In a Quest for Higher Value, Chinese Pharmaceuticals Move Up the Supply Chain

has cemented its position as a supplier of components and low value-added products to the world, but a number of companies are not content to remain downstream suppliers. From autos and airplanes to pharmaceuticals and house wares, some Chinese businesses are moving quickly up the supply chain. The pharmaceutical industry is a good example. By focusing on one company in particular, Zhejiang Hisun Pharmaceutical, China Knowledge@Wharton sheds light on a process that is transforming China’s role in global business.

Between November 30 and January 30, the share price of Hisun Pharmaceutical soared from RMB 12.45 to RMB 19.67 in two months, a gain of 58%. Analysts are bullish about the company’s prospects, and so, apparently, is the stock market. Now Hisun is attempting a tough transition as it works its way up the value-added chain from a successful producer of raw pharmaceutical materials to a maker of generic drugs. Eventually the company hopes to make an even bigger leap, into the highly profitable business of manufacturing and selling patented drugs.

Hisun is not alone, and several other Chinese producers of bulk drugs are attempting similar transitions. The stakes are high: The sales of all pharmaceuticals manufactured in China reached RMB 473.84 billion (US$ 65.4 billion) in 2006, a growth of 22% year on year, in a broad category that includes raw materials such as active pharmaceutical ingredients (APIs), along with finished drugs and Chinese medicines. In the API sector alone, sales reached RMB 125.85 billion (US$ 17.3 billion) in 2006, while total exports of APIs were worth RMB 29.78 billion (US$ 4.1 billion).

China’s Strength

China has several advantages in pharmaceutical manufacturing -- particularly at the lower end of the value-added scale -- which are important in manufacturing intermediates and APIs. Intermediates are the lowest-end products in the process of making a dosage formulation for a drug; they are core ingredients for making APIs, while APIs are the most important part of dosage formulations, or finished drug products.

“Low labor costs, relatively loose environmental protection obligations and an abundance of science graduates have been the traditional advantages of Chinese API makers,” says Ba Yanfeng, an API pharmaceutical analyst with Healthoo.com, a website that specializes in information about pharmaceutical bulk materials. “The state-owned mega-sized Shijiazhuang Pharmaceutical Group, Shandong Lukang Pharmaceutical and Shandong Xinhua Pharmaceutical are good examples,” she says. China is a global producer of bulk antibiotics, and Chinese antibiotic manufacturers are competitive in penicillin, terramycin, streptomycin, sulfanilamides and others. Shijiazhuang Group and Shandong Lukang Group are among the four largest antibiotic API manufacturers in China.

Because of these strengths, China has become a key link in the global supply chain. "Two-thirds of the APIs and a large share of the intermediates sold in less regulated markets, such as India and some other Southeast Asian countries, are sourced from China," says Rahul Garella, vice president of API business for U.K.-based Glenmark Pharmaceutical Europe, a company that sources APIs from both China and India.

While India currently supplies the majority of APIs to the more regulated markets around the world, a significant proportion of the intermediates that are necessary for Indian API production are sourced from China. "APIs are a key part of the generics industry and the availability of the right API determines how quickly a generic can be developed," Garella says.

Hisun Company Profile

 

Once a tiny state-owned company, Hisun is now one of a handful of Chinese pharmaceutical makers that have obtained certification from the U.S. Food and Drug Administration (FDA) and the European Commission, a step that allows them to sell their ingredients for higher prices. Hisun already exports 80% of its manufactured intermediates and APIs to other parts of the world, and it has taken the following steps to transform itself from a pure API maker to a vertically integrated company, which manufactures intermediates, APIs and finished generic drug formulations.

On November 29, Shanghai-listed Hisun announced that it signed a RMB 98 million (US$ 13.2 million) joint-venture agreement with Spain-based Farmaprojects S.A. and another domestic company, Fuyang Xinghai Investment Ltd., to produce and market solid drug formulations to Europe, a key step for the company. Solid drug formulations, or dosage formulations, refer to the finished dosage of a drug, a more lucrative market than the making of intermediates and APIs.

Under the agreement, Farmaprojects will help Hisun apply for EU Good Manufacturing Practice (GMP) certification. The joint venture will act as a basis for the three companies to cooperate on the research, development, production and marketing of different drugs. "We are looking for an approach [to get into the formulation business worldwide]," says Deng Jiufa, a securities representative with Hisun.

Successful API Business

Hisun hopes to leverage its current success as an API manufacturer. Its major API products are animal anti-parasite and health drugs that are widely used by veterinarians, although in the past few years it has extended its product line. “Hisun’s strategy for API business is smart,” says Ba, the pharmaceutical analyst with Healthoo.com. “Its API products either target the specialty drug market or the niche market.”

In the past few years, the company has worked to extend its API business. “Apart from animal health drugs, our API business focuses on the fields of anti-infectives, oncologicals (cancer treatments) and cardiovascular drugs,” says Deng Jiufa, a Hisun securities representative.

Hisun’s excellent reputation in the global API industry has stemmed partly from its close collaborations with some of the world’s leading pharmaceutical companies. In August 2005, Hisun was named by Indianapolis-based Eli Lilly as the sole Chinese drug maker to manufacture the active pharmaceutical ingredient, or API, for Capreomycin, an anti-tuberculosis drug that is effective against drug-resistant strains of the disease. Eli Lilly has agreed to transfer the Capreomycin production technology and at the same time, provide financial support to Hisun’s management. This partnership makes Hisun only the second company to produce Capreomycin under Eli Lilly’s patented technology. In the future, Hisun hopes to produce the finished dosage formulations of Capreomycin, says Deng, and negotiations with Eli Lilly have been underway.

Then in June 2006, Hisun entered into an agreement with Alpharma, the world’s top supplier of the active pharmaceutical ingredient Vancomycin, the treatment of choice for severe hospital infections. Under the agreement, Alpharma would initially purchase Vancomycin from Hisun and, after obtaining the required approvals from provincial and local regulatory authorities in China, begin producing Vancomycin at Hisun’s manufacturing site in Zhejiang Province, in eastern China. Hisun would perform certain services in support of Alpharma’s Vancomycin operation at Hisun’s manufacturing site, and in addition, Hisun would construct a new, expanded Vancomycin manufacturing facility, which would be owned and operated by Alpharma.

Apart from those alliances, Hisun also partners with Pfizer, Merck and Novartis, all top-ranking pharmaceutical companies, on different sizes of deals. Those moves are helping catapult the company to a higher level.

“Hisun is one of the few API makers that is on a fast pace in terms of globalization,” says Tony Zhou, general manager of Perrigo International (Shanghai). “Bai Hua, Hisun’s chief executive officer, has recruited a number of overseas returnees to help make the company [comply] with international practice, and the number of people the company has sent to the United States for developing business is unprecedented,” he says. The Perrigo Company, headquartered in Allegan, Michigan, is the world's largest manufacturer of over-the-counter pharmaceutical products for the store brand market.

Deng Jiufa, the Hisun securities representative, says the company is beginning to cooperate with global pharmaceutical players on research and development. “We not only supply APIs to them (big pharmaceutical manufacturers), but we also partner with them on innovation,” he says, “We are collaborating with some companies on R&D of proprietary ingredients.”

For Hisun, the next step is to start producing dosage-formulated drugs for the world market. Hisun and other leading API exporters in China plan to start doing this. “Hisun is transforming its business to generic manufacture,” says Luo Jiali, vice president of Hisun’s business development division. “We are starting from oncology formulations, which leverages our current strengths in API oncologicals.” The competition is likely to be intense. “Though very few API makers admit in public that they have been allocating more attention to the research and manufacture of dosage formulations, I can smell the fierce competition,” says Luo, adding that some companies are busy working on manufacturing techniques for patented drugs, and looking for strategies to get them launched in the U.S. or European market once the patents expire.

Patent Challenges

One strategy for entering the more lucrative dosage-formulated drug business is a risky one: challenging patents. Some of the world’s leading generic makers, including Dr Reddy's Laboratories and Ranbaxy Pharmaceuticals, both based in India, have been actively challenging the patents of blockbuster drugs in the courts.

Patent challenges, often called Paragraph IV Challenges, arise from the Hatch–Waxman Act, a law passed by the U.S. Congress in 1984 which provides an incentive for generics companies to challenge patents. If a generics company is the first to file an Abbreviated New Drug Application, with a Paragraph IV certification, and successfully defends the ensuing patent infringement case, the generics company is granted a period of market exclusivity for 180 days.

"In the short term, we are considering launching finished drugs to the U.S. market by challenging patents,” Deng says. “It is possible that we will launch our first generic on the world market using this mechanism." The company hopes its first such drug may appear as early as 2009.

However, the process is expensive and risky. “The cost of launching a patent infringement case is very high, usually from $1 million to $10 million,” says Li Weishi, an associate with O'Melveny & Myers LLP. “Without being very sure to win the case, most drug makers are not likely to take this approach.”

Overcoming China-wide Weaknesses

For Hisun to be successful in its new initiatives, it will have to overcome some of the weaknesses that plague Chinese drug companies. Currently, many of the leading companies are commodity-type producers that rely on large-scale production rather than innovative products or sophisticated manufacturing techniques. “China's strength in the production of antibiotics is largely thanks to its low production costs and large production scale, rather than leading the international market in production technology,” says Ba Yanfeng.

“Though Chinese drug makers have advantages in infrastructure and production capacity, they are still weak in global mindset, which makes it hard for them to communicate with global pharmaceutical companies and also with western regulatory bodies,” adds Tong Zhou. “Such problems could lead to unharmonious cooperation with big pharmas,” he says, explaining that Chinese GMP certification is now in disarray, a problem that is compounded by the difficulty that Chinese drug makers have in understanding the requirements of U.S. cGMP (current Good Manufacturing Practice).

GMP is a system for ensuring that products are consistently produced and controlled according to quality standards. The protocol is designed to minimize the risks involved in any pharmaceutical production that cannot be eliminated through testing the final product. Most countries will only import and sell medicines that have been manufactured according to internationally recognized GMP. The cGMP, which applies stricter quality control to the drug manufacturing process, is now being applied in the U.S., Europe and Japan. The "c" stands for "current," and it requires manufacturers to employ technologies and systems that are up-to-date in order to comply with the regulation.

Led by Zheng Xiaoyu, former head of the Chinese State Food and Drug Administration (SFDA), China began enforcing GMP among pharmaceutical manufacturers in 1999. But without a rigorous inspection process, a great number of drug manufacturers obtained GMP certificates simply by bribing regulatory officials. In fact, Zheng himself was executed last July due to corruption and negligence of his duties.

In a move to strengthen regulations and enforce GMP requirements, the Chinese State Food and Drug Administration (SFDA) issued revised standards for GMP certification, effective January 1, 2008. The new standards upgraded requirements in several ways. Whereas the original standards focused on production facilities, the new requirements put more emphasis on the quality control process, including the purchase of bulk materials and the management of documentation.

The Future

Hisun is not the only leading API exporter that has ambitious plans. Other leading companies, especially Zhejiang Huahai Pharmaceutical Co., are among the Chinese companies that are working toward producing dosage-formulated drugs for the world market.

In June 2007, Shanghai-listed Huahai announced that its anti-AIDS tablet has gained approval from the FDA, allowing the company to enter the overseas market. However, Huahai will have to wait until May 2012, when the patent for the drug nevirapine, now held by Boehringer Ingelheim GmbH, is set to expire.

After that, the next logical step for Chinese companies would be to develop and market their own patented drugs. That may be far in the future, but already, Hisun has its eye on the ultimate prize. "We are also developing drugs with the long-term future in mind,” says Deng Jiufa. “We would like to see our own innovative drugs on the market.”

 

The progress of Huahai and Hisun will be closely watched by the world’s pharmaceutical industry. “Possibly in three to five years from now, some of the leading domestic vertically integrated companies, such as Hisun and Huahai, will be able to start expanding through mergers and acquisitions,” Garella predicts.


Published : 2008.01.30



 
















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