China: No Longer A Great Wall For Supplement Makers

Changes in export and import trade laws in China beginning next year could result in increased investment opportunity for U.S. dietary supplement manufacturers, according to industry stakeholder David Turner.

Turner is Chairman and CEO of Zuellig North America and BI Nutraceuticals.

Results of WTO Acceptance

China's acceptance into the World Trade Organization is both driving the country's growth and also changing the legal system significantly, Turner said at the Supply Side West Trade Show & Conference in Las Vegas Sept. 30.

Beginning in 2005, all "foreign corporations will have a relaxation of the opportunities they would have to do business in China," he said. Consequently, the small-medium enterprises (SME) that currently are required to export through a licensed company will no longer have to comply with that rule.

"We are seeing provincial and municipal governments competing for foreign investments, which is providing a very attractive investment climate," Turner noted.

The Chinese government also is funding small businesses' modernization and consolidation efforts. "One such organization...has over 400 companies within its portfolio that's going to be reduced to 100 or even less within a 24-month period in anticipation of either one or several public listings overseas," he predicted.

China has turned attention to manufacturing compliance. The government is placing significant pressure on firms to comply with current good manufacturing practices. "Thousands of companies are under the gun to comply," Turner noted, pointing out the September due date for compliance has passed.

Turner said the goal is for the country to be the world leader in traditional Chinese medicine (TCM) production. "They've brought out good agricultural practices...and have established numerous international research centers to prove the efficacy and safety of traditional Chinese medicine."

A change in the banking climate may be another indirect benefit for U.S. manufacturers. Previously, "Chinese corporations have had access to unrealistic levels of domestic bank funding."

In response, the government "is withdrawing those credit facilities," sometimes as much as 50% or even entirely, he said. As a result, "we're going to see a different trading environment and a different role is going to have to be played by the traditional trader in the marketplace."

China's Cost Advantage: Population

The county's 1.3 bil.-person population means China has a sustainable cost advantage, Turner asserted. The TCM market earns more than $5 bil., equaling approximately half of the country's "so-called 'pharmaceutical' market," he added.

"Why is China a stable low-cost environment?" Turner questioned. "I think Europeans would argue that Poland and the eastern parts of Russia are places there they're looking to do business in preference to China."

However, China presents an advantage "because it has 800 mil. people living in rural areas - that's three times the population of the U.S. - which ultimately is going to move into the industrialized sector," Turner maintained.

"So even with the inflation that we're seeing in Chinese labor, we're going to continue to see [the] Chinese labor process 10 years out not dissimilar to those of today," he maintained.

The Down Side: Lost Contracts & Legal Battles

Despite Turner's contention that "China is ultimately going to be the gateway to providing manufactured finished dosage form products," he conceded there are many obstacles for both Chinese and U.S. manufacturers to reconcile before moving forward.

"A signed contract in China is basically a work-in-progress, it's not a final document," Turner said. "Because of this, many contracts are really not complied with, and many fail over time."

If there is a legal tangle, relationships "will overrule any deficit on the part of the local partner to comply with that contract," he added.

DNP International VP and general manager for development of dynamic nutritional products Mike Smith echoed Turner's comments, stating "contracts exist as long as it's good for the Chinese manufacturer."

"We had firm contracts with half a dozen companies and the decision was made to slow down availability, and as a result...the price tripled in a matter of months," Smith said.

Turner called the Chinese expectation that a minority investor in a corporation will run the venture "peculiar" to typical U.S. thinking.

"Many companies forego the role of chairman to their Chinese partner in order to be able to get the positions of CEO, CFO and other key positions for themselves, but the chairman is the most powerful person in most Chinese corporations according to law," he pointed out.

Moreover, "because of the internal informal organization structure...they wield significant power, and so a lot of time needs to be spent by foreign managers in China dealing with these issues," he warned.

In the same vein, Turner characterized the Chinese legal system and business rules as "unpredictable."

"What may be written into law may be in practice something which is not practical. Many Asian countries are very good at complying with WTO by changing the law to allow something, but their internal procedures prohibit it or slow down the process to give Chinese companies [time] to comply."

Questionable Botanical Integrity

Turner highlighted sourcing of botanicals as particularly problematic for U.S. manufacturers, especially if they do business with SMEs, who are not required to comply with pharmaceutical standards.

"We found increasing numbers of shipments of botanical powders...failed to meet heavy metal and pesticide testing residue tests," Turner said. "One of the reasons for that is their assay methodologies are not the same as those that we use in the West." Similarly, many firms "don't have the standards necessary to actually calibrate their own equipment."

In the same vein, Chinese firms also do not test for almost 30 of the pesticides that domestic firms test for, Turner pointed out.

Another point of concern for U.S. manufacturers is that a growing number of companies are falsifying international certificates of analysis, so the products have not been tested at all when they arrive in this country, he said.

Traceability: A Difficult Proposition

Another phenomenon unique to China is that "basically everybody is a wholesaler," Turner said.

"Traditionally, most Chinese organizations were given the right to manufacture a single product or to grow a single herb," he explained. However, when U.S. firms work with a firm in China, they expect to have access to a number of herbs, and thus, they "need to deal with a significant number of players."

A trading network is subsequently set up across the country, Turner said. "When you buy a product from Company A, even if it is a manufacturer of that particular product, there's not a guarantee...that their factory actually produced that product. More likely, they would have intermediaries perform intermediate steps," making it hard to trace the product's origins.

This becomes particularly problematic when products are spiked: shipments contain pieces of roots and leaves in addition to the active part of the plant to "lower the overall cost of the product."

"They're getting so good at this that even methods such as chromatography...are finding it very, very difficult to differentiate this blended type of arrangement," Turner emphasized.

Another problem resulting from reduced traceability is that products are coming into the country under incorrect product classifications. Therefore, a lower rate of tax is being paid by some importers.

Similarly, some manufacturers are shipping containers in which only "the top 25% of the container actually contains the active product."

Gauging Prices Is A Guessing Game

Smith pointed to pricing instabilities as a significant side effect of doing business in China, since it is a regular occurrence.

The price will drop for several weeks or months at a time, and "eventually, some companies go out of business," or a difference in availability of raw materials will cause prices to rise again.

"These ups and down are a regular part of your purchasing, whether you're a distributor or a final finished product manufacturer," Smith noted, adding "it can be a nightmare at times."

Bioterrorism Reg Compliance

In addition to the changes in their own country, Chinese manufacturers are beginning to adjust to changes resulting from the Bioterrorism Act.

At this point, "more than half of the manufacturers in China are not registered with the FDA, and starting on Aug. 17 at the airports in the U.S., they started to enforce the prior notice rule, so you may notice there's a slowdown in the imports now, there's a lot of checking going on," Smith said.

The bill, signed into law in June 2002, established procedures for prior notice for imports, specified recordkeeping requirements and outlined plans for detention of foods and registration of food facilities (¹ 'The Tan Sheet' June 17, 2002, In Brief).

Smith also pointed out that the agency will soon release GMPs for dietary supplements, which could add to compliance pressures.

"As to the future, the manufacturing will continue in the commodities market scenario where they can really compete well," he predicted.

Words Of Wisdom

"Embrace China," Turner said. "It is going to be a significant player in our marketplace. It will become a manufacturer of finished dosage product and not just a supplier of raw material ingredients."

Smith expressed similar sentiments: "At some point...China is going to have to begin innovating and creating and that will be the long-term future."

Turner encouraged the industry to "carefully select your partners; divorce in China is both problematic, expensive and extremely disruptive."

"I think the generation, the establishment of knowledge transfer programs with suppliers is critical, and if you don't have the capability to work with multiple sources of product, it's far better off to deal with the players," he concluded.