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Coronavirus outbreak drives drugmakers to weigh more diverse supply chains

China has been a major supplier of pharmaceutical ingredients for a range of medicines, from painkillers to antibiotics. However, experts said the novel coronavirus outbreak could prompt overseas drugmakers to consider diversifying their source of supply.

As one of China's key items of healthcare export, the country has more than 1,500 manufacturers producing over 1,600 active pharmaceutical ingredients, or APIs — the basic ingredients used to make drugs — the Ministry of Industry and Information Technology posted on its website in October 2019.

The value of China's API export totaled $30.05 billion in 2018, a 3.2% increase from 2017, according to the China Chamber of Commerce for Import and Export of Medicines and Health Products.

The emergence of COVID-19 — which first spread to Wuhan, Hubei province, at the end of 2019 before moving to other parts of China and over 150 countries — introduced an unexpected obstacle into this established supply system.

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"There is certainly disruption to the global supply chain, from API supply to pharma manufacturing," said Justin Wang, Shanghai-based partner of L.E.K. Consulting, who cited vitamins and antibiotics as two categories where China accounts for a significant portion of global supply.

Production of these drug ingredients, as well as other products such as bandages, suffered a blow during the outbreak as the Chinese government enforced measures including locking down several cities in Hubei, extending the Chinese New Year holiday and advising people to stay at home in January and February to prevent the virus from spreading.

The U.S. Food and Drug Administration announced the first shortage of a medicine caused by the outbreak on Feb. 27. While it did not name the product or manufacturer, it did draw attention to this potential weak link in the pharmaceutical supply chain.

India's Ministry of Commerce and Industry also restricted export of 26 APIs and drug formulations, including a couple of vitamins and progesterone, a critical hormone used in many contraceptives, on March 3. Though the ministry did not give a reason for the restriction, Chris Purdy, CEO of Washington, D.C.-based family planning organization DKT International, said it was likely prompted by concerns about a supply shortage.

In this established supply system, in which companies became increasingly reliant on lower-cost manufacturers in China, the outbreak has been an unwelcome development. "The trade-off between concentration risk and low prices was accepted by the world for many years, but I suspect COVID-19 will force a rethink of national strategies for pharmaceutical procurement," said Jeremy Lim, co-director of the global health program at the National University of Singapore's Saw Swee Hock School of Public Health.

Bringing production back home

Concerns among authorities in the U.S. and Europe about the risk of concentrating API supply in China pre-date the coronavirus outbreak.

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The mass recall of tainted batches of valsartan, a generic blood pressure medicine sold by Novartis Holding AG as Diovan, produced by suppliers including China's Zhejiang Huahai Pharmaceutical Co. Ltd., began in 2018, causing shortages of the drug and highlighting the dangers of over-reliance on one source.

Besides APIs, the U.S. import value of other pharmaceutical products from China — including tablets in boxes, vaccines and plasma — has continued to grow, from $1.36 billion in 2016 to $1.56 billion in 2019, according to data by Panjiva.

"Countries will increasingly look at pharmaceutical and medical device — including masks and sanitizers — supply chains as strategic and elect to manufacture in-country despite higher costs and subsequently price to purchasers," Lim said, adding that the U.S. imports 95% of its ibuprofen, a common painkiller, and 80% of its antibiotics from China.

Even politicians have taken note, with U.S. Senate Finance Committee Chairman Chuck Grassley pointing out in a letter to the Department of Health and Human Services in August 2019 that the U.S relies on imports for 80% of its API supply, with the majority sourced from China and India.

Addressing EU health ministers in a Feb. 13 meeting in Brussels on COVID-19, Czech Republic Minister of Health Adam Vojtěch pointed out that API production is concentrated in China and urged the European Commission to "attract the production and manufacturing of these crucial … APIs back to the EU."

Pharmaceutical companies are also considering action. Richard Saynor, CEO of Novartis' generic-drug unit Sandoz International GmbH, used a Feb. 26 LinkedIn post to describe the COVID-19 outbreak as a reason why drugmakers should plan for the unexpected. He added that he will support the EU's efforts to find the right balance between competitive pricing and security of supply.

Sanofi is planning to go one step further — in a Feb. 24 news release, the Paris-based drugmaker revealed it is establishing a new company to produce APIs. It expects the entity, to be based in France, to rank as the world's second-largest API company with about €1 billion in sales by 2022.

"It is sensible for companies to diversify their supply and minimize risk. The coronavirus is an example of a situation that can punish a company if it concentrates its risk and supply too close in one area," Christian Hogg, CEO of Hong Kong tycoon Li Ka-shing-backed Hutchison China MediTech Ltd., or Chi-Med, said in an interview with S&P Global Market Intelligence.

Other alternatives

For drugmakers trying to minimize supply risks by looking for manufacturers outside of China, Lim said logistics, intellectual property protections, tariffs and costs are among the major concerns.

Some Southeast Asian countries and less well-off nations in the EU already provide alternative options, he said.

"What would be interesting would be blocs of countries such as ASEAN or the EU banding together to provide for themselves," he said.

Hogg suggested drugmakers look to Europe and North America to find alternative suppliers for APIs, because of the established technology in these countries. He is more doubtful of the feasibility of other Asian countries, due to a lack of intellectual property protections and qualified manufacturers.

"We are talking about highly sophisticated pharmaceutical products. Realistically, China has dominated in that place. The reason it does is because it has invested enormously in infrastructure," he said.

But regardless of where companies want to diversify their supply, there will be tradeoffs — most significantly, increasing cost.

"The cost [of production] will be no doubt higher in the western countries," Hogg said.

For less developed countries, Lim said this cost may come in the form of investment to build up expertise in manufacturing. "It is expensive and does not develop overnight, but countries will want to mitigate supply chain risks and it is a necessary price to pay," he said.

For some companies, however, the time, money and effort may not seem worth it. China is an "increasingly resilient market," said Hogg, who added that his company had operated through the SARS outbreak of 2003 and sees "no need for alarm" now.

"In general, China is pretty stable," he said. "Let this [crisis] pass and see what is the genuine ongoing risk of over-concentrating on one country."

READ MORE: Sign up for our weekly coronavirus newsletter here, and read our latest coverage on the crisis here.

Panjiva is a business line of S&P Global Market Intelligence, a division of S&P Global Inc.