China Must Upgrade Its API Industry

By Dai Xiaoxia

Active pharmaceutical ingredient (API) is an important part of China's pharmaceutical industry. Currently, China's API manufacturers face many challenges, and how to accelerate industrial restructuring and build international competitiveness is a significant problem that they have to be face in the new era.

I. Status quo

In recent years, affected by the sluggish economy in Europe and America, China's API exporters face problems including slow business growth and declining profits. Meanwhile, with the continuing increase of environmental protection pressures worldwide and the improving of technical standards, both the production and export of China's API industry face enormous challenges. The development of the industry has been swamped by the gradually surfaced contradictions formed during extensive development over the years.
   On one hand, although the scale of the industry has increased steadily, the profitability of enterprises has continued to decline. From 2003 to 2011, the number of API manufacturers in China increased from 750 to 1075, but their proportion in pharmaceutical manufacturers has remained stable at about 19%. Meanwhile, although the combined sales revenue of China's API manufacturers has tripled, its proportion in the combined sales revenue of China's pharmaceutical manufacturers has decreased from 27.6% to 21%, and the proportion of profits also showed a declining trend.
   On the other hand, the supply of major API is in surplus and their prices are running at a low level in China. Most of API manufacturers have been stuck in an awkward situation wherein output increases while prices fall. In 2010, of the top ten API based on import volume, the prices of seven ones decreased year-on-year. In particular, the prices of cardiovascular drugs, whose export volume has increased fastest, decreased 96% year-on-year. So did another competitive vitamin C. The export volume of vitamin C from China remained between 5 kt and 13 kt from 2010 to 2012, but its price has decreased from US$10 000/t to 3 500/t, a decrease of 65%.
   The annual sales revenue of API, over half of which came from export in 2012, accounts for almost 20% of the sales revenue of the pharmaceutical industry in China. Currently, China manufactures a wide variety of API. Bulk API, such as anti-antibiotics, vitamins, antipyretic analgesics and hormones, and special API, such as statin, spironolactone and losartan, made in China account for large shares in the global market. In recent years, with the sharp increase of labor costs, energy prices and logistics costs, the production costs of API have increased significantly in China. Therefore, Chinese API manufacturers became less competitive in the global market. Moreover, since the Chinese government has strengthened regulations on conserving energy and reducing emissions, manufacturers face increasing environmental pressures. Therefore, industrial upgrading is extremely urgent.
   Currently, the accelerated industrial integration in the global pharmaceutical industry has brought unprecedented opportunities for the industrial upgrading of Chinese enterprises. For one thing, in order to solve a series of problems such as patent expiration and low R&D efficiency, enterprises in Europe and the United States have already initiated cost control and outsourcing production and R&D to developing countries. For another, to avoid price competition and resolve patent disputes, generic drug manufacturers have developed biosimilars and enhanced their competitiveness through contract manufacturing. China has attracted attention from multinational pharmaceutical manufacturers since it has robust industrial foundation, complete supporting industries and huge market potential for the production of API. Currently, 35% of the global pharmaceutical manufacturers take Asia as their first choice to outsource their production. Developing countries which have abundant clinical resources, robust R&D and manufacturing foundation and low production costs, including China, have become the world's important bases of contract research organization (CRO) and contract manufacturing organization (CMO). In China, the market size of CRO has increased from RMB3 billion to 9.8 billion with an average annual growth rate of 34.44%, among which the market size of clinical trial CRO has increased from RMB1.7 billion to 5.6 billion with an average annual growth rate of 34.72%.

II. Pathways toward industrial upgrading

Industrial upgrade means moving toward the high end of the value chain. Actually, enterprises with various sizes and strength have to pursue industrial upgrading through different pathways.

Pathway 1: Bulk API manufacturing → product mix optimizing →diversified development
Most small and medium API manufacturers, to realize industrial upgrading, should pursue diversified development based on optimizing product mix. Given the fact that API are numerous, enterprises should consider the expected returns of products as well as their capability. In practice, the dominance and advantages of a product owned by an enterprise is expressed by “choke point holdings” (CPH). The CPH of a product is determined by the core proprietary information or technology related to the product, government's regulations, customers' preferences, unique and highly efficient business model, as well as brand, quality and output of the product. Enterprises must consider both the expected returns and CPH of products during optimizing their product mix. If both the expected return and CPH of a product are high, the enterprise should concentrate its resources on the development of the product; if the expected return is high while CPH is low, in order to mitigate the risk caused by low CPH, the enterprise should work on the improvement of CPH through M&A or cooperation; if the expected return is low while CPH is high, the enterprise should consider to decompose the business and to create new businesses with high expected returns; if both the expected return and CPH of a product are low, the enterprise must give up developing the product, or outsource it to other enterprises.

Pathway 2: OEM production → transfer of preparations → cooperation
For enterprises which have rich experience in production but lack the ability of R&D and innovation, the best pathway to realize industrial upgrading is to actively undertake R&D and production resourcing from large foreign enterprises. Domestic enterprises can make use of foreign partners' resources in technology, government relations and sales network. Moreover, they can learn all kinds of knowledge in certification, management and standard operation, thus they can be ready for the realization of independent exportation of preparations. Normally, there are three levels of cooperation. The first level is OEM. The client (foreign enterprise) provide production technology of API and preparations, while a domestic enterprise takes charge of production and earns relatively low processing charges. The second level is production transfer of preparation. The foreign enterprise takes charge of the R&D of preparation using domestic API, and the domestic enterprise takes charge of the production of API and preparation. The earning of the domestic enterprise includes product profit and processing charges of API and preparations. The third level is cooperative development. Namely, two parties jointly develop API and preparations and declare patents. The domestic enterprise takes charge of production, while the foreign enterprise takes charge of sales. The earning of the domestic enterprise includes product profit and processing charges of API and preparations, as well as profit sharing of selling the final drugs.

Pathway 3: Exporting pharmaceutical preparations → selling generic drugs overseas
For enterprises that have sufficient funds, strong R&D capability and rich experience in preparation formulating, the suitable pathway to upgrade is to strive for selling generic drugs overseas based on exporting pharmaceutical preparations. First, they should study the related patents of multinational pharmaceutical manufacturers to find vulnerabilities among the patents, so they can take chance to void the patent through putting the issue before a court or they can synthesize the drugs avoiding the scope of patent protection. Second, they should accelerate the abbreviated new drug application (ANDA). Namely, they can synthesize the API through different synthesis method before patents expire, and the generic drugs will appear in the market as soon as the patents expire. Third, they can apply the authorized first-time generic drugs from the original patent holder, thus they can acquire a 180-day period of market exclusivity to manufacture and sell the first-time generic drugs just before the patents expire.

Pathway 4: Innovative drug development → innovative drugs overseas
A very few large API manufacturers that have strong strength in personnel and technology can make full use of government's supporting policies to achieve the overseas sales of their products and to enhance their international competitiveness through development, production and sale of innovative drugs.

III. Suggestions

1. Strictly curb overcapacity. Good API first developed in China will be encouraged and given the market exclusivity for more than one year, just like the 180-day period of exclusivity given to first-time generic drugs in Europe and the United States. Moreover, the enterprise that develops a API first in China can enjoy preferential policies such as tax reduction for a certain time and higher export tax rebate rate. For API whose supply is in surplus, plans to phase them out, including annual phase-out targets, will be enacted and implemented. For API which have seriously excess capacity, the implementation of production quotas can be a possible solution.

2. Increase technical investment. In China, government's investment in research in API is insufficient now and needs to be increased in the future. In order to encourage enterprises to develop, introduce and use new technologies and attract social capitals and venture capitals to invest in the development of API, supporting policies from government including tax preferences and financial subsidies must be strengthened.
3. Encourage M&As among enterprises.
4. Promote the strategic position of API. A development guidance catalogue of the API industry must be drafted. The related industrial standards and a technology standard system of important products must be established. Market entry rules must be established. The industrial structure optimization must be promoted.
5. Strengthen the industrial management and guidance.