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China is becoming a much more sophisticated economy, with a large and well-educated workforce.
For most Western and Japanese biopharmaceutical operations, the question is not whether to enter the vast Chinese market, but how. The evolution of the Chinese market in recent years has given biopharm executives many options to consider.
Kent Kedl, coauthor of The China Ready Company and a partner at Technomic Asia (Shanghai and Chicago), a firm that guides companies investing in China, describes the market's evolution this way:
"Ten years ago, a company that wanted to make a direct investment was forced to go into joint ventures, which were often arranged marriages from hell. Now, companies can step back, look at the marketplace and choose the best strategy, whether it's a green field, joint venture, licensing deal or acquiring somebody. It has really opened up."
Most Westerners' notions of their economic relationship with China focus on using inexpensive Chinese labor to manufacture consumer items—from toys to housewares—and exporting the finished goods from China to the United States, Japan, or Europe.
Scientists at GNI-Shanghai Genomics' laboratory in Zhangjiang Hi-Tech Park use state-of-the-art equipment.
Japanese and Western companies, including those in biopharm, are forging a far richer involvement in the Chinese economy to take fuller advantage of China's rapidly growing consumer market.
China's gradual relaxation of its historic opposition to foreign ownership of companies operating in China, makes it easier for Western companies to pursue capital that is structured more to their liking. This also propels further investment.
We can see this evolution at work in the experience of two foreign biopharm concerns with deepening Chinese operations.
Part of this evolution in the sophistication of Chinese foreign direct investment (FDI) is the natural course of any economic relationship. What begins as low-value-add mutual exploitation either evolves into something deeper, or the party soon moves elsewhere, where the drinks are cheaper. Western companies understand that China has been transformed from just a labor market into a vast consumer market. And the Chinese understand that foreign direct investment will dry up if the capital structures available to Western companies are limited to joint ventures with government-owned companies.
Christopher Savoie, CEO of GNI-Shanghai Genomics, also describes in strategic terms the changing nature of biopharm FDI in China.
"There is a new trend in bio research to move outsourcing more upstream, to involve more intellectual property (IP)," Savoie explains.
This trend has taken time to develop because companies have needed to gain experience to become comfortable with the idea of exposing their IP to Chinese partners.
How to Conduct Business in China
The evolution that occurred at GNI was initially driven by the need to outsource. The high-end validation work GNI was doing in Japan and the United Kingdom was expensive, and the company had grown to understand that it could achieve the same quality result working with Shanghai Genomics at a fraction of the cost of working in Japan or Europe.
But as the value of the work rises, so do the stakes. If a company is going to expose its IP or invest its critical research and development budget in China, it needs a capital structure that goes beyond the "forced marriage" joint ventures that Kent Kedl describes.
This is what happened at GNI. Savoie notes that GNI's investors were wary of investing such a sizable portion of the company's research and development budget on a Chinese company without exerting more control.
"We were told if we could get equity, we could spend all the money we want," Savoie said. Venture-backed Shanghai Genomics was also game, since the acquisition by a Japanese firm offered an exit for investors through the Japanese market.
Hence GNI-Shanghai Genomics was born (through a June 2005 merger)—out of necessity and mutual advantage. The GNI experience illustrates the progression that is taking place all around. As Chinese companies move their own skill sets up the value chain—from relatively low-value testing to higher-value validation work, for example—the nature of the work that companies in biopharm and other industries will source in China will also move up the scale.
When GNI and Shanghai Genomics announced their merger last June, it established GNI's footprint in China through controlling equity in a Chinese company, rather than through one of the joint venture alliances that had been unsatisfactory for so many companies. GNI is headquartered in Tokyo and has operations in the United Kingdom, China, and the United States. Savoie cautions that China is not a market that will provide easy money to those more skilled at leveraging financial markets than running companies.
"A lot of people think China is a panacea," he cautions. "It is not for capital gains investment or financial flips. The way to make money in China is to make money."
GNI's involvement in China is not just about achieving the same or better quality service at a lower cost. Savoie also sees a great opportunity to market its products in China.
"China is an aging society," he says. "There is a huge need to fulfill demand— lifestyle drugs for cholesterol, hypertension. There may be a product liability risk, but there is virtually no market risk."
GNI, which has operations in China, Japan, the United States, and the United Kingdom, develops therapeutic pharmaceutical products internally and in collaboration with other pharmaceutical companies, with the assistance of gene regulatory networks and systems pharmacology techniques.
GNI continues to expand its China reach. Last month it agreed to form a strategic alliance with Beijing Continent Pharmaceutical Co., Ltd., by taking a minority stake in the Chinese pharmaceutical sales and manufacturing company.
In 2005, Qiagen, which provides technologies and products for preanalytical sample preparation and molecular diagnostics solutions, significantly expanded its position in China. First, Qiagen expanded its sales presence in China by adding what is called a "representative office" in Shanghai to support its existing distributor, Gene Company (Hong Kong).
Qiagen's Martin Potgeger, associate director, business development, who led the company's acquisition efforts in China, says the decision to expand to a "representative office" was all about gaining closer access to Qiagen's customers.
"The distributor just gives you the revenues back," Potgeger says. "You have no contact with the customer. That is why we have created a representative office in Shanghai. A representative office cannot sell; it can only support the existing distributor. The advantage is that you gain a much better picture of the needs and limitations of the market."
While the representative office's role is to provide technical support to the distributor, the staff at the office is able to visit directly with customers, which offers insights not available when a third party handles all customer contact. In fact, Qiagen soon discovered there were market needs not fulfilled with the company's current product line.
"This is why we acquired the first company," Potgeger says. TianWei focuses on the research community in China, and its product line is more in tune with the methods used by Chinese researchers.
The second company, PG Biotech, focuses on the diagnostics market, with assay products designed for the avian flu virus and Hepatitis B.
Both acquisitions achieved two objectives. The first was to expand the sales channel for Qiagen products, and the second was to acquire capabilities that were a better current fit for the Chinese market. Without expanding its presence in China, Qiagen would not have gained the knowledge it needed to make the strategic decisions it made in 2005.
The experience of becoming a China-based company is not for the weak or those lacking in subtlety. Navigating the Chinese business culture, as Qiagen's Potgeger described in an interview, is not about understanding variations in business principles, as US and European executives contend with in their dealings with one another.
"In Asia," Potgeger says, "you have different principles."
Potgeger emphasizes that many types of business relationships exist in China. Many Chinese have lived and worked abroad and understand how to deal with Western business people. The cultural gulf is much wider among those who have not worked abroad. Knowing who you are dealing with is therefore a critical first step in building relationships.
Westerners entering China must do their homework. They need to find the right people to help them understand simple protocols and the intricacies of local businesses.
It is also important to avoid applying Western standards on everything that is done in China. When Qiagen was reviewing the website of one of its acquisition companies, it found the site was not professional, according to Western standards. There were too many flashing lights, and too much nonbusiness material, such as photos from a recent company outing. Potgeger says his company's first impulse was to shut the site down. Then he learned that the website's style was common among Chinese companies.
Potgeger also advised bringing your own translator, even if you know one will be there from the other side of the negotiating table.
"He or she should not just be a translator, but should be familiar with your business," Potgeger says."
Understanding how to protect one's assets or intellectual property is also critical to working in China.
Even as China's entrance into the World Trade Organization has raised its awareness of the importance of IP protection as table stakes for doing business globally, the issue remains high on the list of concerns about doing business in China.
Kedl, the consultant who helps companies acclimate to China, says the best results come from those who have the strongest personal relationships. This is often developed over countless dinners where little or no business is discussed.
"What will protect you is not relying on regulation and enforcement," Kedl says. "That is still a long way off in China. What you rely on is relationships."
Kedl tells the story of a client that was being blatantly infringed by a competitor, and a team of lawyers was unable to get the matter resolved. Later, a junior local manager was able to discuss the matter with a local official, with whom there was a close personal relationship, and the infringer was soon shut down by the local authorities.
"Two guys at a very low level who had a relationship were able to do this, while the high-power lawyers were not," he says.
Savoie has found that by making sure that all parties to a contract agree to abide by US law, which is much more robust in protecting intellectual property rights, GNI has encountered few problems.
While many things about China remain challenging—bridging the cultural divide and getting on the same page on basic ways of doing business—the nature of Western involvement in China is clearly moving up the value chain. And the key to this movement is the recognition that China is not only emerging as a nation of consumers, but also is becoming a much more sophisticated economy, with a large and well-educated workforce.
"We are a Chinese company in China because we want to contribute to the local economy, and be a Chinese organization that people will be proud of. We are there to innovate," Savoie says.
That is a whole world from just a few years ago, when working in China was about getting it done for less and bringing it back to the West.
The growing number of international biopharm companies investing in China through mergers and acquisitions, rather than joint ventures, suggests a sea change in how the industry is approaching the Chinese market. This is a natural progression for both sides.
As China sees the advantages of more FDI, it has eased the path for companies looking to invest more deeply through equity participation in Chinese companies. Likewise, Western and Japanese companies are finding they are more comfortable investing and developing a local footprint through this approach.
Joshua Brandt is a San Francisco-based freelance writer.