Western Manufacturers Buy in China

07 June 2004 00:01  [Source: ICB Americas]

For many fine chemical and pharmaceutical companies, China has become an important source of low-cost intermediates. Clay Boswell reports.

Obscured by cultural, linguistic and geographic distances as well as the ambiguity that comes from too many choices, the Chinese fine chemicals market remains something of a mystery to many reluctant Western companies. But major players in the manufacture of active pharmaceutical ingredients have successfully included China in their sourcing strategies, and a number of other companies have emerged specifically to ease the transaction. They say that quality and reliability have improved significantly, and costs are still among the best in the world. Moreover, they note, waiting to enter the Chinese market brings its own risks.

“What people have got to learn is to stop generalizing about ‘the Chinese suppliers’—there are good and bad suppliers just like in America,” says Guy Villax, Hovione’s chief executive.

Hovione, which has sites in Portugal, New Jersey and Macau (a former Portugese colony that reverted to Chinese control in 1999), has worked with Chinese manufacturers since 1979. “Originally we were buying products,” he says. “Later we implemented technology transfer programs involving process, quality control and HSE [health, safety and environment], and turned many of the relationships into outsourcing programs. This was only possible by having established technical bases in Hong Kong and Macau.” Hovione now buys roughly 25 percent in value and 10 percent in volume of its raw materials from the Far East. “It has been very, very positive and constitutes today an integral part of our manufacturing strategy,” Mr. Villax says.

The number of companies manufacturing active pharmaceutical ingredients in China is staggering: about 4,000, according to Susan Capie, president of PharmaVantage, a Babylon, N.Y.-based consultancy specializing in the Chinese pharmaceutical market. They produce 1,350 different active pharmaceutical ingredients (APIs), 98 percent of which are generics, and 300 biological products. Among the best known companies are those that have received approval from the US Food and Drug Administration (FDA), such as Zhejiang Hisun, Shanghai Pharmaceutical Group and Shandong Xinhua Pharmaceutical Group, says Ms. Capie.

“One rising group I work closely with is Zhejiang Hengdian Group—they have four manufacturing plants, API and intermediates,” she adds. “The Sanjiu Pharma Group has been acquiring factories—including Sichuan Long March, Shijiazhuang Lixin and recently… a small Japanese firm. Worldbest Group (a non-pharma conglomerate) has been buying shares in a number of pharma companies—including Jiangsu Jiangshan, Anhui Bengbu and Shanghai Pharma. One very small private company, Dalian Luyuan, has grown enormously due to some partnerships in custom manufacturing with Western firms. Zhejiang Yefeng (Wild Wind) Group is also using its textile money to invest in pharma.”

Other major players are North China Pharma, Lukang Pharma, Xin-hua Pharma, Shijiazhuang Pharma and Harbin Pharma, according to Michael Pang, associate director of the strategic research group of Ipsos (China) Marketing & Consulting Co. Ltd. in Beijing. “The majority of them have been restructured from SOE [state-owned enterprise] to corporate and publicly listed in domestic or overseas stock exchange,” he notes. “After the IPO [initial public offering], they have raised quite large amount of capitals, part of which is used for M&A [mergers and acquisitions].”

Altogether, production of APIs and intermediates by such companies totals about 732,000 metric tons, generating sales of $17.5 billion and profits of $3.5 billion, according to Ms. Capie. Much of the revenue comes from overseas. API exports between January and September 2003 totaled $2.3 billion, an increase of almost 25 percent over the same period in 2002, which itself saw an increase of 7 percent over 2001.

Growing Pains

The most important factor in this growth has been the ongoing liberalization of China’s economy—long centrally planned, it is increasingly market driven. Whereas the state always set production quotas and subsidized businesses, factories now set their own priorities and receive little or no support. They also handle exports themselves rather than going through state-owned foreign trade companies, and they travel and attend trade shows to learn about their markets. An entrepreneurial culture is emerging, notes Ms. Capie, where businesses either sink or swim. Increasing domestic competition is breeding broader product portfolios and alliances, she adds. The necessary consolidation is yielding stronger businesses and back integration, while participation in global markets has brought new knowledge, greater transparency and broadened awareness.

There have, however, been serious growing pains as opportunities outrun capability. Low costs have been the hallmark of Chinese manufacturers, and amid the fierce competition, corners are sometimes cut, particularly in the area of HSE. For example, last November, in a horrifying article entitled “Toxins Are Part of Cost of Boom in China’s Exports,” the New York Times reported that major violations of toxic waste regulations at Zhejiang Hisun, an FDA-approved manufacturer in Taizhou, had resulted in the death of employees and illness among the local population. More generally, toxic discharges and explosions are not uncommon.

“The recent accidents in China have attracted the attention of the State Council (the cabinet of the Chinese government), the most senior authority in the country,” notes Hovione’s Mr. Villax. During the first half of April 2004, 21 casualties resulted from seven separate chemical accidents in China, one of which was again at Hisun’s Taizhou plant. “No doubt a crackdown, if not a review of HSE measures, is in order.” He blames China’s rising accident rate on the rapid growth in industrial manufacture. “It is one of the side effects of delocalization of manufacture,” he remarks. “In Europe, the fine chemicals industry is plagued with overcapacity; we have empty plants and idle people; we have all the know-how; the systems and equipment are in place to treat every waste stream to the last ppm [part per million], every VOC [volatile organic compound] is dealt with—regulations make it tough to remain competitive. The competitive advantage of non-compliance becomes a critical question.”

Such practices are unsustainable, and the most ambitious companies are upgrading their operations to compare with Western and Japanese counterparts. “For those companies who just look into China and have no past dealing with China, I assume they would be very surprised by what they see there,” says Stephen Wang, president of Kingchem, an Allendale, N.J.-based sales and marketing organization representing overseas manufacturers in Europe and Asia. Mr. Wang, whose relations with the Chinese pharmaceutical industry go back 20 years, founded Kingchem 10 years ago. The standards among Chinese manufacturers vary widely, he says. “But for those better ones, if you only look into their ‘hardware’ (the size of the plant, equipment etc.), they are very close to some of the Western companies, especially for those newer plants built in recent years. They will be also surprised how many plants are available in China and how quickly they are improving. The chemistry they are handling becomes more sophisticated each year.”

Many Chinese companies are also working to align their business practices with those taken for granted in developed nations, and turning to both consultants and foreign partners for help. For example, Shanghai Pharma Group has hired the management consulting firm MacKenzie & Company Inc. for help developing more international business, according to Ms. Capie. “I think that Westerners underestimate how fast China is changing and the amount of investment going into both ‘hardware’—new factories, new equipment—but also into the regulatory compliance through the use of FDA consultants,” she says.

Moving Toward Western Standards

Establishing true cGMP operations would be a dramatic demonstration of capability and trustworthiness for any Chinese company. The State Food and Drug Administration [SFDA], China’s version of the FDA, has developed a GMP regime and mandated that all 5,082 API and finished drug manufacturers in China be certified to the standard by July 1 or lose their license to produce. By the end of April, more than 3,000 authentication certificates had been granted to 2,721 of these companies. “It is estimated that about 1,000 pharma [companies] will fail to reach the GMP standard and finally be required to halt production, the majority of which have fallen into business difficulties for quite a long time,” notes Ipsos’ Mr. Pang. Even without compulsory certification, he observes, they would very likely have become insolvent given the extreme competition. “According to SFDA policy, for some special categories that only host one or a few producers, if these producers fail to reach the GMP standard, the drug administration will push them to join hands with the GMP-certified players for transferring production in order to guarantee stable supply in the marketplace.”

SFDA certification is a positive indicator of a company’s manufacturing practices, but it is not the same as certification by the US FDA. “While the Chinese drug administration claims that Chinese GMP standards are getting closer to that of FDA standards, there is still some distance between these two standards,” observes Mr. Pang. He notes that of the many manufacturers to be granted certification by the SFDA, only a handful of them have been certified by the US FDA and allowed to export to the US market. While the requirements are similar, says Ms. Capie, the difference is in the execution. “Firms here [in the West] know that compliance is not just lip service when the FDA inspects—it is a daily practice that also entails regular training. Not all Chinese GMP plants have continuous training/updating for their staff.”

When the SFDA inspects a plant, hardware gets the most attention. “For example, the newer plants with new buildings and new equipment normally are more easily passed,” says Mr. Wang. “They do not pay that much attention to batch records and documentation. For those plants that have experienced an FDA audit, their understanding for GMP is much better than other plants that also hold a GMP certificate issued by China’s SDA.”

The result is that such companies are typically used for non-regulated raw materials. “Most companies view a company with a Chinese GMP as a company that has adopted a stronger view on quality and compliance and has the requisite controls in place, thereby providing a Western company a higher level of confidence,” Mr. Wang notes. “Those companies usually can provide quality material with appropriate analytical support and necessary documentation. The HSE standards are also generally higher than companies without GMP.”

“There are wide disparities in how the GMP is implemented,” says Jim Havlin, sales and marketing chief at ChemPacific. “As time goes by, those companies not in full compliance will not survive.” Some observers in the West expect the new requirements to eliminate the cost advantage enjoyed by Chinese manufacturers, he says. “I don’t believe that. The cost advantage comes from low-cost labor, equipment and overheads. This cost advantage is sustainable in the companies currently practicing good GMP methods. In short, I think people are mistaken if they feel that by strictly enforcing GMP, the Chinese and Indian competitors will disappear.”

Patent issues are the greatest weakness of Chinese producers, says Ms. Capie. “When the Chinese are developing an API they do try to do patent searches via the internet, but that is not complete,” she notes. “No factory yet has patent attorneys on staff, but I think for the larger pharma groups who are seeking partnerships with large Western firms, this may come soon.”

Partnerships with Western companies can provide Chinese companies some of the best insights into the cGMP worldview. Every one of the global top 20 drug makers have joint ventures or wholly foreign-owned enterprises in China, and the scale of these activities is growing, according to Mr. Pang. “The fast growth of China’s domestic pharmaceutical market has already lured many Western companies to localize their production, even R&D, here,” he says, noting that China is expected to become the largest pharmaceutical producer and consumer in the world. Some of these global innovators have turned to Chinese manufacturers for intermediates and API, says Mr. Pang. “For example, Japanese Daiichi is the inventor of ofloxacin, but it now sources ofloxacin bulk drug from Zhejiang Kangyu Pharma. Merck & Co. is the world’s largest manufacturer of ivermectin, and it also uses Chinese-made ivermectin and lovastatin API.” Eli Lilly has reportedly transferred capreomycin production to several companies, among them the Chinese manufacturer Zhejiang Hisun.

However, pharma innovators still use Chinese manufacturers mainly for intermediates, says ChemPacific’s Mr. Havlin. “There has been a large change in the past 10 years in this direction and those pharma innovators that have resisted sourcing intermediates from China now find that they must now do this to remain competitive. The next trend will be to move towards lower-tech, lower-profile older APIs. This should happen in the next 10 to 15 years. Finally, newer APIs will eventually be outsourced; however this is many (25 or more) years away.”

Bridges to China

Many Western companies still avoid sourcing from China altogether, daunted not only by stories that have circulated over the years, but also by the difficulty of distinguishing among 4,000 manufacturers on the other side of the world, not to mention the great linguistic and cultural divide. Others have broached those difficulties by turning to US-based intermediaries such as PharmaVantage, ChemPacific and Kingchem.

“A good consultant familiar with China is best to assist in initial evaluations of potential suppliers,” asserts Ms. Capie, who has over 20 years of experience in China. “Internet research is misleading, as often the best Web sites belong to the worst companies. You need to have someone in the company designated to be the main conduit with the Chinese supplier to ensure smooth, complete communication is maintained, otherwise various departments are receiving communications and not copying each other resulting in misunderstandings and delays. [You] also need to designate someone from the Chinese side to perform the same function—a main channel for all aspects of a sourcing project,” she says. “The customer should visit, be familiar with the key personnel in the factory—not just sales but production and QA. Customer should be as transparent as possible with the supplier on QA/specifications as well as perceived quantity/pricing needs and a realistic appraisal of long term cooperation as well as competition.”

Mr. Havlin points to some of the hurdles a Western company will face. “One mistake made by Western companies is not knowing who actually will manufacture their material in China,” he says. “Will it be the company they are dealing with, or will another factory produce the material? Another one is understanding the true capabilities of the company they are working with. Does the Chinese company totally control the manufacturing process, or will it in turn be further outsourced in China? Finally another mistake is understanding how problems and mistakes will be handled,” he warns. “During any buyer-seller relationship, there will be problems. How these will be resolved needs to be understood up front. For example, does the Chinese supplier have the technical and developmental resources to solve production and quality problems?

“In the case of ChemPacific, we work hard to make this process as efficient as if our customer was purchasing from another Western company,” says Mr. Havlin. “Actually, as a US company with laboratories and R&D capabilities in the US, we stand behind every product, whether we produce it in the US or China. We also have the resources inside China and in the US to solve problems as they occur. This is what differentiates us from other companies manufacturing in China or acting as a distributor for Chinese manufacturing companies.”

Local knowledge is essential, points out Kingchem’s Mr. Wang. “In order for Western companies to successfully outsource from China,” he advises, “they need to have the right staff in place with good knowledge, years of experience and a well-established network, so they can choose the right partner for the right projects.” For ten years, he notes, Kingchem has been performing these services, providing a “bridge” for Western companies by managing risk, identifying the right manufacturing partners, and providing logistics services. “Every company has to go through a learning curve when dealing with China, and one safe way to do it is to select a partner who truly knows China and who conducts business by Western standards and business practices.”

A Good Source For Basic Intermediates

Western API manufacturers sourcing materials from China are generally satisfied with the experience. “We do source intermediates from China,” says Stu Needleman, general manager, development services at Rhodia Pharma Solutions, which has its own sourcing team based there to help in finding and qualifying suppliers. The most important consideration is what clients want and expect, he notes, observing that some have more familiarity with China than others. “We continue to monitor who delivers and who does not and what companies are capable of doing, so we build up our network. Our customers expect us to source from China, India etc., so it will continue.” Quality is fine, he states, and will only get better. “I think what China lacks is larger-scale manufacturing/engineering design….I would not source cGMP work there yet and not final APIs. We started with building blocks and then build a level of experience.” Rhodia and Rhodia Pharma Solutions together have 17 plants of their own in China, he adds, a factor that “gives us local knowledge to stay ahead of the game.”

Ralf Pfirmann, global director of market management at Clariant Pharma-ceuticals, says the company has been sourcing raw materials and building blocks for regulated intermediates and APIs from both India and China for several years. “We do this as a matter of course to reduce our costs for our customers.” In India, Clariant produces raw materials and intermediates at its own facility. In China, the company turns to suppliers with whom it has longstanding relationships. “This activity is a part of using the full purchasing power of a global organization like Clariant to develop selective advantages to support our customers,” he says. “It is anticipated that as the capability of Chinese manufacturers develops even further, companies in this region will become an increasingly important option for Clariant in maintaining our global network of manufacturing in the service of our pharmaceutical customers.”

Nevertheless, the more technically demanding manufacturing of regulated intermediates and APIs remains at Clariant’s two Centres of Excellence in Europe and the US, as well as specialized facilities in France, Germany and the UK. “The goal of developing alternative sourcing relationships is to create additional value for our customers,” Mr. Pfirmann explains. “These facilities have unique technologies and a strong regulatory track record, as well as a history of high-quality production for the pharmaceutical industry. These facilities offer a high level of value in their production for the pharmaceutical industry which would be very difficult to duplicate from a different supplier.”

Mr. Pfirmann considers the basic issues around sourcing from China to be essentially the same as sourcing from anywhere else. “Quality, logistics and a strong working relationship are key elements that have been addressed as our work with producers in this market has grown. At Clariant, it is our job to manage the various issues that present themselves to create advantages for our customers. Where we can address the important issues of quality and consistency and take advantage of lower costs inherent in Chinese production, we do so.”

Cambrex also obtains raw materials and some basic intermediates from China. The selection there is broad, of good quality and getting better, and reasonably priced, states a representative of the Cambrex Purchasing Council. Another driver is the availability of certain raw materials that are no longer available in Europe. However, sub-standard packaging materials, incomplete import documentation and uncertain transport times are occasionally problems. “We cannot source items that cannot be planned well in advance of demand: The long lead times prevent them being a viable source in this situation,” she says. “We will also not use suppliers in China for certain classes of materials that require particular attention to storage conditions, packaging, and transport regulations.” Supplier selection is critical. “We have learned that extensive use of pre-shipment samples, detailed packaging specifications, and anticipating import document details can prevent problems. There are also benefits to using a reputable agent.”

Hovione never buys from suppliers before sending its own staff to make a visit that includes a tour of the plant and a meeting with the employees, Mr. Villax says. An audit usually follows. “The key question is, ‘Are these the kind of people we want to do business with? Is this a supplier for the long-term?” He notes that Hovione’s main suppliers in China have been on the company’s approved list for many years.

Solid Relationships Take Time to Develop

Time may be short for companies that have stood aloof. The partnering environment, though clearer, is becoming less favorable with time, observes Kingchem’s Mr. Wang. “They may find their competitive edge diminished because their competition may already be taking advantage sooner,” he notes. “The ability to set up joint ventures may not be as attractive since many of the well-established companies are already strong enough, so they are less interested in foreign partners. Their only interest is if you are a customer who will buy products from them. Additionally, most of the well-established companies do not have cash difficulty, since some are already publicly traded.”

Leonard Schwarz, chairman and CEO of Aceto Corp., a pharmaceutical and specialty chemicals distributor that sources a large proportion of its products from China, agrees that Western companies cannot afford to put off engaging with the Chinese market. “They should have substantial worries,” he says, “as the Chinese are the most competitive chemical producers in the world, particularly for fine and specialty chemicals and pharmaceuticals.” At the same time, however, he advises companies to look before they leap. “They need to fully understand the culture and how to do business in China. It is very different than in the West and even in Japan. They need to make an investment in time and energy to understand the Chinese way.”

Mr. Villax agrees that Westerners will have a difficult time if they are not sensitive to the Chinese mind-set and culture. “Relationships take many, many years to build, they then become relations of trust and friendship between individuals that respect each other,” he explains. Hovione has provided suppliers with process technology and quality control (QC) know-how, contributed to product development strategy and provided market expertise, he says. Moreover, the company is perceived in China as an end-user with a long-established plant in South China that pays fair prices. “We have therefore always received great service—a situation probably different from those that brokers and intermediaries have reported. On the other hand Hovione is very careful at selecting the best suppliers, and in China this is like finding a needle in a haystack.”

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