingly competitive. As a consequence, only firms that can meet demanding pressures on manufacturing cost can compete, and margin pressure continues to erode profits. An important competitive attribute of these firms is their ability to continually improve manufacturing to reduce costs. In the next two sections, we consider motivations for offshoring in the context of drivers, enablers, sustainers, and barriers associated with both China and India for R&D and manufacturing. Following this assessment, we address the impact of offshoring by U.S. companies to China and India and the effects on the U.S. pharmaceutical industry of a growing and increasingly aggressive domestic industry in India. OFFSHORING IN PHARMACEUTICAL RESEARCH AND DEVELOPMENT Overall, offshoring of R&D in pharmaceuticals is not very common but has been growing at a rapid pace in recent years. Outsourcing of drug-discovery services, such as chemistry, TABLE 1 The Top Multinational and Domestic Pharmaceutical Companies by Market Share in China and India [5, 6] China India Multinational Companies Pfizer Inc. AstraZeneca plc Roche AG Novartis AG GSK plc Bayer AG GlaxoSmithKline Pharma Ltd. Pfizer Inc. Sanofi-Aventis Abbott Novartis AG Wyeth Merck Astra Zeneca plc Janssen-Cilag Infar India Domestic Companies Shanghai Pharmaceutical Group Co. Ltd. Guangzhou Pharmaceutical Holdings Ltd. Tianjin Pharmaceuticals Group Corp. Yangtze River Pharmaceutical Group Harbin Pharmaceutical Group Co. Ltd. Shijiahzhuang Pharmaceutical Group Co. Ltd. North China Pharmaceutical Group Corp. Beijing Double-Crane Pharmaceutical Co. Ltd. Northeast Pharmaceutical Group Co. Ltd. Ranbaxy Laboratories Cipla Ltd Dr Reddy’s Laboratories Ltd. Wockhardt Ltd. Nicholas Piramal India Ltd. Sun Pharmaceuticals India Ltd. Lupin Ltd. Aurobindo Pharma Ltd. Cadila Healthcare Ltd.
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The Offshoring of Engineering: Facts, Unknowns, and Potential Implications biology, screening, and lead-optimization, accounted for $4.1 billion in 2005, and is expected to approach $7.2 billion by 2009.  Starting with comparatively high-volume, low-value work, offshoring related to drug discovery has moved up the value chain to services ranging from preclinical chemistry to large clinical trials. Companies in India and China provide manually intensive but highly skilled outsourcing services that include nucleotide sequencing and synthesis, protein expression, and library construction. A few firms even provide chemical services in molecular biology and bioinformatics. In places with an established hospital infrastructure and support activities such as India, clinical trails with good supporting analytical work are becoming increasingly common, not only because of cost, but also because of access to skilled workers, treatment-naïve, and well stratified patient populations and the prospect of reducing development time. Offshore Research and Development in China Traditionally, foreign firms have shied away from investing in R&D in China because of the widespread prevalence there of generic brands and counterfeit drugs, inadequate IP protection, and Chinese consumers’ inability and unwillingness to pay for expensive medicines. Even today, according to a recent report from Ernst & Young, only about 20 percent of the world’s leading pharmaceutical companies have plans to invest in R&D in China.  According to Kalorama Information, global pharmaceutical firms will outsource about $3.5 billion in research in 2006, but less than 5 percent of that is earmarked for China.  China’s current pharma R&D environment (Figure 5) is reasonably advanced in clinical trials and lower complexity chemistry but less so in preclinical and biology-based drug discovery.  Although MNPCs have been cautious about FIGURE 5 China’s current environment for pharmaceutical R&D. Reprinted with permission of ©The Boston Consulting Group. All rights reserved. 
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The Offshoring of Engineering: Facts, Unknowns, and Potential Implications offshoring R&D to China, the scope and scale of these activities have risen. Today, almost all of the top 20 MNPCs are doing some form of chemistry-based work in China. Prior to 2001, 40 percent of Chinese medical enterprises had cooperative projects with foreign firms.  A few leading MNPCs have built their own R&D centers 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 conduct research in industrial biology and pharmaceuticals focused on natural products. After spinning off its industrial-enzymes divisions in 2000, the new Novo Nordisk designated China as its global center for competency in microbial protein expression. The company plans to double the staff in the next two to three years to 60 scientists and gradually transition from a highly skilled biotechnology provider to an innovator in target identification for cancer and inflammatory diseases.  GlaxoSmithKline (GSK) has worked with Chinese scientific and research groups on several occasions. At the beginning of the 1990s, the company cooperated with Shanghai Institute of Material Medica (SIMM) in evaluating approximately 10,000 herbal medicines and undertook collaborative projects worth $7 million. Since the merger, GlaxoSmithKline has invested more than $10 million in R&D projects in China.  Roche invested more than $10 million in a new R&D center in Shanghai’s Zhangjiang High-Tech Park at the end of 2004. Currently, the center has 40 scientists working on basic chemical synthesis. The center plans to begin research in traditional Chinese medicine and is expected to gradually develop more comprehensive R&D capabilities.  Twenty percent of Lilly’s chemistry work is being done in China, where costs are one-quarter of what they are in the United States or Western Europe. Lilly helped start a laboratory, Chem-Explorer, in Shanghai in 2003. The start-up company works exclusively for Lilly and has a staff of 230 chemists, 20 to 25 percent of whom have Ph.D.s. In addition, Lilly does about 50 percent of its clinical research outside the United States, mostly in Western Europe. However, it has been predicted that Lilly will do 20 to 30 percent of its testing in China and India in the next few years.  AstraZeneca was one of the first MNPCs to set up clinical trials in China in 2002.  In December 2003, the company announced a $374,000 three-year partnership with Peking University’s Guanghua School of Management to fund programs at the China Centre for Pharmacoeconomics and Outcomes Research to support reform of China’s health care system.  Pfizer, one of the largest foreign pharmaceutical enterprises in China, has more than 1,500 employees in four state-of-the-art plants throughout the country, as well as a management center and a trade company. Pfizer China located an R&D center in Shanghai, following the lead of AstraZeneca and Roche. Part of the Shanghai center’s strategic plan is R&D on biometrics, which would support the development of new drugs.  Other large MNPCs, such as Servier, Novartis, and Sanofi-Aventis, are also planning to support research in China on compounds from traditional Chinese medicines as a basis for drug discovery. Novartis has announced its intention to make captive research investments (i.e., establish its own facilities) in China. Offshore Research and Development in India A 2004 survey of 104 senior executives in a wide range of industries, including eight pharmaceutical companies, ranked India among the top three countries where they planned to spend R&D dollars in the next three years.  With some of the top technical universities in Asia, a large community of entrepreneurs, Western-trained graduates, resourceful managers, and researchers who are at ease with the English language, India has a welcoming business environment for global collaboration in R&D.  Global R&D companies, such as U.S.-based AMRI and Nektar, Switzerland-based Evolva, and Germany-based Taros, have already opened research facilities there. In 2002, about 40 global trials were conducted in India, and in 2005, the number rose to about 200.  Many leading MNPCs have invested in R&D work in India (Figure 6). For example, Pfizer doubled its investment in clinical research in India to roughly $13 million and plans to invest another $30 million in the next five years.  AstraZeneca made an early investment in the late 1980s in a captive R&D center in Bangalore, where its new candidate drug molecule for tuberculosis is under final development. In addition, the company has forged a partnership with Torren Pharmaceuticals to work on a drug for hypertension.  Novartis has entered an agreement with Syngene International, a biopharmaceutical company based in Bangalore, to carry out R&D to support new drug development. The research teams in Syngene, with skills in synthetic chemistry and molecular biology, also conduct high-value R&D in early-stage drug discovery for other global clients.  Compared with China, India has a relatively well developed R&D environment in clinical trials and basic chemistry, in contrast to biology and preclinical work (Figure 7).  However, China is more advanced in the field of proteomics and molecular biology for target identification, while India is better at clinical data management and lead optimization work.  Thus different areas of the R&D value chain are being conducted in China and India, but neither country has an environment that supports end-to-end R&D. DRIVERS, ENABLERS, BARRIERS, AND SUSTAINERS FOR RESEARCH AND DEVELOPMENT Drivers There are multiple complex reasons that MNPCs are offshoring R&D work to India and China. According to a study by Thursby of R&D intensive firms, the drivers for offshoring
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The Offshoring of Engineering: Facts, Unknowns, and Potential Implications FIGURE 6 R&D activities by MNPCs in India. © 2004, A.T. Kearney, Inc. Reprinted with permission.  FIGURE 7 Various opportunities along the value chain. Reprinted with permission of ©The Boston Consulting Group. All rights reserved. 
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The Offshoring of Engineering: Facts, Unknowns, and Potential Implications include low cost, market factors, the quality of R&D personnel, and collaboration with university scientists.  Cost and Time The cost of bringing a drug to market is more than $800 million and can take 8 to 12 years. Of every 5,000 drugs tested, only about five reach the clinical trial stage, and only one is approved by the FDA.  This high “failure” ratio adds significant risk to pharmaceutical R&D, forcing major pharmaceutical companies to focus on fewer projects to address increasingly specific indications. Cost advantage is one of the driving forces for offshoring of R&D. In general, direct cost savings can be as high as 60 percent, or even 80 percent, on salaries in the drug-discovery phase, and 60 to 70 percent per patient in clinical trials.  Biologists in China are paid 20 to 33 percent of what similarly qualified biologists are paid in the United States. The average annual salary of a full-time employee with a Ph.D. in an MNPC in Shanghai is about $12,500, approximately one-fifth the salary in the United States. Because clinical trials account for 40 to 75 percent of drug-development costs, savings in this phase of R&D can be significant. In India, clinical trials cost as little as 40 percent of those conducted in Western countries.  For example, in a clinical data-management center established by GSK in Bangalore, the combined salaries were barely one-third of salaries for an equivalent center in the United States; GSK had an annual cost saving of $30,000 per employee. Staff of the center has been expanded from four 10 years ago to 300 today. Along with the lower costs, drug development time is much shorter. In low-cost countries, Phase III clinical trials can be completed six to seven months faster than in domestic markets because of faster patient enrollment and higher patient concentration.  For example, the German manufacturer Mucos Pharma asked SIRO Clinpharm in India to find 750 patients to test a drug for head and neck cancer. Within 18 months, the company had recruited enough volunteers in five hospitals. In Europe, it took twice as long to find just 100 volunteers in 22 hospitals.  Another advantage of offshoring R&D is multi-shift work across multiple time zones. For instance, scientists in the United States can focus on more complex processes while offshore staffs perform the repetitive tasks. In this way, MNPCs gain flexibility in their pipeline management. Market Potential MNPCs with offshore activities and investments in China and India often seek access to the domestic markets as part of their global market strategy. (Market growth in both countries is described later.) Offshore R&D allows companies to build close relationships with local governments, research institutes, and hospitals that can help secure their positions in the local market. In addition, offshore R&D brings companies closer to 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 standards rise, particularly in the cities, a number of formerly common diseases and conditions associated with poverty have been almost entirely eliminated. At the same time, higher incomes, new diet patterns, less physical exercise, and more work-related stress, including a recent decline in job security, have combined to increase the incidence of diseases new to China but common in Western countries, such as diabetes, cardiovascular disease, and other stress-related disorders.  In addition, the aging population in China is growing as life expectancy increases annually, and the birth rate is declining. People over 60 now account for 10 percent of the total population, and this number is expected to rise to 30 percent within five decades.  By 2020, people 65 or older will account for 16 percent of China’s population. These trends point toward a larger, more diversified market demand for drugs in the future. As per capita GDP rises, purchasing power will also rise, enabling sales in the pharmaceutical market to increase by 6 to 8 percent annually. In addition, Western pharmaceuticals and diagnostics are increasingly believed to be more effective than domestic versions or traditional Chinese medicines. A Large Talent Pool Finding qualified scientists, engineers, and physicians is essential to offshoring R&D. China and India, which have large talent pools, make it possible for R&D work to be carried out at lower cost. However, there are still questions about quality, such as whether there are enough well qualified researchers to maintain or even improve the quality of research. In a study conducted by Gary Gereffi and Vivek Wadhwa at Duke University , the numbers of engineering bachelor’s degrees and associate degrees awarded annually by India were reported to be 112,000 and 103,000, respectively. For China the numbers were 351,537 and 292,569, respectively, about 2.5 to 3.5 times higher than in the United States. In addition, in China the number of doctorates in domestic science and engineering has increased rapidly. From 1975 to 2005, China’s global share of science and engineering (S&E) doctorates increased from near zero to 11 percent; at the same time, U.S. global share fell from half to roughly 22 percent.  Another component of the talent pools in China and India is doctorates earned overseas. In 2001, the number of Chinese S&E doctorates earned in Japan, United Kingdom, and United States equaled 72 percent of the total S&E doctorates earned by American citizens and permanent residents.  From 1986 to 1998, of all S&E doctorates earned in U.S. universities, Chinese students accounted for 8.4 percent in biological and agricultural science and 9.1 percent in engineering.  From 1993 to 2000, the total number of engineering doctorates awarded in U.S. universities fell
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The Offshoring of Engineering: Facts, Unknowns, and Potential Implications slightly, from 2,228 to 2,206; however, doctoral awards in engineering to Chinese citizens increased 30 percent from 543 to 711 in the same period.  In recent years, with the booming economies in China and India, more and more Chinese and Indian scientists and engineers, especially in high-tech fields such as biomedical studies, have chosen to leave the United States for home and have taken their technical skills with them. According to China’s Bureau of Education, since 1978, about 700,000 Chinese college graduates and scholars have gone abroad for advanced degrees, and about 170,000, or 24 percent, have returned. A high portion of the graduates earned degrees in chemistry and life sciences. Currently, 40 to 60 percent of postdoctoral students in the United States are from China and Taiwan. Within 10 years, there may well be a reverse brain drain in U.S. biotechnology.  The scientific disciplines most relevant to the pharmaceutical industry are chemistry and biology. Graduates in chemistry in both China and India outnumber their U.S. counterparts by more than fivefold at the bachelor’s level and more than threefold at the master’s level.  Even correcting for variations in quality, these large numbers provide an impetus for moving higher value work offshore. Enablers Resources Another important factor driving MNPCs to offshore their R&D work to China is that valuable resources might be discovered from traditional Chinese medicine (TCMs), 12,807 medicinal materials derived from natural sources, about 5,000 of which may have some proven clinical efficacy. TCMs’ share of the global market in herbal medicines ($60 billion in 2002) is expected to rise to $5 trillion by 2050.  The expected advantages of TCMs for MNPCs is that they may provide drug-discovery leads and diversify an MNPC’s pipeline. In addition, both China and India offer access to the broad human gene pool and patient population. Data on different populations is becoming increasingly important as the industry shifts from developing blockbuster drugs to drugs targeted at patient populations with specific genetic polymorphisms.  The large patient pool (and large number of treatment-naïve patients) makes it easier and faster to enroll patients in clinical trials. Infrastructure China has 185 bio-related institutes and research laboratories, 1.4 million doctors, more than 1 million nurses, and 20 facilities with GLP (Good Laboratory Practices) certification. As many as 300 contract research organizations (CROs) now offer support for clinical trials, which also provides an infrastructure to support the offshoring of R&D work. In India, half a million doctors, 171 medical colleges, and 16,000 hospitals provide a broad infrastructure for offshoring clinical R&D.  Six laboratories in India have secured GLP certification, and a dozen more are about to. In addition, more than 20 CROs in India now handle Phase II through Phase IV trials. Sustainers Government Support According to the director of the Pharmaceutical Department, which is overseen by the State Economic and Trade Commission of China, the Chinese government encourages foreign pharmaceutical companies to expand their businesses from just manufacturing to include R&D. They promise that foreign-funded research centers will be exempt from import tariffs and custom taxes. In addition, companies that transfer technology to China will be exempt from business taxes.  The list of key focus areas in the current Five-Year Plan includes biotechnology and innovative drug discovery. Funding in some areas of biomedicine and biotechnology—most notably genetics—has increased rapidly in the past few years.  From 2000 to 2005, an average of $600 million in public funds went to China’s biotechnology sector. India’s Department of Biotechnology has funded more than 1,800 R&D projects, helped to develop 12 vaccines, and transferred 54 technologies to the biotechnology industry, 17 of which have been commercialized.  Many life-science parks, such as Shanghai Zhangjiang Life Science Park, have been established to encourage foreign investment in the pharmaceutical and biological sectors. These parks, which are focal points for the clustering of similar companies, offer MNPCs basic amenities and fiscal and regulatory incentives. A good example is the Beijing Economic and Technological Development Zone, in which both domestic and foreign companies are exempt from taxes for two years after they start making profits. For the next three years, they are taxed at half the normal rate.  By the end of 2005, there were 60 such parks in China and five fully operational parks in India and 17 more at various stages of planning or construction.  These special economic zones attract foreign direct investment (FDI) in knowledge- and manufacturing-based businesses, and thus attract offshoring by foreign firms. Improvements in Patent Protection Sustainable development of offshore pharmaceutical R&D requires a well regulated business environment and a well established legal system to protect MNPCs from misappropriations and infringements of patents and from counterfeit drug makers. A new law in China, the New Medicine Examining Statute, encourages innovation by controlling prices and protecting intellectual property. First, it extends the protection period for new medicines, in some cases from
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The Offshoring of Engineering: Facts, Unknowns, and Potential Implications eight years to 12 years. During the protected period, only licensed companies can produce the drug in question. Second, profit margins for new medicines can be higher than for other products, so manufacturers can recoup the costs of R&D more quickly. Third, the government is reducing bureaucratic red tape by contracting out the licensing of new medicines and production plants. All of these measures will stimulate investment, improve R&D, and cut the time-to-market for new medicines.  In September 2003, the Chinese government also passed a regulation for implementing the Law on Drug Administration. The regulation defines new drugs as “drugs that have not appeared in the domestic market,” a stricter standard than the old rules that defined new drugs as “drugs produced in China for the first time.” The new standard has unnerved many domestic pharmaceutical research institutions, whose main products are imitations of sophisticated foreign drugs. According to the old rules, these drugs could be patented as new drugs only if foreign drug makers had not manufactured the originals in China.  Although the trend appears to be toward greater protection of IP, it will take some years for sufficient case law to establish how the government will actively protect the IP rights of foreign firms. Barriers Regulatory Barriers Even though the business environments of China and India have improved in recent years, some regulatory barriers still impede MNPCs’ offshore R&D activities. For example, in India, new chemical entities discovered outside the country must undergo initial Phase I trials outside the country; only then can a Phase I trial be conducted in India.  This delays the time-to-market for new drugs. In China, slow approval time (usually 9 to 12 months) is a serious problem. The process of registering a drug and obtaining production and sales permits involves numerous central, provincial, and local authorities and can take several years.  In India 3 to 4 months is the norm. Supply of High-Quality Talent The large pool of scientists and engineers in China and India is one of the attractions for offshore R&D. However, with the rapid growth of offshore activities and competition from the growing number of domestic companies, the demand for qualified engineers is increasing. For example, in India, the share of global clinical trials is expected to rise from the current level of 1.5 percent to 15 percent by 2011. In addition, the number of global trials is increasing by 10 percent per year. At current training levels, India will turn out only one-tenth the required numbers of clinical research assistants.  Thus early movers in offshoring of clinical trials will have an advantage; later entrants will have to work harder to find trained staff. In addition, this competition for skills will accelerate wage inflation and erode some of the cost advantages of offshoring. Another problem for MNPCs is that, although the potential supply of talent in low-wage countries is large and growing rapidly, only a fraction of potential job candidates are qualified to work for foreign companies. The reasons for the lack of suitability are inadequate language skills, poor quality of education, and limited practical experience. Another problem is cultural differences, which are especially apparent in interpersonal skills and attitudes toward teamwork and flexible working hours.  According to Wadhwa and Gereffi’s survey results, multinational and local technology companies in China felt comfortable hiring graduates from only 10 to 15 elite universities across the country and complained that the supply of these graduates was limited.  Interviews with 83 human-resource managers in multinational companies reveal that, on average, only 17 percent of engineers and 14 percent of researchers in the life sciences were suitable for hiring by foreign companies. Among all candidates, only 10 percent in China and 25 percent in India would be suitable for offshore R&D by MNPCs. As McKinsey reports, only 2.8 to 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 of high-wage countries.  The scarcity of experienced and skilled middle-management-level workers for offshoring companies is even more serious. In China, for cultural and historical reasons, students are not encouraged to think innovatively. However, innovative thinking is the quality that pharma R&D thrives on. The ratio of graduate students to professors in China can be as high as 20 to 1, compared with a 3-to-1 ratio in the United States. Physicists, chemists, and engineers dominate the talent pool in China. Although the output in applied biology has increased rapidly over the past decade, the percentage of biotechnology- and biology-related fields in China is still modest. Furthermore, it is estimated that just half the potential talent pool in China is geographically accessible to multinational companies. Protection of Intellectual Property As discussed earlier, R&D work conducted in developing countries is fragmented and concentrated mostly in relatively lower value-added areas of chemical synthesis and routine analysis. MNPCs tend not to offshore their most proprietary R&D activities because of uncertainties about the protection of intellectual property.  These same uncertainties may encourage MNPCs to pursue only fragmented work offshore and not to work across the entire value chain. Venture-Capital Funding Besides establishing fully owned subsidiaries in China and India, MNPCs can offshore R&D work to CROs and through
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The Offshoring of Engineering: Facts, Unknowns, and Potential Implications partnerships with local firms. Establishing a high-technology company, such as a pharmaceutical research firm, is capital intensive, and there may not be a short path to profitability. For such firms to be established, funding sources and legal and business infrastructure must be available. Therefore, the current lack of established venture capital (VC) firms and funds in China and India represents a barrier to offshoring activity. The VC industry is at an early stage in both China and India, where most funding has traditionally come from government, financial institutions, and individuals. Currently, most VC funding is from foreign firms, although domestic VC companies are emerging. As wealth accumulates in China and India, private-equity funding may play a larger role. Government policy toward the regulation of finance and investment will certainly influence the extent of domestic and foreign investment. In India, returning expatriates, particularly from Silicon Valley, have encouraged the establishment of a regulated VC industry.  The Securities and Exchange Board of India (SEBI), which regulates the stock market, is now also responsible for regulating VC funds. The first regulations, issued in 1996, offer tax benefits similar to those of U.S. limited partnerships. There are currently 84 VC funds and 54 foreign VC funds registered with SEBI, and many other funds are still unregistered.  Although the goal is to promote an exit strategy, the mechanism by which venture capitalists recoup their investments through an initial public offering (IPO), most investment exits are currently realized through mergers and acquisitions. The barriers to VC funding in India include the reluctance of businesses to give up their majority stake to an investor, the lack of fund-management experience, and the lack of infrastructure to provide legal and business support. However, the presence of domestic stock exchanges, a history of domestically managed mutual funds, and a growing entrepreneurial spirit are contributing to confidence in VC investments. [33, 35] In China, VC funding has been growing rapidly, from just $418 million in 2002 to $1.27 billion in 2004 , and the Chinese Venture Capital Association (CVCA) has become an umbrella organization to promote the industry.  Exits from venture investing are predominantly in the form of IPOs on foreign exchanges; some are realized through mergers and acquisitions. [36, 37] The main concerns about VC funding in China are the lack of a domestic exchange for IPOs, the lack of experienced fund management and legal capability, and, given the weak IP regime, the inability of companies to retain value from technology. OFFSHORING IN PHARMACEUTICAL MANUFACTURING Pharmaceutical manufacturing encompasses a variety of process technologies on different scales. Primary manufacturing involves synthesis of the drug substance, also called the active pharmaceutical ingredient (API) or bulk drug substance. This is followed by secondary manufacturing, which involves drug-product formulation; in this stage the drug is produced in its final dosage form. The last stage involves the filling, finishing, and packaging of drug products for distribution to patients. These stages are often performed at different sites and may be broken down into further steps. For example, in API manufacturing, it is common for chemical intermediates to be supplied by one company to another. The technical and regulatory requirements for the manufacturing facility depend on whether the drug is a chemical or a biological product. High-potency drugs and biologics typically require more containment, hence more infrastructure and stricter maintenance procedures. The volume of the drug depends on its potency and the frequency of dosing. Low-potency drugs that require frequent dosing are produced in large volumes. High-potency drugs that are used sparingly are produced in low volumes. Thus there is a continuum in the size and scale of manufacturing facilities. Manufacturing of Active Pharmaceutical Ingredients Manufacturing of the API is frequently offshored by outsourcing to a third party. The primary motivation is cost efficiency. Because FDA approval is required for facilities and processes in the United States or abroad that supply product to the United States, the quality of the API is guaranteed. In China, the world’s largest producer of APIs, sales are expected to increase by 17.6 percent in the next few years, from $4.4 billion in 2005 to $9.9 billion in 2010. In India, the third largest global manufacturer (after Italy), sales are expected to increase by 19.3 percent per year, from $2 billion in 2005 to $4.8 billion by 2010, according to a study conducted by Italy’s Chemical Pharmaceutical Generic Association.  APIs accounted for 60 percent of pharmaceutical exports from India in 2001.  The APIs manufactured in offshore facilities are almost all generic, and thus off-patent products, the point at which cost savings on manufacturing provides a competitive advantage. Patent protection for these products has expired and non-infringing processes can be developed and used for manufacturing them, thus lowering IP concerns. The expansion of the generics market is expected to continue, both in absolute terms ($2 billion growth between 2000 and 2002) and as a percentage of contract manufacturing in India (expected to increase from 20 percent in 2000 to 62 percent in 2010).  An interesting change may be in the wind, however. 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 API for a brand new drug.  With this business model, the innovator firm can leverage low-cost production before the drug has generic status. Success will depend on protection of IP for the product and process. Indian companies are becoming more sophisticated. Companies that started as contract manufacturers for inter-
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The Offshoring of Engineering: Facts, Unknowns, and Potential Implications mediates, and then APIs, are becoming vertically integrated and moving into drug-product formulation. This is possible because of improvements in R&D skills, which have enabled them to challenge patents and adopt an aggressive acquisition, IP-based approach to expansion into regulated markets. For example, Ranbaxy USA has submitted more than 20 abbreviated new-drug applications (ANDAs) to the FDA for review of generic products. The Ranbaxy group acquired OHM Laboratories (USA) manufacturing facilities in 1995 and European generics, including Bayer AG, RPG (Aventis), Terapia SA, and Ethimed NV.  Nicholas Piramal acquired Avecia and Pfizer’s manufacturing site in Morpeth, U.K.  The rise of the Indian pharmaceutical industry, with expertise in reverse engineering and patent challenging, could have a significant impact on the global generics market. In effect, these firms are practicing reverse offshoring by reaching back to U.S. and Western European firms for skills to fill out the value chain. Indian and Chinese companies are increasingly interacting with each other to leverage their unique strengths. For example, India has emerged as a preferred trading partner with China; India’s imports of pharmaceutical products from China increased by 172 percent in 2004 to $303 million in 2005. China is also the leading pharma export market for India. In 2005, imports from India were valued at $58 million. By contrast, U.S. drug product exports to China were valued at $29.5 million.  Manufacturing of Final-Dosage Products The growth in offshore secondary manufacturing appears to be driven by a combination of both low-cost manufacturing structures and the growth of domestic pharmaceuticals markets. Low-cost manufacturing in China and India enable companies to sell pharmaceuticals at prices affordable to the local population. Low-cost manufacturing also enables penetration into other developing markets where the costs of pharmaceuticals are prohibitive, such as in Southeast Asia and Africa. Final-dosage manufacturing in India and China is done by a mix of third-party outsourcing and foreign direct investment in manufacturing facilities run by Indian subsidiaries of MNPCs. The company websites of GSK, Pfizer, Wyeth, Aventis, and Abbott (five of the top six MNPCs by domestic sales in India)  indicate that they have established manufacturing sites in India to cater to the Indian market and for exports, mainly to Middle Eastern and Asian markets. They also provide some external manufacturing services, including API manufacture, but the focus of these operations is on secondary manufacturing. It stands to reason that, if they can meet the tough cost demands for local sales, they can also leverage higher margins on sales in the regulated markets. Manufacturing of Biologics Although both India and China have substantial and growing biopharmaceutical industries, offshoring of biopharmaceuticals manufacturing is still small by global standards because of the nature of these products and processes, the lack of regulatory clarification, and the relative immaturity of the industry. Patents on the first generation of biopharmaceuticals are beginning to expire, but the FDA has not yet issued clear guidelines for how bio-similar or follow-on biologic products should be assessed for safety and efficacy as generic-like substitutes. Such products can enter the marketplace but only after clinical trials have been completed. Thus the concept of generics does not apply to biological products as it does to chemical drugs. Biological therapeutics cannot be as easily characterized by physico-chemical methods or bioassays; hence their safety and efficacy depend more strongly on the manufacturing process. Thus it can be difficult to transfer a product to a different manufacturing site, which may require clinical evaluation. However, the technology for characterizing biologicals is evolving rapidly. There is a continuum of molecular complexity in biologicals reflected in the molecular weight and extent of post-translational modification of the molecule during synthesis. Some smaller molecules, such as insulin, which have been manufactured for a long time, are sufficiently well characterized that injectable insulin can be manufactured by numerous companies.  The European Medicine Evaluation Agency has published guidelines, including comparison guidelines, for products manufactured at multiple sites.  However, the lack of clarification by the FDA poses a barrier for companies interested in producing bio-similar or outsourced products for the U.S. market. DRIVERS, ENABLERS, BARRIERS, AND SUSTAINERS FOR OFFSHORE MANUFACTURING Drivers The primary drivers for offshore manufacturing are low-cost operations and access to rapidly growing pharmaceutical markets in India and China. If a company can manufacture and produce at a cost low enough to be competitive in emerging markets and still be in compliance with FDA requirements, then that company can expect to be cost competitive in regulated markets. In the future, as the efficiencies of manufacturing processes by emerging Chinese and Indian companies improve, MNPCs will have more opportunities to offshore their non-core manufacturing activities. In addition, as Indian and Chinese companies become more innovative, competition to supply the global market will increase, driving improvements in both cost and technology.
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The Offshoring of Engineering: Facts, Unknowns, and Potential Implications Low Cost Structure Both India and China have lower capital, labor, and raw-material costs than manufacturers in Western Europe or the United States. The largest savings (approximately 60 percent) for these companies is in labor costs. Total cost savings are estimated to be $10,000 per million tablets.  Arthur D. Little Benelux estimates annual per-person labor 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 installed cubic meter of reactor capacity are at least 40 percent lower than in the West and can be as much as 90 percent lower.  Growing Markets The value of Chinese and Indian pharmaceutical markets is considerably less than the value of the market in the United States. However, with an expanding, increasingly affluent middle class willing to pay out of pocket for treatment, the markets in India and China are growing. Increased sales of existing drugs at low prices and a wider range of new products in the market are reflective of the growing number of people who can afford more therapies and are demanding world-class treatment. Thus opportunities abound for pharmaceutical companies to expand their operations. India’s pharmaceutical market, which was estimated to be worth $4.5 billion to $4.9 billion in 2004, has grown steadily for the past 15 years. It is estimated that value will rise from $5.3 billion in 2005 to $16 billion in 2015.  In China, the pharmaceutical industry is one of the fastest developing sectors, driven by the medical needs of the country’s 1.6 billion people. During the 9th Five-Year Plan (1996–2000), the average annual growth rate of the pharmaceutical industry was 17 percent. For comparison, the rate worldwide is 13 percent. Biotech-based pharmaceuticals in China were worth about 20 billion RMB in 2002, or about 6 percent of the total value of the pharmaceutical industry. This share is predicted to rise to 12 percent in 2006.  Estimates of the Chinese market vary widely. IMS estimates that the value was $11.7 billion in 2005 and will be the seventh largest in the world by 2009.  In a BCG report, it is estimated that China will become the fifth largest drug market, with a value of $37 billion, by 2015. Enablers Experience and Existing Manufacturing Infrastructure Domestic chemical and pharmaceutical industries grew rapidly in India following the passage of the 1970 patent law recognizing process patents but not composition-of-matter patents. Similarly, in China companies have developed expertise in the reverse engineering of drugs available in Western markets. As a result, there is now a large, experienced workforce with considerable knowledge about the process science and engineering of pharmaceuticals. This talent pool for MNPCs makes it possible for domestic companies to be innovative in designing non-patent-infringing processes. There is also considerable manufacturing infrastructure already in place, such as manufacturing plants and equipment vendors to supply the industry. Consolidation and Standardization Medium-sized industries in both China and India are consolidating, and many smaller manufacturing units are closing down. The top 20 companies in India increased their market share from 29 percent to 56 percent in 2004, reflecting this trend.  As a result of these consolidations, the remaining facilities are increasingly able to meet international operating standards, which is likely to increase confidence in India as a global supplier. The Drug and Cosmetics Act of 1940 was modified to encourage the standardization of drug manufacturing.  Many plants in India are also approved by regulatory bodies, such as FDA, EMEA, MCA-UK, and TGA-Australia. In fact, India has the largest number of FDA-approved facilities outside the United States. Ernst and Young predict that in the future Indian companies will fall into one of three categories: global companies that offer both generic and brand-name drugs and co-promotion deals medium-sized and large companies resulting from the consolidation of equally sized small to medium companies companies that have reduced their scope of operations and specialize in a niche activity In China, the number of pharmaceutical manufacturers is decreasing, but the productivity and scale of manufacturing is increasing. It is estimated that there are 3,000 GMP-certified manufacturing facilities in China today.  Skilled Workforce China and India have large and growing numbers of suitably trained graduates in engineering, life sciences, and pharmaceutical science. However, only a fraction of this population is suited to working in international companies. Because both countries are large, part of the talent pool may be inaccessible at the desired locations. A McKinsey report that provided data on the supply of engineers and life-science researchers in China, India, and the United States for 2003 projected the compared annual growth rate for 2003–2009 (Table 2).  The pharmaceutical-science talent pool in India can be estimated based on the number of academic institutions. The All India Council for Technical Education has approved 445 institutes with a combined annual intake of 24,670 students for the diploma or bachelor’s degree in pharmacy. In addi-
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The Offshoring of Engineering: Facts, Unknowns, and Potential Implications TABLE 2 Supply of Engineers and Life-Science Researchers in China, India, and the United States, 2003 Theoretical Maximum Talent Supply (in thousands) Engineers CAGR Life-Science Researchers CAGR China 1,589 (159) 6% 543 (54) 6% India 528 (132) 6% 674 (101) 4% United States 667 (538) 2% 852 (692) −2% Note: Numbers in parentheses are workers suitable for recruitment. Source: Adapted from Das, 2006.  tion, 132 institutes have been approved for students pursuing master’s degrees in pharmacy; these institutions take in 2,680 students annually.  Health Insurance The health-care systems in China and India are largely market based. In China, employer insurance is mandatory in urban areas, although the value is capped and the law is not always implemented. Domestic private insurers have also emerged. Government primary health-care insurance exists in rural areas, but the coverage is inadequate to meet most people’s needs. Overall, only 29 percent of people in China have some form of health insurance, and out-of-pocket expenses accounted for 58 percent of health-care spending in 2002.  In India, almost all expenditures for health care are out of pocket. The easing of regulatory restrictions has allowed the entry of some multinational insurers into the market. Although life insurance has been available for some time, private health insurance schemes are just appearing. One example is a Prudential-ICICI product that covers serious procedures, such as heart-bypass surgery, organ transplants, and cancer treatment.  It is anticipated that increases in private insurance will expand the market, particularly at the high-value end. Sustainers Supportive policies in host countries are necessary to sustain and develop offshoring manufacturing activities. These policies include (1) a commitment to education to ensure the supply of high-quality workers and (2) lowering of barriers to international trade to encourage companies to offshore and to make long-term offshore operations profitable. Educational Infrastructure The Indian government is supporting the development of a growing number of international-class academic institutions to support growing industries. The Indian and National Institutes of Technology are already recognized for producing high-quality engineering students. In addition, the foundation of the National Institute for Pharmaceutical Education and Research (NIPER) was established in 1998 to produce graduates and research similar in quality to the standard in the pharmaceutical sciences. There is a demand for at least 10 more NIPER-like institutes.  Another accelerating field is biotechnology. The Department of Biotechnology (DBT), established in 1986, is responsible for developing a scientific and technical workforce.  The focus of NIPER and DBT is (1) to produce 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 India, but will also enable the development of Indian companies that can compete on a global level. Government Trade Policies The government of India is taking several steps to encourage the contract manufacturing of pharmaceuticals. Grants and incentives are offered in the following categories: domestic manufacturing for sale in a domestic tariff area (DTA) domestic manufacturing/service unit for export of goods and services less than 100 percent (export oriented unit [EOU] or software technology parks of India [STPI] schemes) manufacturing/service activity from a special duty-free enclave (SEZ) investment in R&D The concept of a SEZ is modeled on earlier, highly successful initiatives by the Chinese government to increase FDI. FDI restrictions have been eased so that FDI of up to 100 percent is now permitted for bulk drugs and their intermediates and formulations (including bulk drugs produced using recombinant DNA).  In addition, biotechnology TABLE 3 Programs in India Supported by the Department of Biotechnology  Number of Universities Annual Intake of Students General biotechnology 41 530 Agricultural biotechnology 9 110 Medical biotechnology 1 10 Marine biotechnology 2 30 Neuroscience 3 25 Industrial biotechnology 1 10 Masters In Technology Biotechnology 9 140 Masters in Veterinary Science 2 15 Post MD (Doctor of Medicine)/Master of Science Certificate 2 9 Post-graduate diploma 4 56 Totals 74 935
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The Offshoring of Engineering: Facts, Unknowns, and Potential Implications parks are being set up across the country and the Small Business Innovation Research Initiative (SBIRI) has been set up to encourage public-private partnerships in the biotechnology sector.  The government has reduced the costs associated with international trade to make offshoring more attractive to MNPCs. Exporters are allowed to import inputs on a duty-free basis for products that will be exported. In addition, excise duties on pharmaceutical products are being lowered. Currently, the excise duty is 16 percent, but since January 7, 2005, the excise duty has been levied on only 60 percent of the maximum retail price of the drug. There are plans to reduce the excise duty from 16 percent to 8 percent.  Barriers Insufficient protections of intellectual property and price controls have deterred MNPCs from manufacturing and distributing their products in China and India. In addition, complicated and opaque bureaucracies can also be challenging, particularly to new entrants. The quality of infrastructure for utilities, transportation, and communications is also poor in some places, particularly away from major cities. The poor quality of infrastructure can pose risks to supply chains in a partnership-type offshoring model and may require significant investment by an MNPC setting up in-house facilities. However, these barriers are not specific to pharmaceutical manufacturing and, therefore, are not addressed further here. Intellectual Property In the United States, it commonly costs $800 million and takes 10 years or more to launch a new drug. It is impossible for most Chinese drug makers to develop new pharmaceutical compounds, which cost hundreds of millions of dollars. According to the president of Beijing Kevin King Management Consulting Company Ltd., “In a rather long period of time, copying foreign drugs after their patent protection is over, or, for some drug makers, seeking legal loopholes in the patents of foreign drugs to legally produce generic medicines will be a major development strategy of Chinese drug makers. This may lead to frequent legal disputes.”  Counterfeiting remains a problem for foreign firms in China. According to Chinese law, domestic firms can produce imitations of foreign drugs awaiting administrative protection from the State Drug Administration (SDA). While SDA reviews the application for protection, it makes information on the drug available to domestic companies to ensure that the foreign drug is not similar to drugs already being produced in China. In 2000, the China Daily newspaper reported 50,000 cases of counterfeit or inferior pharmaceutical products in China, which led to the closing down of 1,345 factories.  Membership in the World Trade Organization (WTO) requires compliance with international intellectual-property regimes. As soon as China joined the WTO in 2001, the Trade Related Intellectual Property Agreement (TRIPS) went into force (India joined the WTO in 1995 but did not implement TRIPS until January 2005).  Under China’s New Pharmaceutical Administration Law, which went into effect in December 2001, stronger measures are being taken against counterfeiters. In 2003, 994 manufacturers and distributors of counterfeit drugs were ordered to cease operations, and counterfeit drugs and facilities with an estimated market value of $60 million were seized.  However, both in China and India compliance with these 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 failed patent disputes in China are Prozac (Eli Lilly, 1999); Viagra (Pfizer, 2004); and Avandia (GSK, 2004). However, it is noteworthy that these patents were disputed by the manufacturers in a court of law, rather than simply copied, as had been done in the past. Price Controls The price of drugs is controlled by the Chinese and Indian governments for the purpose of making them affordable to the broad population. However, price controls have been found to delay the introduction of new products because they limit profits and create large price disparities between markets, which increase the likelihood of arbitrage . Although the number of drugs under price controls has been reduced (Table 4), it is unlikely that price controls will be abolished. In fact, recommendations by the Indian prime minister’s task force on drug affordability may further reduce profits. For example, the task force recommended the “de-branding” of drugs, so that only the manufacturer’s identification and the generic drug name are displayed on packaging.  Wage Inflation Labor costs are a major source of cost advantage in pharmaceutical manufacturing. Low costs are also the basis for competitive advantage for Indian and Chinese firms competing in the global market. Currently, there are large differences in labor costs in the United States and Western TABLE 4 Number of Drugs under Price Controls in India since 1970  Year Number of Drugs 1970 Almost all bulk drugs and their formulations 1979 347 bulk drugs 1987 142 bulk drugs 1995 74 bulk drugs
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The Offshoring of Engineering: Facts, Unknowns, and Potential Implications Europe on the one hand and India and China on the other. However, with increasing offshore activity, it is likely that there will be wage inflation in the pharmaceutical manufacturing industry as there has been in other industries, such as business process offshoring and information technology, which will reduce the cost differential. According to the Culpepper Pay Trend Survey, the base salary increase for technical employees is about 3 to 4 percent in the United States and 6.3 percent in China. India and the Philippines project salary increases of 9.2 percent and 11.2 percent, respectively, which are much higher than in most other countries.  These rates may increase further and thus diminish the labor cost leverage. Distribution The success of new entrants in the offshoring market depends not only on their product range and marketing, but also on their ability to access customers. Both China and India cover vast geographical areas and have large rural populations, which can pose challenges. More than 17,000 distributors were operating in China in 1997, channeling medicines to hospitals, retail pharmacies, and stores. In India, almost all pharmaceutical sales take place through a complicated network of more than 6,000 wholesalers and more than 500,000 independent retailers.  Foreign firms must use domestic distributors, but, because they are not exclusive agents, the distributors simply take orders for hospitals and retailers but do not promote their products. The large number of intermediaries makes launching products difficult and increases cost pressures. It also introduces multiple points for the entry of counterfeit drugs. Some uncertainties remain as to how China’s WTO obligations will apply to drug distribution. Furthermore, because the Chinese government has been slow to reform its health care system, it may be difficult for foreign drugs to get on the all-important reimbursement lists; thus they may not be able to supply the largest Chinese buyer—the state hospital system.  In China, about 85 percent of drugs are sold in hospitals (mostly private);  the rest are sold through retail outlets. Because of consolidation in the retail distribution chain, the top 100 drugstores owned 36,420 outlets in 2005.  This will certainly facilitate penetration into the domestic market. IMPACT OF OFFSHORING U.S. Employment The slow, evolutionary changes in labor markets in developed economies will continue in response to continued offshoring.  It is estimated that in 2008, 160 million jobs, or about 11 percent of the projected 1.46 billion service jobs in all sectors worldwide, could, in theory, be carried out remotely. Some occupations are more amenable to remote employment than others. In the United States today, about 80 percent of workers are employed in services, about 19 percent in manufacturing, and only 1 percent in farming.  The Bureau of Labor Statistics reports that employment in U.S. manufacturing has decreased by two million jobs in the past 20 years. Over the same period, manufacturing output has increased, meaning that factories have higher productivity than before, leading to higher national income and a higher standard of living. Net employment increased by 43 million jobs in other areas, such as educational and health services, professional and business services, trade and transportation, government, leisure and hospitality, and financial services (see Figures 8 and 9).  Does offshoring of R&D create the risk of a rapid loss of high-wage jobs and wage suppression? According to the McKinsey report, offshoring will have little effect on wage levels in developed countries, but local wage inflation will probably continue in some offshoring locations as long as companies concentrate demand on a few cities. Over the past 30 years, the United States has experienced an 11 percent decline in manufacturing jobs, but wages have remained stable. By comparison, it is estimated that a total of 9 percent of jobs in services in the United States could theoretically be performed offshore. Assuming that half of these service jobs are actually relocated offshore in the next 30 years, the resulting job turnover would be around 225,000 jobs per year, or 1 to 2 percent of the 16 million jobs created every year in the U.S. economy. The theoretical maximum global resourcing of full-time employees in the pharmaceutical industry in 2003 was approximately 200,000, about 13 percent of total employment in the industry. The actual offshore employment in 2003 in low-wage countries was about 10,000. The number is projected to double by 2008, to 21,000 (see Figure 10). Thus offshoring in the pharmaceutical industry will have a small impact on overall employment.  In research innovation and development, the United States remains the unchallenged leader. Today, almost one-third of science and engineering researchers in the world are employed by U.S. firms. Thirty-five percent of the science and engineering research papers are published in the United States, and the United States accounts for 40 percent of global expenditures for R&D.  In addition, in a survey by Duke University of 58 U.S. companies that outsource 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 U.S. engineering employees produced equivalent or higher quality work.  Although there may not be an imminent threat to American leadership in technology, the number of young professionals in emerging markets is growing by 5.5 percent annually, while growth in developed countries is only 1 percent. By 2008, the supply of suitable young engineers is expected to be nearly the same in developing and developed coun-
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The Offshoring of Engineering: Facts, Unknowns, and Potential Implications FIGURE 8 Net annual change in employment for selected sectors in the United States, 1991–2005.  FIGURE 9 U.S. employment levels in professional and business services, 1996–2005.  tries.  The United States must ensure that its workforce is trained to meet that demand. U.S. Industry The study by the McKinsey Global Institute shows that, far from being a zero-sum game, offshoring is a game of mutual economic gain.  The study found that every dollar of corporate spending outsourced to a low-wage nation had the following benefits for the United States: U.S. companies captured more than three-quarters of 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 paid to local workers, profits earned by local outsourcing providers and their suppliers, and taxes collected from second- and third-tier suppliers to the outsourcing firms. U.S. companies saved $0.58 because of cost advantages in offshore countries.
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The Offshoring of Engineering: Facts, Unknowns, and Potential Implications FIGURE 10 Offshore employment in IT, pharmaceuticals, and overall analyzed for 2003 and 2008. Adapted from . Corporate savings invested in new business opportunities boosted productivity and created new jobs. Direct benefits to the United States from corporate savings, new exports, and repatriated profits totaled $0.67. U.S. consumers benefited from goods and services at lower prices. In 2004, U.S. imports of services amounted to $296 billion, and exports of services amounted to $343 billion, giving the United States a balance-of-trade surplus of $47 billion in services. In manufacturing in 2005, the United States had a deficit; the U.S. exported $807 billion and imported $1.47 trillion. With more than 100 million U.S. workers now working in the services sector, outsourcing is expected to increase at an exponential rate in the next decade, constituting a larger share of the U.S. trade balance and giving the United States a comparative advantage in services.  This trend may be mirrored in the pharmaceutical industry. Reverse Offshoring The offshoring of manufacturing has greatly enhanced the capabilities of the pharmaceutical industries in India and China. Indian companies, in particular, are becoming increasingly sophisticated and expanding globally. Companies, such as Ranbaxy and Dr Reddy’s, that started in contract manufacturing of intermediates, and then APIs, are becoming integrated by moving into final-dosage formulations and becoming highly skilled in R&D. This has enabled them to challenge patents in the United States and Europe and to follow an aggressive path of acquisition. Thus many major Indian companies are pursuing acquisitions of companies that manufacture generic products for regulated markets in the United States and Europe, a strategy of “reverse offshoring” (see Table 5). As the Indian pharmaceutical industry with expertise in reverse engineering and patent challenging grows, it could have a significant impact on the global generics market. Indian investor companies use revenue generated by generics manufacturing to build up their R&D capacity with the goal of becoming innovator firms themselves. Because of the high level of expertise required to develop a new drug and the associated high costs and risks, alliances with Western companies have become an effective tactic for developing this capability. This strategy can also be advantageous for MNPCs, because collaborative R&D is one way for companies to diversify the risks in their product pipelines. As Table 6 shows, these alliances cover all stages of the pharmaceutical value chain. One striking example of reverse offshoring is Ranbaxy’s recent decision to license a product developed in house to the level of Phase I to an American contract research organization, PDD, for preclinical and clinical development and commercialization. There are no fully integrated Indian or Chinese innovator pharmaceutical companies today, so MNPCs do not face direct competition in this area. However, this situation could change, as offshoring of non-core activities in manufacturing and R&D continues, enabling MNPCs to focus on product development, marketing, and distribution, which may have the effect of shrinking the workforce based in the United States. As long as American and European markets are among the largest and most lucrative in the world, smaller pharmaceutical firms or subsidiaries of MNPCs will be attractive investment targets for growing Indian firms seeking a foothold in regulated markets. Hence it is not clear if the net effect will be a decrease in U.S.-based activities, but the costs of some drugs may fall. FUTURE TRENDS Offshoring is an increasingly hot topic that generates controversy about its impact on U.S. employment and the 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 must be supplemented by anecdotal evidence. The quality of these data is further compromised by the absence of standard definitions. This was a particular problem in this analysis of the offshoring of pharmaceutical research and manufacturing because much of the data we found was highly aggregated or anecdotal. More specific statistical data on employment and the demand for engineering positions broken down by academic majors, degrees, and functions in the industry in both the United States and abroad will be necessary to produce a clearer picture of how offshoring will impact the science and engineering workforce in the U.S. pharmaceutical industry. Major European pharmaceutical companies, such as Novartis and GSK, have shifted their R&D centers and
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The Offshoring of Engineering: Facts, Unknowns, and Potential Implications TABLE 5 Indian Acquisitions of U.S. and European Pharmaceutical Companies Acquirer Acquirer’s Expertise Target Date Target Activities Reference Reliance Life Sciences Biopharmaceuticals GeneMedix Ltd. (UK) 2007 Manufacture of biosimilars The Economic Times, February 8, 2007 Matrix Laboratories API and dosage-form manufacturing DocPharma (Belgium) 2005 Manufacture of API and dosage-form g Indian Chapter for Democratic Convergence, www.icfdc.com, accessed March 2007 Explora (Switzerland) 2005 API R&D The Hindu Business Line, September 20, 2005 Jubilant Organysys Ltd. Products and services for global life-science industry Target research (USA) 2005 Contract R&D www.jubl.net, October 2005 Malladi Generic API manufacturer Novus Fine Chemicals (USA) 2005 Generic API manufacturer PR Newswire, October 5, 2005 Dr Reddy's Laboratories Development and manufacture of generic and branded pharmaceuticals and bulk pharmaceutical ingredients BMS Laboratories Ltd. (UK) 2002 Manufacture and marketing of generics Pharmabiz.com, April 20, 2006, www.drreddys.com, accessed March 2007 Meridian Healthcare Ltd (UK) 2002 Marketing and distribution Pharmabiz.com, April 20, 2006, www.drreddys.com, accessed March 2007 Betapharma (Germany) 2006 Generic drug manufacturer The Guardian, February 6, 2006 Ranbaxy Laboratories Research and international generic manufacturing Terapia (Romania) 2006 Manufacture of generics www.terapia.ro, June 8, 2006 Allen Generics (GSK, Italy) 2006 Manufacture of generics www.ranbaxy.com, accessed March 2007 RPG (Aventis, France) 2003 Manufacture of generics Basics (Bayer, Germany) 2000 Manufacture of generics Ohm Laboratories (USA) 1995 Manufacture of generics Sun Pharmaceutical Industries Ltd. API and dosage-form manufacture Caraco Pharmaceutical Laboratories (USA) 1996 Generic dosage manufacturer www.sunpharma.com, accessed March 2007 Wockhardt Ltd. Pinewood Laboratories Ltd. (Ireland) 2006 Manufacture of generics www.wockhardt.com, accessed March 2007 Wallis (UK) 1998 Manufacture of generics CP pharmaceuticals (UK) 2003 Manufacture and marketing of generics Esparma (Germany) 2004 Manufacture and marketing of generics Dishman Pharmaceuticals Contract and custom manufacture of APIs and intermediates Synprotec (UK) 2005 Specialty chemicals www.pharmaceuticaltechnology.com, accessed March 2007 Nicholas Piramal India Ltd. Research and generic manufacturing Pfizer, Morpeth (UK) 2006 Finished-dosage packaging, supply chain www.nicholaspiramal.com, 2006 Aurobindo Pharmaceutical API and dosage form manufacture Milpharm (UK) 2006 Manufacture of generics www.aurobindo.com, accessed March 2007 Pharmacin (Netherlands) 2006 Manufacture of generics The Times of India, December 30, 2006
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The Offshoring of Engineering: Facts, Unknowns, and Potential Implications TABLE 6 R&D Alliances between Indian and Western Pharmaceutical Companies U.S./European Party 1 Expertise of Party 1 Indian Party 2 Expertise of Party 2 Announcement Date Activities Reference Merck (USA) MNPC Advinus Therapeutics Ltd (Tata group) Drug discovery and contract services 2006 Drug discovery and clinical development www.merck.com accessed March 2007, R.T. Badam, Associated Press Newswire, November 16, 2006 Bristol Myers-Squibb (USA) MNPC Syngene International Private Ltd (subsidiary of Biocon) Research 2007 Research R. Guha, Market Watch by Dow Jones, March 14, 2007 PPD Inc (USA) CRO Ranbaxy Laboratories Ltd. Research and international generic manufacturing 2007 License to PPD for development and commercialization, including preclinical and clinical studies PR Newswire Europe, February 27, 2007 GlaxoSmithKline (UK) MNPC Ranbaxy Laboratories Ltd. Research and international generic manufacturing 2003 (extended in 2007) R&D and commercialization PR Newswire U.S., February 6, 2007 Eli Lilly (USA) MNPC Nicholas Piramal India Ltd. (NPIL) Research and generic manufacturing 2007 Clinical development, marketing The Times of India, January 14, 2007 Biovitrum (Sweden) Biopharmaceuticals Orchid Chemicals Custom manufacturing 2006 Medicinal chemistry A. Krishnan, Global Insight Daily Analysis, October 30, 2006 ClinTec (UK) Clinical research Dr Reddy's Laboratories Research and generic manufacturing 2006 Clinical development and commercialization Business Standard, January 13, 2006 Wyeth (USA) MNPC GVK Biosciences Contract research 2006 Synthetic chemistry Express Pharma Pulse, March 17, 2005 AstraZeneca (Sweden, UK) MNPC Torrent Pharmaceuticals Ltd. Manufacturing 2005 Drug discovery Reuters News, February 22, 2005 manufacturing facilities to the United States, which is an interesting trend that is not addressed in this report. If this trend continues, the basis on which offshoring estimates are made will be altered. Further work is also necessary to clarify the reasons for, and the impact of, the reverse offshoring phenomenon, that is, firms in India and China looking to acquire operations in the United States and Western Europe. Special care must be taken in future studies when data from different sources are compared. For instance, China and India have different definitions of “engineering” that may not be consistent with the definition used in the United States.  In addition, when assessing the competitive advantages of an engineering workforce, it is important to consider the quality, as well as the number of engineers. Standards and criteria in different countries for qualified engineers may vary with the specific job requirements. Thus data on the engineering workforce must be specified by skills and functions. This report addresses location-specific factors related to offshoring that make them attractive destinations (the pull) for offshoring for specific parts of the overall value chain. The factors that drive a particular company (the push) to consider outsourcing should be examined in detail. These factors might include the high cost of operations in the United States/Europe, the pressures of operating in regulated markets, trends in R&D productivity, etc. Identifying and understanding these factors may be particularly important in assessing the impact of offshoring on the U.S. pharmaceutical industry. CONCLUSIONS The major leverage points for offshoring pharmaceutical R&D are cost, time, and access to scientific and engineering talent. An additional advantage in moving clinical trials offshore may be access to treatment-naïve patients. Not all parts of the pharmaceutical value chain are being moved offshore at the same rate. Thus offshoring activities differ across the R&D value chain. We could find no examples of an end-to-end offshore R&D model. Operating offshore provides MNPCs with access to innovative human resources, although the competition for skilled labor is increasing, and wages are rising above inflation. Offshoring of pharmaceutical manufacturing provides MNPCs with cost advantages because of the reduced cost of goods sold, and tax leverage, especially if the offshoring location includes a science and engineering zone. Offshoring also allows flexibility in capacity management. The focus of offshoring so far has been on generic products, which minimizes intellectual property risk. Operating offshore provides
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The Offshoring of Engineering: Facts, Unknowns, and Potential Implications access to new and developing markets, which gives companies a strategic advantage. We have noted a domino effect in the pharmaceutical supply chain, as suppliers in India offshore to China to reduce costs even further. An increasingly sophisticated local industry is evolving from companies that develop core competency in contract manufacturing. An emerging trend is reverse offshoring, that is, Indian companies with strong manufacturing bases and positive cash flows investing in U.S. and European acquisitions to improve their access to technological innovation and markets. These companies are also developing in-house R&D capabilities with the intent of becoming major global players in the industry. Overall, offshoring in the pharmaceutical industry is taking place further afield as companies seek access to the lowest cost resources in the supply chain. MNPCs that are being pressured by domestic health care systems to lower their costs are attracted by growing international markets. China and India are of particular interest because of their rapid economic growth. Government policies on intellectual property, education, health care, and FDI incentives add to a location’s attraction for companies considering offshoring. Although offshoring in the pharmaceutical industry is expected to have a minimal effect on U.S. employment, particularly in R&D, the offshoring of both manufacturing and R&D is likely to increase as the global industry grows. This growth is expected to lead to corporate savings, new exports, and repatriated profits. The corporate savings can be reinvested in new business opportunities to boost productivity and create new jobs. Hence there is likely to be a shift toward higher value-added services from the United States. For U.S. customers, offshoring represents the benefits of lower prices for goods and services. 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