Novartis' China Gambit

With its latest plans for investment in China, Novartis (NYSE: NVS  ) might seem to be borrowing a page from other manufacturers, such as Nike (NYSE: NKE  ) , that are tapping into the Asian country's cheap labor. In fact, Novartis' move is less about capturing the near-term benefits of low-cost workers, and more about a long-term effort to establish a position in an increasingly affluent country. The investment makes good strategic sense, even if the payoff is far from certain.

Following the lead of other drugmakers, such as AstraZeneca (NYSE: AZN  ) and Roche, Novartis disclosed plans today to pour $100 million into China over the next three years to create a research-and-development center. Novartis Chairman Daniel Vasella justified the investment in part by commenting that "the level of scientific expertise in China is growing rapidly."

Still, just as is the case with AstraZeneca's China plans, the size of Novartis' outlay is a drop in the bucket when considered in terms of the $4.5 billion it invested in research and development last year. If Novartis were looking to leverage China's labor cost advantage in a big way, one would think the investment would be much larger.

In reality, while China does have a massive pool of unskilled labor, the reserve of skilled workers is substantially more limited. Foreign drugmakers are absorbing some the country's limited number of scientists, even as an indigenous drug industry is blossoming and competing for the same workers. With the mounting demand for scientists, wages are going to rise rapidly. As a result, any low-cost advantage in drug development that China has now likely will rapidly evaporate in the not-too-distant future.

Rather than leveraging cheap workers, Novartis' main interest appears to be building its brand in China. The country remains a relatively small pharmaceutical market, but it won't stay that way for long, so Novartis is wise to get in early. But as other U.S. companies have found, an investment in China does not guarantee long-term primacy. Home-grown copycats tend to spring up, and this is also likely to be true in pharmaceuticals, given China's lax enforcement of intellectual-property rights. Nevertheless, the opportunity is too great for Novartis to ignore.

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Fool contributor Brian Gorman does not own shares in any the companies mentioned.


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