- The New Post-Crisis Economic Game: Emerging Economies Gain Advantage and Speed Up R&D Spending
- Asia's Growing Army of Scientists and Engineers Is Increasing Its Share of Scientific Publications and Patent Applications
- Emerging Economies' Catch-up Strategies Target Biotechnology Development
- Technological Convergence in the Life Sciences Transforms the Global Pharmaceutical Industry
- New Markets Constitute New Frontiers for R&D Offshoring
- The Creativity Gap: Asia's Challenge to Achieve Qualitative Parity with the West
- Navigating the New World of Global Innovation
New Markets Constitute New Frontiers for R&D Offshoring
The outsourcing of manufacturing is a well-established practice in business, to such a point that we speak of the "hollowing out" of Western economies, especially those of the United States and the United Kingdom, which have contracted out much of their manufacturing (particularly manufacturing assembly) to cheaper destinations in emerging economies. The offshoring of nonmanufacturing functions came later and has grown rapidly at double-digit rates; today most large U.S. and E.U. companies across a broad range of industries (including automotive, financial services, energy, commercial aircraft, and defense) offshore not just minor but also major business functions, even those traditionally associated with their core competencies. Offshoring today embraces not just IT and business process (back-office) functions, but also marketing, engineering, procurement, product development, design, and R&D, as shown in Figure 1-7. Just as IT outsourcing is showing signs of maturing, the new trend is global innovation offshoring, which is growing at double-digit rates and encompasses product development and design, as well as R&D.
Figure 1-7 Offshored business functions, by industry: percentage of firms offshoring the business function
Reproduced with permission from Booz Allen Hamilton, “Next-Generation Offshoring: The Globalization of Innovation,” Duke University, March 2007; and A. Lewin, et. al., “Why Are Companies Offshoring Innovation? The Emerging Global Race for Talent,” Journal of International Business Studies (40), no. 8: 1,406–1,406.
The software, information technology, and electronic appliance companies first established large R&D facilities in emerging economies. IBM, Intel, AT&T, and Motorola all have high-tech labs in China. GE opened the J. F. Welch Tech Center in Bangalore, India; by 2003, after only three years of operation, the center had filed more than 95 patents. Between 1999 and 2003, the number of employees there had grown by 80% and stood at 21,000 (14,500 are captive and another 6,500 are outsourced). Twenty percent of the center's budget is for long-term projects, such as new-generation washing machines and the key parts of the GE-90 jet engine. Microsoft, which has research facilities in Silicon Valley, San Francisco, and Cambridge, UK, has added Beijing and also opened a large R&D center in India. Industries that are following suit now include pharmaceuticals, biotechnology, and healthcare.26
As noted earlier, the huge investments in education, R&D, and regulation reform made by leading Asian nations are extending the landscape of available capabilities beyond the triad of the United States, Europe, and Japan, where the bulk of networked pharmaceutical R&D used to take place. As Asian nations and other emerging economies improve their competencies and accelerate innovation, they are forcing Western pharma companies to rethink what they regard as their core activities and which functions it makes sense to outsource or perform collaboratively in the new destinations.
The global pharmaceutical market is evolving rapidly. As we describe in Chapter 3, "A Reshuffling of Markets and Growth Opportunities," between 2005 and 2015, traditional Western markets will grow considerably, but at a moderate pace; none of these markets will double. The markets in China and India, on the other hand, will triple in a decade. By 2015, China is expected to be the fifth-largest pharma market in the world (after the United States, Japan, France, and Germany). India will be the tenth-largest market, followed by Brazil, Mexico, South Korea, and Turkey. China and India have the second- and third-largest growth opportunity globally.27
Indian companies are growing rapidly, as is their international collaboration (which includes licensing, acquisitions, manufacturing outsourcing, joint R&D ventures, and marketing alliances). As a result, many large venture capital and private equity firms have recognized opportunities in India. More than 350 private equity (PE) firms operate in India, and more are coming, with many of them pursuing active healthcare investments. At the same time, Indian companies have been making investments mostly in Europe, focusing on generics and contract manufacturing while creating their own R&D divisions.
As noted, Western pharmaceutical companies face major challenges, including rapidly maturing product portfolios, blockbuster drugs going off patent, and exploding costs of new drug development. In the past eight years (between January 1, 2001, and April 1, 2009), the market capitalization of the top nine pharmaceutical companies has dropped $712 billion. Between 2008 and 2015, drugs worth $300 billion are coming off patent, which means large potential revenue losses for the U.S. and European pharmas. Biotech companies will eventually face some of those same problems: A number of successful biologics drugs will go off patent within a few years.
Western companies face escalating costs of drug discovery and clinical testing just as their revenue streams are coming under pressure. Large emerging markets with improving local capabilities represent potential solutions to those challenges. China and India also offer opportunities for mature product life-cycle extensions based on reformulations, repackaging, and nonpatentable improvements. Collaborative partnerships with Asian companies can be a good way to improve market access for patented drugs through such tactics as comarketing and other joint ventures. Asia also represents a huge outlicensing opportunity. However, U.S. companies apparently have lagged behind their European rivals in key future markets such as India. In particular, U.S. biologics makers such as Genentech and Genzyme have not developed strong direct sales and marketing capabilities in India.
For biotech companies building a biosimilars business, emerging economies may also represent an important opportunity for joint ventures. The production of biologics is much more complex than chemical pharmaceutical generics, so the experience of Western biotech companies could be leveraged to share the cost advantages of emerging economy companies.
As noted earlier, several Asian economies today are viewed as good locations not only for manufacturing, but also for cost-effective innovation. The first step in such a process may be the globalization of clinical trials support. We discuss this process in Chapter 5, "Globalization of Clinical Trials." In 2006, the pharmaceutical industry employed approximately 1.97 million persons (full-time equivalents or FTEs); more than 300,000 of them worked in R&D. Sixty thousand to 65,000 persons worked in clinical support functions, and only about 10% (of related FTEs) are estimated to be "globalized" or "offshored." However, this ratio is likely to reach 30% and could even be as high as two-thirds of FTEs.28 Different pharma companies have shown different levels of commitment to this process by outsourcing different amounts of chemistry work, data management, biometrics, or discovery. For example, Wyeth is considered a leader in globalizing end-to-end clinical data management. After its 2003 decision to offshore complete data management functions to Accenture, Wyeth transferred 100 full-time jobs to Accenture. This also meant much larger increases in the numbers of globalized jobs engaged in clinical data management for Wyeth. The resulting cost reductions were estimated to exceed 40%.
Of the two R&D production phases, development constitutes the lion's share of spending. According to one report, about 70% of the R&D budget goes to development, while the remaining 30% goes to discovery research.29 In pharmaceuticals, the development phase comprises preclinical and toxicology tests, clinical trials Phases I–IV, and also post-clinical research. Some reports estimate that drug-development costs could reach $2 billion per drug in the near future. Since the end of the 1980s, the average cost of a new drug, including failures and clinical trials, has been growing 9% annually. Additional safety data and other trials required by the Food and Drug Administration (FDA) have increased the number of patients needed per new drug application from 3,200 in 1988 to 5,000 in 2004. McKinsey, a leading consultancy, sees the challenge in terms of dramatically rethinking the entire process of drug development based on globalization and eventually resulting in what it calls a "$100 million drug"—an even more ambitious target than the $300 million or so envisioned by Ernst and Young. In such a scenario, discovery and development time would decrease from 12–14 years to 5–6 years, the number of patients needed per approved drug would drop from 5,000 to 2,500, the clinical costs per patient per year would come down from $20,000 to $10,000 and the success rate (discovery to market) would improve from 1 in 5,000 to 1 in 2,500. McKinsey admits that the goal may sound intimidating, but other industries have set and achieved audacious goals, such as low-cost laptops designed for developing countries.30 Moving toward such a revolutionary objective requires companies to work in powerful consortia of complementary skills and capabilities, open source competition, and a global approach. This would represent breakthrough change because companies would need to be ready to offshore functions associated with their core competencies; until recently, such a move would be regarded as heresy. Today constantly rethinking and updating what constitutes a company's core competencies is becoming standard practice in high-tech industries.
The outsourcing of R&D activities has been going on in the pharmaceutical industry for quite some time, except that this outsourcing used to be strictly limited to Western firms and scientific institutions. Biotech companies, universities, government laboratories, and independent contract researchers have collaborated with the pharmaceutical companies for years. Since the 1970s, the emergence of the biotechnology sector has offered the pharmaceutical industry new opportunities to discover new products at lower risk and cost.31 Another important development was the Human Genome Project (HGP), which prompted pharmaceutical firms to get involved in genomics research by forming partnerships with companies that had specialized genomics capabilities. The emergence of combinatorial chemistry as an enabling technology that was hard to develop in-house also spurred major pharmas to create research partnerships with providers of combinatorial chemistry expertise. For example, Oxford University partnered with Pfizer. Academic institutions such as Duke, the University of Wisconsin, and Harvard, to name but a few, have partnered with pharma companies in research focused on Alzheimer's disease, diabetes, cardiovascular diseases, and others.
It is worth considering the factors that are pushing pharma and biotech companies to start offshoring more than just manufacturing (for example, India has 75 FDA-approved pharma contract manufacturing plants, while China has 25 and Taiwan has 12) and selected clinical trials. Governments strictly regulate pharmaceuticals development and manufacturing; in the United States, the FDA is responsible for this. As we noted, clinical R&D accounts for 30% of all R&D spending and 23% of all scientific and professional R&D personnel, with Phase III trials by far the most expensive component. These economics have created an entire industry of contract research organizations (CROs), which provide clinical trial services for companies that elect not to conduct those trials in-house. Western-based CROs compete vigorously with ones from Asia, and trials are also conducted in a variety of destinations around the world, including Asia and Central Europe. (See Figure 1-8 for international comparison of labor costs.)
Figure 1-8 Labor cost comparison, by country
Reproduced with permission from Merrill Lynch, KPMG & CII report, March 2008, quoted from Pharma Summit 2008: “India Pharma Inc.—An Emerging Global Pharma Hub.”
On the push side, three factors are at play: a shortage of talented personnel, competitive pressures to cut costs, and growing company experience with offshoring. The last factor makes companies more confident to extend offshoring to new frontiers and functions. As mentioned earlier, Asia's supply of skilled and relatively inexpensive manpower is growing rapidly just as the West is experiencing relative shortages of science and engineering talent, demographic decline, the retirement of baby boomers, and the new phenomenon of Asian graduates in science and engineering deciding to return home after completing their studies or earning doctoral degrees in the West. Rising healthcare costs, the prospect of comprehensive and regulated healthcare in the United States, and global competition all contribute to an acute need for the drug industry to find ways to drastically cut the costs of drug development.
On the pull side, emerging economies in Asia and elsewhere have not only improved their IP protection systems by signing up to TRIPS. As we have pointed out, these countries have upgraded their scientific, innovation, and educational capabilities as well. They are also becoming increasingly attractive markets for health-related products and are developing local LSIC companies that are becoming competitive partners for JV collaboration, investment, and acquisition. The Asian challenge is indeed formidable, yet crucial areas of weakness will still require time and effort to overcome.