China Expansion by Western Companies

April 2011
T3 Advisors

While international real estate analysis is often challenging, we thought it would be interesting to take a specific look at China based on conversations with several life science clients and colleagues recently on the nuances associated with establishing a facility there.  Given the ripe market for healthcare in China where a huge, aging population is coupled with dramatic government healthcare initiatives, it’s no surprise western life science and healthcare companies are being pushed more than ever to take advantage of the growing opportunities there.

While I think a gripping best seller could probably be written on strategy, opportunities, and anecdotal experiences of setting up a Chinese manufacturing facility, I thought it would be best to limit the data dump and highlight only several themes consistently mentioned by colleagues and clients.

On Choosing Location:

The major components of site selection for manufacturing and distribution facilities are:

Proximity to Consumer Base

Any company looking to manufacture and distribute a product needs to identify its intended consumer base now and anticipate where it will be in the future.  Today, China’s hospitals are rated on a tier system where top tier (Tier 3) represents high cost, high quality urban hospitals demanding certain drugs and diagnostic tools (IVD, Molecular Diagnostics, Med Device), while lower tier (Tier 1) represents more rural users demanding basic sets of care needs (Point-of-Care Diagnostics, Essential Drugs and Therapies).  Government initiatives will aim to reduce the inequalities of the healthcare system by creating more rural outpatient centers and county hospitals, increasing insurance coverage, and regulating more expensive drug prices, among other things.

Understanding what product and/or diagnostic service a company will offer should be one of the drivers of where it will locate, based on the demographics above.  While there are obvious advantages to being located in an urban location (talent pool, civil infrastructure), a company developing drugs and devices that are more likely to be used by China’s rural inhabitants may want to look West to take advantage of closer proximity to end users and lower wage expectations for workers.  Companies developing the higher end drugs and preventative diagnostic tools will more likely look to set up facility closer to urban areas and hospitals.

Other questions on where to locate could include:

As you move away from metropolitan locales, how does the balance of cost versus talent pool play out? As site location moves farther from coast, deltas, airports, or urban centers, does civil infrastructure adequately support distribution?  Are there opportunities to lease existing buildings or spaces or do companies need to build their own facilities? Are there any government incentives the new company can leverage (e.g. tax benefits, subsidies, “Go West” campaign, etc.) being located one place versus another?  Are there particular medical clusters in China (Shenzhen, Beijing)?

People:

It is impossible to characterize a country’s entire talent pool in one broad statement but there are commonly acknowledged differences among classes of Chinese employees, typically rooted in generational differences.   Finding the right people – particularly, the right managers – can be crucial toward bridging the cultural divide between the respective business cultures of East versus West.  Where “old school” Eastern business behavior and deep, long-lasting relationships can often collide with Western bottom line operational demands, it makes a huge impact when a company can identify employees receptive to new ways of thinking while securing management able to convey methodologies to the larger pool of workers.  The challenge can be of such magnitude that a global real estate head recently mentioned to us how his company seriously considered acquiring a Chinese company solely on the premise it would get access to its employees.

One other important factor we’ve heard mentioned is the development of trust between Western managers and their Eastern counterparts.  Some will say you simply must relocate a US employee abroad to have any chance at success because the charge of breaking old habits and ensuring corporate standards are implemented can’t be done from a world away.  We had one client tell us a manager of one of their plants was using the facility to manufacture and distribute on behalf of his own private operation, incidentally selling some of the company product in the process .  Obviously, it violated generally accepted ethical standards but because it was not an uncommon practice in that part of China and because the manager determined the risk of getting caught and prosecuted successfully was so low, he decided the risk was worth the reward.

Others will say you can find extraordinarily talented managers in China that can conduct business and impose corporate standards with great success.  These people will also say relationships forged through their time in China are far more deeply seeded than those made professionally in the US.  Summing up, knowing where the more malleable managers and employees and proper screening is crucial for success in Chinese operations.

china great wall-resized-600

Other employee questions:

How much talent variation can one expect when evaluating more urban centric location to more rural?  Are there clusters to take advantage of an existing pool of experienced workers (e.g. finance workers in Hong Kong, Chengdu developing telecomm, etc.)?  How will increased pressure on wage escalations impact where you do business?  What are your IP rights in the event workers move on to work for competitors (or even start own business to compete with yours!)?  How are patents and other Western protection rights considered in China? What recourse does one have if those rights are violated?

Availability/Site Selection:

Once geographical parameters have been set, what can one expect to find when surveying and touring the market?  A colleague with significant experience working in China remarked how Chinese building facades look like they could be in Vegas but walk inside and try to lean on an interior wall and watch your hand fall right through like it was made of tofu.  While partnerships between Western companies and Eastern manufacturers have been leveraged in the past for entry into the Chinese market, healthcare reform will bring stricter government approval requirements for quality and safety over the years to come.  This could easily call into question the conditions of existing buildings and as such, will likely drive Eastern companies to want to control their production facilities as much as possible to ensure compliance, calling for more “ground up” construction.

When a site is selected, it then comes time to design the space, which can bring up another set of questions.  What commonly used benchmarks are unique to China that one should consider when planning for and designing a manufacturing building there? Does one try to implement flow process that works domestically or build off of what currently exists as production standard that is familiar to workers?  How can a company prepare for Chinese regulations and validation standards?

Other availability/site selection questions:

Government Role:

It’s been consistently said the Chinese government plays a large role in any project or business proposed in the country.  Are there any specific policies/guidelines affecting the medical devices sector (limited to national players, subsidies focused to research projects, etc.)? How high are entry barriers (higher taxes, bureaucracy) for the medical sector? Can the new company manufacture and distribute its products in China?

Sustainability:

What are China’s policies on sustainability and does the government mandate certain efforts be made by outsiders to construct and operate under sustainability guidelines?

How to navigate Currency/financial effects and regulations?

How will this work be financed, how can cash and profits generated in China be repatriated? What are the taxes/fees for doing business in China?  China has currency export regulations and the tax authorities ask to see all contracts.

Summary:

As is the case when embarking on any international facilities project, proper due diligence and strategic planning, coupled with as much colleague collaboration as possible, is instrumental to identifying challenges before they become problems.  Chinese healthcare demographics and initiatives will continue to drive US drug and device manufacturers to build there and the more time you take to understand the complexities involved with such a project, the less exasperated you will sound when saying we’re “building a factory in China”.

Thank you to Scientia Advisors and Phil Plottel for providing information and incite when researching this article.