The Basics On China Pharma, Part 3: Mistakes To Be Avoided.

This post is part 3 of a three part series by Robert Walsh, the founder of Samsara Biopharma Consulting, and his colleagues, Jennie Shi, Wendy Zheng, and Zhou Tong. It is a follow up to "The Basics on China Pharma" and "The Basics On China Pharma, Part 2: Getting Into China The Slow Hard Way." Here we go:

We want to remind readers that our focus in these posts has been on small-to-medium sized pharma companies looking at China, not massive multinationals. The big issue facing the smaller pharma company is that it may lack the in-house resources to set up and really manage a China market entry.

We have seen many failed approaches to China made by smaller pharma companies and we set forth some of them below in an effort to help prevent similar future failures :

1. A small publicly listed United States company has a novel drug delivery system for an older generation antibiotic, for which they have strong patents. Ignoring approaches from several reputable Mainland Chinese pharma companies, they assign to a middling-grade Taiwanese company (introduced to them by one of their early investors) the China, Korea, and SE Asian rights to their product line. So far, four years have passed, and the Taiwanese company has yet to obtain registration in its own market, let alone anywhere else in Asia, including the Mainland.

Diagnosis: Poor partner selection, overly broad grant of license territory

2. A couple publicly listed Vancouver, Canada, biotech startup companies decided to jump directly into China to develop and test bed their own product lines. Though senior management of both companies are Chinese, they are research types with no real idea how the pharma business actually works in China. Both companies spend more than half their companies’ startup funding to buy what appeared to be successful Chinese biotech companies in Jiangsu and Sichuan, and use these as their conduit to the Chinese market.

From day one, the acquired companies are a problem. The management and workers rarely listen to Vancouver. One of the Chinese companies, it turns out, has a lot of debt that was somehow missed during the somewhat ad hoc due diligence process. Both companies have quality problems related to poor facility design and operations, though both had received the first round of the SFDA’s Good Manufacturing Practices certificates back in 2000, when these could be obtained from the province with a wink and a nod. The icing on the cake was that neither of the acquired Chinese companies were particularly competitive; their sales expenses were high, and their profit margins were running right around 3%.

Though both of these companies were in Vancouver and both were using the same approach, they were doing so in total ignorance of the other’s actions. One of these companies went under and the other ended up being acquired by a much larger company that very quickly sold all of the Chinese assets.

Diagnosis: In both cases, the Chinese-Canadian senior management overestimated their own ability to get things done in the Chinese pharma market. They were solid scientific bench researchers, but badly out of their depth on the actual business and operational end of pharma. Due diligence on acquisitions was amazingly shallow, as senior management chose to mistakenly rely on their back-home guanxi over professional assistance.

3. A United States based biotech company is somehow persuaded to enter a Joint Venture with a Chinese company working in the same field. The sweetener for the deal is that a major Central Government funded high tech zone will host the JV, and its party leaders have promised land and some funding.

The deal was announced to great fanfare in the summer of 2008, but by October the US company has announced that the deal is as good as dead. The nuts and bolts technical due diligence on the Chinese side was not as thorough as it should have been and the US company assumed way too much about the state-of-the-art in China and had overestimated the value of Chinese government assistance.

We at one point spoke with people from the US company and they told us the following:

We realized pretty quickly that the commitments from the high tech park administration could evaporate when leaders changed work assignments. The Chinese JV partner had a lot of very basic stuff to learn about running a well-documented quality operation, and we decided it would be a lengthy and expensive process to constantly send our people over to bring them up to speed. There was a loophole big enough to drive a truck through that allowed us to back out, so we did before the JV became a money pit, and we did it quickly. We just assumed that their operational competence would be pretty much the same as ours, maybe with a few easily corrected areas, but this was in no way what we eventually discovered.

Diagnosis: The US company rushed into the deal and put too much faith in the administration of a government-backed high tech zones (some are better than others). The US company also failed to grasp the level of overall technical and regulatory competence of its JV partner.

4. A US-based research biotech company has strong patents covering a valuable new method relating to industrial enzymes and amino acids. It begins exploring the China market without registering its valuable IP there.

The company also sold a number of kits featuring its technology to what it thought were university researchers at China’s top institutions. Ordinarily, these things are covered by what is called a “bench license,” not requiring any payment of royalties, so long as the technology is not put to commercial use. The company’s management otherwise gave not much thought to China, and instead focused on selling into developed country markets.

As the years passed, the U.S. company’s technology went from the laboratory bench to large scale industrialization in China, making a fortune for a number of Chinese companies that never paid a penny in royalties to the U.S. company. And now for the amazing part. The U.S. company's U.S. patent protection will be expiring soon and the Chinese companies, which now know exactly how to make the product, are chomping at the bit to invade the U.S. with their product as soon as the U.S. company's patent protection ends.

Diagnosis: This company failed to register its IP in China early enough. It also failed to assemble a business team to oversee its relationships with companies employing its technology overseas.

Editor's Comments:  Before Samsara began this series, Walsh told me that so much of what we write about on China Law Blog he had seen in the China Pharma world. I certainly can say the reverse regarding Walsh's post above: that so much of what he writes about the China Pharma world applies with equal force to the non-Pharma world.