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China is on the rise as a center for pharmaceutical R&D, but companies are still getting their footing for operating in China and the services industry has some maturing to do.
I recently got a firsthand look at the evolving drug development services sector in China. I visited six CROs in Beijing and Shanghai and gained other valuable insights while attending the Impact China II conference, which was sponsored by the Strategic Research Institute. I came away with the sense that what is going on in China is very impressive, but the Chinese CRO industry still has a long way to go.
Chinese pharmaceutical services companies that target Western drug companies are concentrated in three main areas: pharmaceutical chemicals, clinical research, and discovery services. The chemical segment has emerged as a principal source of raw materials and non-GMP intermediates for the pharmaceutical industry globally. Even the leading Indian active pharmaceutical ingredient (API) manufacturers are sourcing early-stage materials in China. Although manufacturing generic APIs for the local Chinese market is well established, the production base is still small for APIs manufactured under US and European GMPs. Intellectual property protection remains a major concern in China and is another factor holding back the development of contract chemical manufacturing.
The clinical research sector is still in its early stages, dominated by the major global CROs such as Quintiles (Research Triangle Park, NC, www.quintiles.com) and PPD, Inc. (Wilmington, NC, www.ppdi.com) that have opened offices and laboratory services in Beijing and Shanghai. Only a few local CROs have opened, including Excel PharmaStudies in Beijing (www.excel-china.com). Frontage Laboratories (Malvern, PA, www.frontagelab.com), a US-based provider of development services, recently opened a bioanalytical and pharmaceutical chemistry laboratory in Shanghai.
Investors target early development
Currently, the hottest sectors for Chinese CROs serving Western companies are early research and development (R&D) services, especially discovery chemistry. The standard bearer for the sector is Wuxi PharmaTech (Shanghai, China, www.pharmatechs.com). Established only in 2001 to provide discovery and process chemistry, Wuxi PharmaTech has grown to more than 250 employees and has ongoing relationships with Merck, Pfizer, and other major pharmaceutical companies. Wuxi recently opened a 250,000-ft2 chemical manufacturing facility, which operates to Western GMP standards.
The success of Wuxi PharmaTech has enticed entrepreneurially minded Chinese chemists and venture capitalists from the United States and China into establishing new research organizations offering discovery-oriented custom-synthesis and drug metabolism and pharmacokinetics (DMPK) studies, preclinical research, and bioanalytical testing. In fact, China's pharmaceutical services sector feels a lot like Silicon Valley during the Internet start-up boom of the late 1990s. Pharmaceutical services companies are receiving substantial valuations from investors even before they generate their first dollar of revenue, and founding entrepreneurs can't help but talk about "when we do our initial public offering." Bridge Pharmaceuticals (Beijing, China, www.bridgepharmaceuticals.com), a newly opened preclinical CRO established with SRI International (Menlo Park, CA, www.sri.com), recently received $22 million in venture capital from US investors.
Luring back Chinese scientists
New services companies are built around veteran scientists from Big Pharma, and venture capitalists are aggressively recruiting senior Chinese chemists and pharmacologists from major pharmaceutical companies to return to China to lead the start-up operations. These Big Pharma veterans bring two critical sources of value: their scientific expertise and their network of relationships with colleagues in Europe and the United States.
The expertise of expatriate Chinese scientists is critical because China has relatively little indigenous drug discovery and development experience. Because of past disregard for intellectual property protection and low income levels, Chinese drug sales consist primarily of over-the-counter and generic products. Almost no new molecular entities have been developed in China, so the region has little or no local talent base for critical disciplines such as medicinal chemistry, GLP toxicology, and dose formulation. Most start-up operations are limited to providing small-scale, cookbook chemistry services because they lack the expertise to do more. A key to success for these start-up operations is to pass on the skills and experience of the returning expatriate scientists to locally educated graduates.
The returning scientists' relationships with US and European colleagues are critical to the success of the new service ventures. Most of these companies do not have sales and marketing staffs and depend on their founders' relationships to bring in new business. Because the founders usually leave families behind in Europe or the United States, they travel back frequently and use those trips to make sales calls.
Those trips home are important for new business development, but they can interrupt management continuity and undermine efforts to build organizations that inspire the confidence of Western pharmaceutical companies. The issue relates to more than technical expertise; it also relates to how the operations are run.
For instance, although Chinese CROs are very conscious that cost is their principal source of competitive advantage, their cost management can go too far. A case in point: Executives are anxious to assure potential clients that they make every effort to respect and safeguard intellectual property, but entry to laboratories is still not controlled tightly. Keycard access is used sparingly, and reception desks are often left unattended.
Another example: Housekeeping standards are not always appreciated. Even in non-GMP or non-GLP discovery operations, it is disconcerting to see used latex gloves lying on tabletops in animal dosing rooms or cigarette burns on the floor. Poor housekeeping will immediately turn off a delegation from Big Pharma.
Big Pharma interest
Industry has a growing concern that the labor-cost advantage driving Western interest in Chinese drug development services may not last much longer. Labor costs for CROs around major cities such as Beijing and Shanghai are rising at the rate of 15–20% per year, meaning they are doubling every five years. In addition, companies often must provide nonwage compensation such as housing and car allowances. Competition for scientists with postdoctoral and full-time work experience at major Western pharmaceutical companies is particularly intense. Some observers believe that the combination of wage inflation and the likely appreciation of the renminbi against the dollar will greatly diminish the cost advantages of Chinese CROs in the next 5–10 years.
Despite the potential erosion of the costs advantage, Big Pharma companies are anxious to get established in China. Immediate cost savings are the main driver, but they have a longer-term objective as well: the local market opportunity. China already ranks as the ninth largest pharmaceutical market and, according to some projections, will jump to the position of fifth largest market in 5 years.
Some major pharmaceutical companies still are searching for an appropriate way to operate in China, but others have jumped in with both feet. Roche established an R&D facility in Shanghai, and Novartis announced plans for one. One of the most innovative approaches has been the ChemExplorer (Shanghai, China) venture in Shanghai between Lilly (Indianapolis, IN, www.lilly.com) and Chem-Partner (Shanghai, China), a discovery services CRO. ChemExplorer was established using what has been labeled the "B–O–T" model, which stands for build–operate–transfer. Under that model, ChemPartner had initial responsibility for setting up ChemExplorer's laboratories, hiring staff, and managing operations. Over time, management of the scientific operations has been transferred to Lilly, which appoints the senior scientific staff, although administrative responsibilities have remained with ChemPartner.
It is clear from my visit that China is on the rise as a center for pharmaceutical R&D, but the trend is still in its early stages. Pharmaceutical companies are still getting their footing for operating in China, and the pharmaceutical services industry still has a lot of maturing to do.
One scene at the Impact China II conference captured the state of affairs for me. On one side of the conference hall sat a five-member team from a major pharmaceutical company that came to explore how its company should establish operations in China. On the other side of the hall sat a senior research scientist who was there at his own expense to determine whether he should accept an offer from a venture capital firm that was recruiting him to lead a CRO start-up.
He worked for the same Big Pharma company that sent the five-member team.