While the Covid-19 pandemic continues to take its toll around the world, its aftermath on the global economy and daily life are yet to be fully comprehended. An increasing number of voices are advocating the need in the post-Covid world to rethink how society operates and fundamentally reassess our very economic model and values. The argumentation is that the “old” world and models have shown their limits and are not sustainable—simply continuing to follow these is a failsafe recipe for disaster for humanity.

Within this framework a recurring theme is the imperative to reconsider how supply chains are organized to ensure that dependencies from other parts of the world are reduced, if not altogether eliminated. This would represent a complete reversal of the trend towards globalization that began over the last thirty or more years. All industries would be impacted, including pharmaceuticals. Voices relayed by politicians in both the EU and the U.S. are calling for a reshoring of pharmaceutical production.

In such a context, continuing to rely on China, and other Asian countries, as sources of pharmaceutical fine chemicals may appear as anachronic nonsense that goes against “common sense.”
However, in our view, this thesis does not withstand a close analysis. Once the dust and emotions associated with Covid have settled, a more balanced attitude is poised to emerge.

The future pharmaceutical supply chain will be shaped by taking into account the competitive advantages associated with different locations. The pendulum will swing back to create equilibrium and common sense will eventually prevail—with the understanding that reshoring, autarchy and self-sufficiency per se does not make more sense than complete offshoring.

A key to success for Western companies will be the ability to select the best option—on a case-by-case basis—depending on the product considered. This should determine with whom to partner in foreign countries in order to leverage competitive advantages without incurring pitfalls. In this article we present a simple set of objective criteria to guide the supply source selection process focusing specifically on China.

Is China out?
Over the last ten years, following a number of developments, the suitability of China as a source of pharmaceutical fine chemicals, including both intermediates and finished API, has increasingly come under the spotlight in the West. This scrutiny is the result of several factors, including:

• Setbacks incurred by some Western pharmaceutical companies that have attempted to transfer the production of some API to China and found the set-up and/or partners retained proved to be unsuitable and/or not competitive. A notable example being represented by Pfizer with steroids.

• High profile problems including casualties caused by Chinese imports of poor quality heparin and more recently reports of nitrosamine contamination in sartan API used in the treatment of hypertension. These problems have seeded doubts about the suitability and reliability of Chinese sources and these concerns are being echoed and amplified by regulatory issues encountered by several Chinese pharmaceutical fine chemical producers. FDA’s wrath following GMP compliance issues are often associated with data integrity and compliance with standard operating procedures—a number of Indian vendors have also been caught.

• Continuing double digit labor cost inflation and escalating investment requirements have narrowed the cost advantage traditionally enjoyed by China. This is evident when total sourcing costs, including extended length of the supply chain, time and other resources required for solving inefficiencies and problems caused by distance and communication issues are duly factored in.

• Supply disruptions for basic building blocks and intermediates like substituted benzo-nitrile precursors used in the synthesis of various sartans having occurred since 2016-2017 following numerous site closures and operating restrictions imposed by Chinese authorities in the aftermath of industrial accidents and public outcry associated with mounting environmental problems. Several of these supply disruptions have resulted in end product shortages in the West. A notable example is represented by BIT (benzisothiazolinone) biocides used in industrial and personal care applications—both the EU and the U.S. are entirely dependent on their BIT production of intermediates sourced from a handful of Chinese producers.

•  Recent trade frictions, tariff war and saber rattling between the U.S. have further complicated the situation. The Chinese government has hinted it may consider leveraging its status as the world’s dominant API supplier as a bargaining chip to gain concessions from the West. Past experience suggests that this may represent more than a theoretical threat—ten years ago China leveraged its dominant position in rare earths, a product family critical for the electronic and catalyst industry—curtailing exports in retaliation of the seizure by the Japanese Coast Guard of one of its fishing boats. Within this framework, a statement made by a Chinese official at a recent congress of the Communist Party, said, “…while (China) is at the mercy of others when it comes to computer chips, we are the world’s largest exporter of vitamins and antibiotics. Should we reduce the exports, the medical system of some western countries will not run well.”

• The Covid-19 pandemic is wreaking havoc on the supply chain for several products following the shutdowns that affected most Chinese provinces while slowing trade flows—a situation exacerbated by the:
   - Indian authorities’ decision to impose export restrictions on various API.
   - Severity of the pandemic in Northern Italy (Lombardy), a region that region hosts many fine chemical producers that supply custom made intermediates and API to U.S. pharmaceutical companies. This area was particularly hard hit and forced some producers to shut their plants or to operate at slower rates.
   - Surge in demand for some API used in intensive care wards caused by the wave of Covid-19 patients in the EU and the U.S. resulting in shortages. The situation has made the West realize its dependence on imports for a substantial share of its API and related intermediates. Depending on the source, estimates are anywhere between 40 and 70%, and could be even more for some specific products like beta-lactam antibiotics.

Not surprisingly, following these developments more and more voices are advocating a reversal of the pharmaceutical supply chain offshoring to ensure security of supply and prevent new shortage situations. Politicians and other constituents have quickly relayed and exploited these voices arguing national security imperatives and opportunities to bring back home value added industrial activities and associated well paid jobs.

As a result, on both sides of the Atlantic, governmental and industrial bodies are increasingly recommending measures to revive local pharmaceutical fine chemical production and substitute imports, particularly from China. In such a context, opinions calling for a more critical and balanced assessment of potential benefits and returns expected from reshoring these activities in light of the substantial investments likely to be required are quickly dismissed.

The thesis backed by reshoring supporters is that the reborn Western pharmaceutical fine chemical production base will rely heavily on new technologies like continuous processes and artificial intelligence. These advanced techniques and others are viewed within the industry as having the potential to completely change traditional rules of the game in terms of capex outlays and environmental footprint—factors that could obliterate the competitive advantage traditionally enjoyed by offshoring to China.

Never follow the crowd
While it is beyond the scope of this article to argue whether new technology and political support will effectively lead to a massive reshoring of the pharmaceutical fine chemical production base to the West, a legitimate question to ask is whether abandoning and writing off China as a fine chemical source makes sound business sense.

It is not possible to answer yes or no to such a question—this would mean treating the entire Chinese fine chemical industry and its more than 35,000 companies as a whole. This would obviously be a gross oversimplification. Similarly, the answer to the question as to whether China can represent a suitable source depends on the specific product considered. Therefore, a thorough case-by-case analysis taking into account the products to be sourced and individual potential suppliers is needed. Not all situations are comparable.

To this end it is important to recognize the diversity of the Chinese fine chemical industry structure. A further complication is represented by the opacity, particularly for foreigners, of the Chinese industry where the same company is often reported and known by different names. Its affiliation and real scope of activities, namely production or simply trading, are frequently unclear.

Similarly, sourcing “standard/catalogue” types of products like early stage intermediates and off-patent API involves very different issues and challenges compared to custom made molecules—be these advanced intermediates or finished API.

Under these circumstances, the selection of the right supplier in China for a given product is far from trivial and requires thorough due diligence applying objective criteria and insights.

Based on the experience accumulated over the last years, a pragmatic checklist for screening and ranking potential suppliers has been developed and is proposed in this article.

This checklist is reported in Table 1 and considers eleven factors—four relating to the company/plant location while the other seven are specific to the company ownership structure, financial position and operations. Each factor is given a weight reflecting its perceived importance—the company being attributed a score between 0 (worse) and 10 (best) against all factors—the highest scoring companies being retained for focus.



The location of the company must be evaluated, taking into account the province where the company/plant is located and its physical setting. The commitment and support provided by various Chinese provinces to the chemical industry differs, and so too does the regulatory framework governing chemical operations that within those provinces, some of which have developed following high-profile industrial accidents that occurred over the last few years and led to the creation of guidelines imposed by the Chinese Central Authorities.

The policies and attitudes of the provinces vary depending on their degree of economic development, density of population and contribution of the chemical sector to their GDP. Within this frame, the provinces that are the most supportive of the chemical industry and the most advanced in having developed a predictable regulatory framework appear to be Jiangsu, Guangdong, Shandong and Zhejiang. These provinces host twenty-one out of the thirty top chemical parks in China and have issued firm deadlines for companies to transfer or close plants located in areas declared unsuitable for chemical activities. These regions have provided a more predictable framework that does not yet exist in other provinces where decisions to close chemical operations can be unpredictable.

Next to the province, an important factor to consider is a plant’s physical location. Ideally this should be in a large industrial park—preferably dedicated to chemical activities. The declared intent of the Chinese authorities is to have chemical companies—particularly small- to medium-sized ones—move their activities to parks. This set-up facilitates the monitoring of compliance and enables tenants to have access to infrastructure and services like utilities, wastewater treatment and fire protection that would be out of reach for individual companies.

It is important to note that while industrial parks are invariably managed by cities and local governments, not all parks are equally attractive and suitable. Top ranking parks are those that have a certain size—larger parks tend to receive more attention and support from local authorities given their important socio-economic impact. They tend to be better managed and more selective in the selection of perspective tenants, reducing the risk of industrial disruptions. Accidents affecting a single tenant in smaller parks often trigger a domino effect that impacts all other companies there. Authorities will not hesitate to close the entire park under such circumstances. The list of top-ranking chemical parks in China are given in Table 2.

Given the priorities set by the Chinese authorities it is also critical to assess whether the plant is located at a suitable distance from sensitive areas including surface water bodies or residential areas. For example, in the short- to medium-term, all chemical factories located at a distance of less than one kilometer from the Yangsu River are slated to be closed or to be relocated ideally at a distance of five to ten kilometers away from water bodies. The grace period granted by the authorities differs depending on the province and size of the company.
Having analyzed how the company scores against location related factors, the company profile and operations are assessed in terms of:

1. Ownership structure – publicly owned Chinese companies score higher compared to their state-owned counterparts, reflecting more entrepreneurial drive and flexibility. Privately-owned, unlisted companies score the lowest and tend to be financially stretched and opaque, stressing the need to exert appropriate due diligence when checking a company’s financial position and rating—a determinant of viability.
2. Size – ideally the company selected is large enough to ensure its continuing viability and achieve adequate economies of scale while small enough to care. As a benchmark to assess this criterion we recommend taking into account as a proxy of size the number of employees—it’s easier to check. The top score of 10 is attributed to companies with more than 500 employees, while a score of zero goes to entities with less than 150. Chinese vendors with such a limited size tend to have stretched finances and do not always operate according to best standards, which threatens their short- to medium-term reliability as supply source.
3. Financial position – a benchmark of particular importance is represented by a firm’s debt load compared to sales or EBITDA. The publicly available www.gsxt.gov.cn/index.html website provides a valuable source of information.
4. Geographical coverage and experience in dealing with foreigners – communication hurdles associated with language issues and different mental models should be carefully taken into consideration by a Western player when selecting and dealing with a Chinese company. To this end, companies that have a purely domestic Chinese focus are likely to prove much more problematic than vendors that operate on export markets.
5. Quality standards – absence of quality standards should sound an alarm signal. Comparably, reliability claims based solely on ISO standards should be viewed with caution. More reliable indicators are adherence to Chinese GMP—a stamp of quality involving increasingly hurdles imposed by the local authorities. Or even better, look for adherence to Western health authorities’ standards.
6. Licensing situation – due to either lack of resources or structural problems, several companies in China continue to operate without having the licenses mandated by the authorities for the various products they are handling in their plants. Until recently, an attitude of benign neglect has prevailed with authorities most often closing their eyes. However, following a number of industrial accidents, since 2016 the situation has completely changed. Today, not having the required licenses is no longer tolerated and is a failsafe recipe for closure. Therefore, when selecting a potential supplier, it is critical to do your due diligence regarding the company’s licensing situation—particularly if the product of interest is considered by the Chinese authorities as hazardous and appears on the list published by authorities.¹
7. Type of chemistries and products involved – contrary to common belief, fine chemical production in China is strictly regulated and subject to multiple permits. Introducing a new product in a plant requires a thorough evaluation of associated risks, particularly if the synthesis involves one of the eighteen reactions listed by the Chinese authorities as hazardous (see Table 3). Obtaining a permit involves substantial costs—in the range of RMB 300,000 to 800,000—and takes between one or two years. Four assessments are needed: one covering safety to be submitted to the “Safe production supervision Administrative bureau”; a second one is the Environmental assessment required by the “Environmental Protection Agency”; the third one is the occupational disease prevention assessment needed by the “Health bureau”; and lastly an energy assessment is needed. Due to these hurdles, several Chinese vendors often prefer to decline requests for new custom-made products, preferring to stick to their catalogue.

By systematically applying these criteria it is possible to objectively position the various Chinese vendors on a matrix. The horizontal axis shows their score in terms of location, while the operational score is listed vertically (see Figure 1). This helps to distinguish between four categories of perspective suppliers: a) better to avoid; b) good location but questionable standing; c) good standing but poor location threatening long term viability and reliability; d) good candidates worth close consideration.

Summing up
In the aftermath of Covid-19, sourcing pharmaceutical fine chemicals from China appears to be an anathema. However, erasing this country as a potential source, as advocated by some, does not in our view represent a sound business decision. It does not make much sense to close our doors to the large and diverse Chinese fine chemical industry. Western firms trying to produce locally all they’ve been importing from China would require massive investments and involve long lead times for dubious economic benefits.

A more balanced approach is required. One where pharmaceutical supply chains appropriately combine inputs coming from China with operations performed locally. Extreme measure should be avoided. Within this framework, the selection of the most suitable Chinese suppliers based on objective factors is of paramount importance. It is a process that requires developing adequate insights on these players in order to conduct proper due diligence. 

*Note: The authors would like to thank Ms. Dai Lu of Alfa Chemicals Nanjing for her invaluable contributions to this article.

1. https://www.mem.gov.cn/gk/gwgg/agwzlfl/gg_01/201503/t20150309_237187.shtml

---

Dr. Michele Jermini is the Managing Director of Alfa Chemicals (Suisse) SA; mjermini@alfachemicalsint.com

Dr. Enrico Polastro is a Vice-President of Arthur D.Little; polastro.enrico@adlittle.com