I've been critical of pharma's claims that developing countries are going to save them from the inevitable patent cliffs. "The expansion of health care in developing countries will drive foreign sales," it was said, but unfortunately those countries just don't have the wages to justify the high prices -- meaning high profit -- that pharmaceutical companies get in developed countries.
Taking advantage of the lower wages, on the other hand, sounds like a positive move.
A push eastward
Or would it be faster to go westward from Switzerland, Novartis' (NYSE: NVS ) home? Oh, never mind. At any rate, the drug giant announced last week that it's heading to China in a big way. The company plans to invest $1 billion in its research center in Shanghai over the next five years, which will make the Shanghai location the company's third-largest research center.
Novartis also plans to establish a manufacturing site in Changshu, China, which will be charged with getting the kinks out of scaling up production. You'll note that this is different than actually manufacturing drugs in China. While it's possible to do so with the Food and Drug Administration's blessing, considering the reputation that China has, I imagine it will be awhile before we see big moves of product manufacturing to China.
The next day, Novartis continued the push into China by buying an 85% stake in Chinese vaccine maker Zhejiang Tianyuan Bio-Pharmaceutical. The move was likely made to help push Novartis' vaccines into China with a readymade sales force, but Tianyuan does have a research and development pipeline that will presumably stay in China and take advantage of the lower costs there.
Novartis isn't the only one with a presence in China. Johnson & Johnson (NYSE: JNJ ) , Pfizer (NYSE: PFE ) , Roche, AstraZeneca (NYSE: AZN ) , and others have all established footprints in China.
A better way?
The move into China may be a good long-term play for pharmaceutical companies, but there's a way for them to take advantage of the lower employee costs without the capital expenditures required to establish research centers in China.
Just like practically every other industry, there are outsourcing companies available to do pharmaceutical research on the cheap. And if you're interested in taking advantage of pharma's insatiable appetite for lower costs, many of these companies are public.
The biggest play on China outsourcing is probably WuXi PharmaTech (NYSE: WX ) . The company bought an American outsourcing company, AppTec Laboratory Services, so it's not a pure China play anymore, but it still has some China-like growth qualities. In the second quarter (the last reported), China-based laboratory services grew 26% year over year.
Last year, much-larger Covance (NYSE: CVD ) signed a deal with WuXi to establish a joint venture in China, but then quickly reversed course and decided to expand in China on its own. With such a large customer base, if Covance can expand the services it offers in China, it should be able to reap benefits from the lower cost.
A little bit further down in the drug development pathway, Pharmaceutical Product Development (Nasdaq: PPDI ) helps pharmaceutical companies run clinical trials. Last week, the company closed on its acquisition of Excel PharmaStudies, a player in Chinese clinical research outsourcing. The move nearly doubles the number of employees PPD has in China and should help the company gain more business from pharmaceutical companies interested in running global clinical trials without a global price tag.
Mandarin isn't a required course in grad school. Yet.
While pharmaceutical companies push to lower costs, investors should keep in mind that the costs savings from moving research into China are somewhat limited. Drug companies still need to attract the best scientists, and while many of them live in China and are willing to accept lower wages because of the lower cost of living, there are a lot of good scientists who have no inclination to move to China.
The relatively high cost of drug development won't go away completely because of the availability of qualified Chinese workers. The cost-cutting will help somewhat, but profits at drug companies will still be driven by the launch of new drugs.
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