An Industry in Transition - A Multilevel Analysis of China's Pharmaceutical Industry

The functionally specialized players in the Chinese pharmaceutical industry have accepted the need for revenue generation as well as self-financing. However, developing new “rules” that connect the means to this new end represents a challenge for reform policy makers and managers. Professor Steven White and Xielin Liu explore the changing industry dynamics and the challenges in implementing reform with the goal of creating a more market-based economy in China.

by Steven White, Xielin Liu
Last Updated: 23 Jul 2013

The organizational structure of the Chinese pharmaceutical industry now, 20 years after economic and enterprise reforms began, looks strikingly similar to the Soviet-style model under central planning-- a collection of disconnected, functional groups. One organization is responsible for R&D, another for manufacturing, a third for distribution.

However, the mechanisms within this system that brings products from development to the market have changed dramatically. In today’s China, the focus has shifted to revenue growth and profit generation. Steven White (Assistant Professor of Asian Business at INSEAD) and Xielin Liu (National Research Center for Science & Technology for Development, Beijing) closely examine the changes in the dynamics and structure of the cross- and intra-functional networks in China’s pharmaceutical industry to understand the simultaneous fundamental change and structural persistence.

Under central planning, organizations in complementary functional areas (i.e., research, manufacturing, distribution) were brought together to introduce a new product to the end-user. In that system, the Ministry of Public Health would decide everything related to the pharmaceutical industry, from allocating research programs and controlling the internal operations of research institutes, to directing the technology transfer to particular manufacturers, and distributing the products to hospitals and other outlets.

Reforms have brought a fundamental change in those dynamics, including both the objective of the organizations as well as the authority and responsibility for decision-making. Now, managers are encouraged to exercise their own discretion in decision-making, and simply fulfilling a dictated plan with no regards for efficiency or effectiveness has been replaced by a more competitive and profit-driven mindset.

In addition, organizations are forming their own linkages with others, either to sell their outputs or combine resources for joint gain. For example, research results are now being auctioned to competing manufacturers, and at times, manufacturers are commissioning specific research as a sub-contracting activity. Evidence of this new cross-functional network -- major manufacturers are now involved with 30 to 75 percent of the new compounds they produce. Similarly, intra-functional collaboration is also on the rise.

What has led to this? The answer, say the authors, lies in the fundamental change in the incentive structure as economic performance has become the key performance parameter. Organizations are now responsible for generating their own funds as well as developing their customer base. This has significantly impacted cross-functional networks where complementary capabilities have started coming together in the form of alliances or investments. As a macro-trend, the coordination process has largely shifted from a “bureaucratic allocation” to a “bilateral negotiation.”

The challenge of successful reform, however, lies within the organizations. In the past, managers were responsible for meeting but not setting goals. While they now take responsibility, this can lead to industry-level sub-optimal allocation of resources. For example, many research institutions have expanded into low-volume manufacturing away from the area of their core competency and maximum competitive advantage, because the government guarantees wages for the workers within their organizations, making it “free” for the organization itself.

The authors highlight other transition driven challenges such as the turf protection phenomenon, which causes the organizations to remain confined within their regulatory, and at times geographical, boundaries. Mergers, and therefore efficiency gains, between organizations separated by such barriers are extremely rare.

This analysis provides a basis for further system-oriented research into the complex interactions within industries and economies in transition.

INSEAD 2002

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