Mixed news for service providers

European and North American service and materials providers will be inclined to welcome the rising costs in China because it will improve their cost position relative to their competitors in China. A 25% increase in labor costs, combined with a 10% appreciation in the renminbi, would have the effect of raising the cost of sourcing in China by 25–35%. European providers may get an even bigger gain in competitiveness in light of the rapid devaluation of the euro and British pound. After factoring in the additional costs of managing long-distance sourcing relationships, bio/pharmaceutical companies will see the costs advantages of sourcing from China narrow and may be more inclined to stick with local providers.

However, the second-order effects of the rising wage costs may cause service providers in mature markets even more pain than they are facing today. That's because Chinese service providers and manufacturers will respond to their eroding competitive cost position in starting materials and simple chemistry by moving to higher value-added products and services such as formulation, advanced chemical intermediates, and biologics. This move to higher value-added services is exactly the strategy that North American and European companies have used to stay in business in the face of low-cost competition from the BRIC countries. They will now be looking at lower-price competition in the more sophisticated services and technologies that have been their refuge in recent years.

In a recent essay posted on the Project Syndicate website ( http://www.project-syndicate.org/), two distinguished economists, Mohamed El-Erian, CEO of the investment giant PIMCO, and Nobel Prize winner Michael Spence, stated that if global trends continue, "not much more than a decade is needed for the share of global GDP [gross domestic product] generated by developing economies to pass the 50% mark when measured in market prices." This change would be a fundamental transformation of the world economy and a dramatic shift in where the greatest opportunities for growth will be in coming years.

Surprisingly, pharmaceutical service providers, especially those offering nonclinical development and manufacturing services, have been slow to recognize this shift in the world balance of economic power and to respond to the new opportunities. Most continue to maintain an "us versus them" mentality and ignore the fact that their most important customer base, the global bio/pharmaceutical companies, are making major commitments to the emerging markets. The roster of Western active pharmaceutical ingredient and dose manufacturers that have embraced the emerging market opportunity is small, and includes Lonza (Basel, Switzerland), Evonik (Essen, Germany), AMRI (Albany, NY), and DSM (Heerlen, The Netherlands). Those companies got a head start on exploiting the new opportunities that the emerging markets offer.

The rising costs of doing business in China and other emerging markets may provide a momentary competitive reprieve to pharmaceutical service providers in North America and Europe. However, those companies may end up being sorry that they got what they wished for because the response to those rising costs may be more even challenging. Rather than fighting the tide, they need to learn how to rise with it.

Jim Miller is president of PharmSource Information Services, Inc., and publisher of Bio/Pharmaceutical Outsourcing Report, tel. 703.383.4903, fax 703.383.4905, info@pharmsource.com
http://www.pharmsource.com/.