China Law Blog

The Economist Magazine (h/t to IP Dragon) recently ran a story on large pharma Novartis' plans to invest $100 million to create a Shanghai, China, research facility.  The story is entitled, "A novel prescription: A big Western company moves into China, but not for the usual reasons." Novartis intends for this Shanghai facility to become "one of its three big research hubs, alongside Cambridge, Massachusetts, and Basel in Switzerland'and ahead of its other facilities in Vienna, London, La Jolla, New Jersey, Tokyo and Singapore."

The Economist magazine described Novartis' motives for going into China "different and rather unusual" because its motives are not cheap production.  The Economist is a great magazine, but whoever wrote this article appears to have missed the last couple years of China's development.      

The article begins by noting that most "cutting-edge pharmaceutical research is carried out in Western Europe, America, Israel and Japan, all of which have highly educated populations and strong intellectual-property laws."  True enough.  It says countries like China "must content themselves with the less sophisticated back-end work of product development rather than basic research."  Generally also true.  The article then notes that "confidence in China's domestic drug industry is so low that the government is reluctant to approve clinical trials of anything not being used abroad."  Also true, but this reflects more on the credibility of Chinese drug manufacturers than on anything else.

The article then discusses Novartis' China plans:

The company says its plans are not motivated by a desire to cut costs. Indeed, it argues that there is, in effect, an international market price for top scientists that is the same wherever they operate. By locating in Shanghai, perhaps China's most expensive city, Novartis turned down inland areas where prices are lower and government inducements abound. Shanghai, it hopes, will have more appeal to globetrotting researchers'and the city is packed with universities and hospitals bubbling with ideas.

Come on. 

Novartis' choice to locate in Shanghai, rather than in Chengdu, does show cost was not the only factor in its decision where to locate within China, but costs had to have been a major factor in its decision to go to China at all.  The overwhelming majority of my firm's clients go to China to save on costs and yet they mostly go to Shanghai because they view Shanghai as the best source for both Chinese and ex-pat talent and the China's best city for business.  Oftentimes, they chose Shanghai because they themselves [as company owners] would rather go to Shanghai to check up on things than go to someplace like Shenyang, Wuhan, or Tianjin.  I cannot tell you how many times I have heard someone say along the lines of "I know we could have saved money by setting up shop in [fill in the blank], but, I just really like Shanghai." 

Novartis' new facility will create new drugs for "China in particular, and in Asia more generally:" 

China offers a huge pool of subjects for study and a promising market for any resulting treatments.  Although it will be at least five years before any new drugs emerge, there may be subtle marketing benefits for Novartis in the meantime. Because of a recent crackdown on corruption throughout China, Western companies are no longer allowed to meet purchasing directors in hospitals, which are major distribution points for drugs. This has had a huge impact on sales: Novartis has watched its annual sales growth drop from 25% to 10%. Developing a reputation for advanced research into critical diseases could help its brand.

More broadly, Novartis' investment is a bet'albeit a modest one, given its gigantic research budget'that China is now evolving into more than just a commodity producer with cheap labour.

This is NOT new. 

Countless companies in countless industries have come to see China as more than just "the world's factory."  Countless companies in countless industries are in China or going to China to "make a buck, not save a buck." 

Asked about "concerns over intellectual property," Novartis Chief Executive, Daniel Vasella, described the situation as "tolerable, if not ideal."  He went on to say that when "it comes to counterfeiting, for example, producers of fake drugs are still not tracked down by the authorities, but they are dealt with when exposed by others. And since drugs take such a long time to develop, Mr Vasella believes intellectual-property protection will be sufficient by the time the research laboratory produces its first fruits." 

In its post, "Novartis to China: Simply Brilliant," the always excellent Thomas PM Barnett Blog had an interesting take on Novartis' China strategy.  Mr. Barnett views it as "New Core" setting "the new rules.'  Novartis is spending $100 million on its China research facility even though China is not "global center for Big Pharma R&D and [even though it is] a weak environment for IP protection and [even though] Shanghai offers no costs savings as a location."  Despite all of this, Barnett sees Novartis as having gone into China because it has "rising healthcare issues, especially cancer given all that pollution and smoking.  According to Barnett, the "New Core is most incentivised to push newer and riskier technologies because it's facing the most change over the shortest timeframe and thus experiences the most damaging churn -- along with all that wealth creation." 

The bottom line for Barnett is that Novartis chose to "locate labor where the problems are greatest."  In other words, Novartis took its solution to the problem, which is no different than the company that sets up a factory in China to make product for sale within China.  Novartis is not the first to go into China planning to make it a "second home market," nor will it be the last.