The SARS-CoV-2 pandemic has drawn significant attention to just how much US pharmaceutical manufacturers rely on manufacturers outside the United States, both for drug substances and finished dosage drugs. It also has demonstrated the risks associated with global supply chains that are overly reliant on specific regions such as China and India, which may be more vulnerable to crises such as the current pandemic or geopolitical / trade instabilities.
Hopefully the ongoing investigation of the impact of the global pandemic will result in an increased focus on risk mitigation for pharma supply chains. Here are some of the key factors we believe have led to the disruption of US pharma supply chains, and how they might be addressed in the future.
Where US Medicines Really Come From
In the US, 90% of all prescriptions are filled with generic drugs. The vast majority of these are produced outside of the US. More than 30% of generics consumed in the US are produced in India. In addition, India gets about 68% to 70% of its raw materials and intermediates from China.
Many people in the US don’t realize just how dependent the pharma industry is on China. Some know that many generic prescription therapeutics come from India, but most are unaware of India’s reliance on China for low-cost raw materials and intermediates.
In fact, while about 80% of the Active Pharmaceutical Ingredients (APIs) used in US drugs come from India, it’s estimated that 48% of the world’s pharmaceutical ingredients produced for use in generic medications come from India and China combined. This proportion is even higher in certain essential drug classes such as antibiotics and others. All of this adds up to a significant reliance on a single country: China.
How the US Pharmaceutical Industry Became Dependent on China
The 20th century brought major changes to the economics of the US pharmaceutical industry. The Drug Price Competition and Patent Term Restoration Act of 1984, more commonly known as the Hatch-Waxman Act, streamlined the process for approvals of generic therapeutics. This resulted in a significantly higher number of approved generics while also reducing drug costs.
Another major shift came in the next decade, when large pharma companies began moving towards an outsourcing model. This coincided with significant growth in the pharma industry in India, China, and other regions. In addition, changes to the US federal tax code from 1996–2006 gradually diminished the role of Puerto Rico in the US supply chain by encouraging pharma companies to offshore production to lower-cost regions such as China and India.
Ever-increasing pressure for lower-cost generic drugs has only added momentum to these trends. With such razor-thin margins, the US market is simply not cost-competitive in the generic pharma market.
China, by contrast, has historically had significant cost advantages:
- Lower labor costs
- Most raw materials are already produced in China, which also reduces shipping costs
- De facto subsidies from the Chinese government, including lower power costs, currency manipulation (which further reduces labor costs), and turning a blind eye to intellectual property theft
These and other factors enable China to keep the prices of generic drugs artificially low. This also drives down the cost of drugs from India because of its dependence on low-cost raw materials from China. As the current situation has shown, however, this model for cheap drugs comes with other costs.
Supply Chain Threats Create Disruptions and Shortages
Four major threats to US supply chain management are particularly visible at present, many of them directly related to overreliance on China:
- Geopolitical issues, particularly the current policy and tariff situation between the United States and China.
- Emerging disease threats such as SARS, MERS, and SARS-CoV-2, which have created unanticipated price spikes and supply disruptions.
- Environmental challenges and pollution factory shutdowns. These are a direct result of re-regulation and new regulations in China designed to control pollution and limit other environmental impacts.
- The shifting regulatory landscape. Most countries do not share the exact same regulations as the US FDA, in spite of efforts to harmonize global regulatory standards (e.g., ICH). As a result, launching a drug in the US may require different studies, data, or cost structures than doing the same launch in other highly regulated regions of the world.
Recent events clearly demonstrate the vulnerabilities these threats create. Lockdowns in the first quarter of 2020, for example, curtailed the number of cargo shipments from China and India, and these still are limited from some regions.
In another potentially ominous foreshadowing of things to come, the promotion of antimalarial drugs hydroxychloroquine and chloroquine as possible treatments for COVID-19 caused supply shortages and skyrocketing prices. As a result, their export from India was blocked for several weeks. Restrictions were soon relaxed, but a similar situation could easily happen again as new therapeutics are identified as — or suspected to be — effective against COVID-19.
Among drug products considered essential to provide care for COVID-19, another wave of shortages is likely in the near term. Supplies of sedatives, painkillers, anesthetics, and muscle relaxant supplies have been a constant issue throughout the pandemic.
How Quickly Could the US Reshore Production?
Moving drug production back into the US isn’t going to happen overnight. The shift to offshore manufacturers occurred over the last 20–30 years, and reversing that momentum would require a comprehensive effort over at least a decade. Even in cases where capacity exists in the US, shifting API sources is a process that can take 18 to 24 months or even longer.
US capacity mostly has remained stable as the production of generics shifted offshore. However, much of it is tied up in the production of drugs that don’t have generic competition, and thus have much higher profit margins. Bringing generic production back to the US would require domestic companies either to reduce their focus on high-profit novel drugs or to build out additional capacity for generic production. Whatever the benefits of doing so, particularly for essential APIs, changes like these will require long-term strategies.
There is little appetite among Americans for more costly generic drugs. According to a recent study by Johns Hopkins University, Americans pay more for health care than any other developed country — 25% more than Sweden, 108% more than Canada, and 145% more than the Organization for Economic Cooperation and Development (OECD) median. And US prices have roughly doubled since the year 2000.
Minimizing Risks to the US Pharma Supply Chain
Whether or not reshoring becomes a reality in the wake of the COVID-19 crisis, pharma companies need to take a better look at their supply chains and consider new risk management strategies. Here are three possible ways they could do so:
1. Diversify supply
Because generics are a low-margin business, most niche generics are dependent upon a single source for their API. This is a huge risk, regardless of where that company is located, because any major event — a fire, a tsunami, an earthquake, a tariff situation, or a geopolitical conflict — can create supply disruptions and shortages. The cost to qualify secondary sources typically discourages generic companies from doing so. That will have to change to minimize future disruptions.
2. Increase safety stocks
Most generic companies maintain a safety stock of their finished product. These typically range from a supply adequate for three months, six months, or up to a year, depending upon stability of the drug and its shelf life.
These stockpiles provide a safety valve when supplies get interrupted, enabling companies to satisfy current demand while they get their supply chain in order. Unfortunately, the safety stock maintained by most companies isn’t high enough to handle a spike in demand that could be driven by today’s global pandemic, particularly if such a demand spike coincides with a supply disruption / shortage. Pharma companies need to consider increasing their safety stock of raw materials, intermediates, and APIs. And again, multiple API sources will be needed.
3. Look to closer neighbors
The US supply chain potentially could be shored up by relying more on other countries closer to home.
Puerto Rico, for example, still has a lot of infrastructure that likely could be ramped up if the US reinstated the tax incentives that were wiped out in the mid-90s. This solution isn’t without challenges, especially since Puerto Rico has seen an exodus of much of its population to the US mainland and the island continues to struggle through recovery from Hurricane Maria. It would take a significant amount of reinvestment, but it could reduce the amount of time needed for the US to bring additional production online.
Mexico and Canada also offer possible alternatives. Mexico still is considered a lower-cost region for pharma production. While it doesn’t compare in costs to China or India, it’s still significantly lower cost than the US.
A Realistic Path Forward
The cost of shifting all production of essential medications back to the US make a complete reshoring highly unlikely, now or in the foreseeable future. Instead, the US would do well to take a more strategic approach.
In general, the most obvious steps to take now are to expand risk mitigation strategies and consider multiple suppliers. This will require a multi-layered look at supply chains to ensure that different suppliers aren’t getting their raw materials from the same sources. At best, US pharma companies could expect to shift production of 30%-50% of critical medications closer to home. But even that may be a lofty goal.