OR WAIT null SECS
What if we are underestimating China’s response to US/EU inshoring?
In the words of Bill Gates, “We always overestimate the change that will occur in the next two years and underestimate the change that will occur in the next ten.”
That quote has been on my mind as I watch what’s happening in pharmaceuticals manufacturing right now. Drug makers, especially API producers, are leaving China in increasing numbers, motivated in part by the pandemic but also by forces that predate COVID. Change is in the air. But, as Gates warns, we often inflate what will happen now and misunderstand what will happen later. I think the present is a prime example.
The pandemic highlighted a long-existing issue in pharma manufacturing: the heavy reliance on China, which produces almost half the APIs used in the world. Many countries rely on China for their entire supply of critical ingredients. Europe, for example, closed its last Paracetamol factory in 2008 because it could not compete against China (and to a lesser extent India) on cost.
As a result, that supply became vulnerable to the same issues with compliance, tariffs, IP protection, and geopolitical uncertainty that have been complicating Chinese manufacturing in recent years. Then, when COVID hit and important medical supplies, including paracetamol, became scarce, the wisdom of outsourcing production was called into question.
Now we are seeing a swing in the opposite direction: governments and drug makers are exploring ways to bring production back to North America and Europe so that recent history doesn’t repeat itself. How much production will actually leave China, however, remains to be seen.
I estimate that a maximum of only 15% of current production will actually leave. It could be much less in the end. Suggesting it will be higher, however, falls into the trap of overestimating short-term change, especially, with the world still in the throes of COVID-19. But in another year or 18 months, when we will have learned how to live with the pandemic, market dynamics will prevail. By then, I’m skeptical that we will witness a mass exodus of pharmaceuticals companies from the Chinese market.
Why? Because there are huge hurdles facing even the drug makers who feel most motivated to leave China. They will first need to secure financing to set up a domestic or proximate production facility. Then they will have to meet massive compliance requirements (and rely on slow-moving inspectors) before they can start production. The amount of time and money it takes to inshore production looks somewhere between unrealistic and impossible. Therefore, most will stay in China while an intrepid few will leave.
It will be important to see how many global drug makers exit China and how they negotiate the reshoring effort. But it will also be important to keep this minority in context: they are not rewriting the status quo in pharmaceuticals manufacturing. Not yet, at least.
It would be tempting to observe the ongoing migration from China and conclude that reshoring or dual sourcing will transform drug making as we know it over the next decade. But I think that misses a more important point.
Namely, that China will react. It won’t sit idly by while a quarter of drug production departs. Beijing will respond in ways that will reverberate throughout pharmaceuticals manufacturing.
In one scenario, China takes up a protectionist position behind its own drug companies. It could pull investment out of Europe and the US and erect higher trade barriers, forcing every drug maker to reconsider their production strategy and adapt to a shifting competitive landscape.
In an alternate scenario, China tries to stop the bleeding by raising standards for quality, transparency, and equal treatment between foreign and domestic companies. Those moves would make Chinese manufacturing look like the best option once again, but they would only isolate more production in Asia where it will remain vulnerable to supply chain issues
We should also factor in how regulators in Europe and the US respond in coming years. If they found ways to unleash investment and cut red tape, the decision to inshore production would look more feasible regardless of what China does.
It will take years for these developments to play out. Once they do, however, the landscape in pharmaceuticals manufacturing will look drastically different than it does now. Everyone in the industry must decide for themselves how best to adapt. But one thing is certain: inaction isn’t an option. The transformation happening over the next decade requires everyone to embrace a new set of assumptions and build a fresh playbook around them.
I suggest we all get started soon.