Asian Outsourcing: Getting It Right
Choosing an outsourcing business structure that ensures successful outcomes
by Daniel Bartholomew and Matthew Shocklee
In an atmosphere of declining R&D productivity, mounting pricing pressure and changing regulatory requirements, pharmaceutical and life sciences companies face increasing challenges to achieve and maintain profitable growth and innovation. Pharmaceutical outsourcing offers companies one of the strongest opportunities to address these challenges, allowing companies to focus limited Resources on the highest-return business initiatives, to access specialized expertise, to achieve cost-saving benefits and to reduce burn rates that lead directly to greater shareholder value.
The race for the most coveted outsourcing locations and reliable service providers is on as global pharmaceutical companies increasingly turn to Asia-Pacific countries to satisfy their global outsourcing needs. Pharmaceutical outsourcing in Asian countries, especially China and India, has exploded in the recent years. For years, China and India have been global factories for raw materials and, more recently, active pharmaceutical ingredients (APIs). In addition to manufacturing, Singapore, India and China increasingly provide economically viable alternatives for R&D, specifically for early-stage drug development.
As Pan-Asian countries expand their experience and knowledge in pharmaceutical R&D, GMP compliance and supply chain management, they are subsequently expanding their service capabilities to include late-stage R&D and finished-product manufacturing. Dozens of generic Indian pharmaceutical products, including injectables, are now distributed in the U.S. China is also catching up to India in the finished-product manufacturing arena, as several Chinese pharmaceutical companies have filed ANDAs with the FDA to seek entry into the U.S. market. Western interest in these regions is growing; however, China is quickly emerging as a favored destination for Asian-Pacific business. In the most recent PricewaterhouseCoopers CEO survey, which looks ahead to the next three years, 55% of the CEO respondents indicated that they plan to set up operations in China while just 36% said they plan to do the same in India during the same time period.
While the expanded Asian business potential and outsourcing capabilities offer greater cost-saving and revenue-growth opportunities, Western pharmaceutical companies must carefully navigate the challenges that arise from operating in these regions. One challenge lies in meeting regulatory compliance. Though products made in China and India offer Western pharmaceutical companies -- and consumers -- attractive price incentives, most Asian contract manufacturing organizations (CMOs) still fail to demonstrate the rigor of regulatory compliance that Western companies demand and their customers expect. Government officials in Asia know they have to overcome a huge hurdle: they must instill confidence in the quality of its products. Unfortunately for them, recent incidences of injectables contamination (some of which caused patient deaths in China) and animal food poisoning have marred China's reputation.
Decreased ability to transfer some of the production risk to a CMO partner is also becoming increasingly difficult for Western pharmaceutical companies. In many industries, the ability to transfer risk (whether financial, performance or other) to your outsourcing partner can be a key driver for outsourcing. This is not the case in highly regulated industries such as pharmaceuticals. Pan-Asian CMOs are steadily enhancing their performance capabilities and moving from lower-tech functions (front-end, raw material production, packaging materials and API intermediates) to more technically challenging functions (high-end R&D, finished API and pharmaceutical product manufacturing). Consequently, the inherent risks, including potential for litigation and diminished production quality, increase significantly as operational transparency becomes more difficult to maintain.
As is often the case, Western companies must realize that the very Asian companies with which they look to partner may also become their future competition. As Asian companies -- especially Chinese enterprises -- look to prosper in the global economy, they are searching for global market share and influence for themselves. Most Western multinational companies with a Chinese presence have only recently begun to consider the potential that Chinese enterprises could emerge as global competitors. This theme became evident in our CEO survey, in which 52% of the respondents indicated that they expect Chinese companies to become significant competitors in the next three years.
Even with these challenges, Western companies should not be deterred from taking advantage of the vast resources and superior competitive costs that Asian outsourcing offers. Truly global pharmaceutical companies have demonstrated the benefits of Asian outsourcing, and those Western companies that successfully navigate the landmines and secure a market foothold in these regions can ultimately gain a substantial competitive advantage.
The Eastward Progression: Pharmaceutical Global Outsourcing Process
For Western companies to successfully establish their footprint in Asia-Pacific countries and achieve successful outsourcing outcomes, they must thoroughly understand their unique outsourcing imperatives, create an optimal global business structure, and effectively and efficiently build and manage the new global business model. As Figure 1 outlines, there are numerous considerations along the life cycle of the global outsourcing decision process, all of which companies must address to ensure that they select the right business model and business partner(s) to ensure high quality and successful global outsourcing operations.
Increasingly today, understanding the organization's risk appetite and risk profile are driving factors in being able to answer the why, what, where, who and how of outsourcing pharmaceutical operations to Asia. Global outsourcing has unique risks that typically fall into regulatory, political, financial, organizational, brand and security categories. Understanding the unique risk characteristics of the Asian countries and how they relate to the risk categories and the organizations' risk profiles are all critical success factors to outsourcing in Asia.
Once an organization has defined its risk profile, determined the most appropriate scope of business operations to outsource and identified the Asian market where its operations are most likely to succeed, the company must select the business model and suitable business partner(s) or outsourcer(s). While the number of credible outsourcing partners today is growing exponentially across all Asian countries, the potential business model options come down to four basic alternatives: traditional direct outsourcing, captive/acquisition, build-operate-transfer (BOT) or joint venture (JV). Each of these business models has their own merits and differentiators.
The most common outsourcing model is a "traditional outsourcing" relationship, in which the primary company contracts one or more services from a third-party provider or outsourcing partner. Alternately, companies can create a "captive," in which they actually own the overseas operation and operate it themselves. Based on the need to quickly enter a market and retain full control, an "acquisition" of an existing capability/provider may be an attractive and similar option. A third option is a lease-to-buy or "build-operate-transfer" (BOT) model. This collaborative relationship involves three components: building an offshore development center using the synergies of its existing offshore infrastructure; operating the offshore development center for a predetermined time period, building up the necessary people, processes and infrastructure; and then transferring the legal entity at the end of a mutually agreed-upon time frame to the pharmaceutical company. The fourth option is a joint venture (JV) business model, which involves setting up a business operation jointly with a service provider where one or both of the parties retain an option right to fully acquire the equity position of the other party(s). In the JV model, investments and returns are typically shared proportionally.
As Figure 2 outlines, there are merits for each of the business models, and whether a particular model is the appropriate fit will depend on the unique needs of the organization over the planning horizon for the outsourcing initiative and the specific Asian marketplace targeted for the outsourced function.
Multinational companies that outsource to China (and, to a lesser extent, India) often do not fully understand that, the greater contribution the market makes to their revenue and earning, the more the market will be a driver for reform and change for their own organization and strategies. For example, companies that rely on IP ownership should rethink their value management or fall victim to powerful forces that seek to devalue IP in select markets, such as China. Likewise, companies that face global market value degradation should reconsider product development management to obtain more choice and vertical depth, develop global M&A strategies for capacity management and revenue growth, and enhance organizational capacity to perform successfully in the diverse emerging economies of the Asia-Pacific region. Further, to avoid potential risks and ensure quality outputs, these companies must remain agile and strengthen the controls within their global organizations.
As the pendulum for the pharmaceutical industry shifts from the West to the East, the pharmaceutical landscape for multinational companies in Asia will look radically different. Western companies that want Asian market share and a competitive advantage must seize opportunities to get a foothold in the region, quickly learn to navigate the risks and sustain a growing presence. While operational risks continue to concern the industry, Asian outsourcing can provide unlimited opportunities for companies agile enough and willing to take a process- and risk-driven approach.