Nearly a decade after New York Times columnist Thomas Friedman declared the business “World is Flat,” we’re seeing some interesting changes that have less to do with technology. These changes have more to do with local economics. Countries like India and China had the advantage of having a workforce of engineers and chemists available to work at a fraction of what their U.S.-based counterparts received.
That advantage is diminishing for several reasons:
Labor costs in China and India are experiencing double-digit growth rates each year. India has been experiencing a “persistently high inflation” since 2009, according to The Economist in an Aug. 2012 article about inflation in India. The headline of a June 21, 2012 article in The Times of India says it all: “Salaries rose by up to 27% in FY12 amid high inflation.”
Back in May 2011, in an article entitled, “India Struggles to Cap Wage Inflation” (May 12, 2011) the Financial Times reported: “India’s industrialists are fighting a sharp rise in salary demands as they strive to hold on to scarce talent in the world’s fastest growing large economy after China. India is battling the highest inflation of the big Asian economies.” Meanwhile, a China Daily article, “Chinese wages see double-digit growth” (May 29, 2012), reported that “The average annual salaries of urban Chinese workers at non-private companies” increased by 14.3 percent year-on-year.
When employees don’t get raises, they often quit to get paid more at a competing company. According to “How to Stop Employee Turnover in India,” published July 2, 2012 on Forbes.com, “A recent Mercer survey highlights that no fewer than 54 percent of Indian workers are seriously considering leaving their jobs, and … other independent studies confirm the correlation between intention to leave and actual turnover. The really tricky part is that the people considering leaving are not even desperately unhappy.”
The problem with turnover is that it is very difficult to achieve milestones on long-term projects when companies have to constantly retrain their staffs on client matters; the challenge for customers is that every few weeks, they’re dealing with new team members. Furthermore, at a certain point in their careers, local employees may not want to work for multinational companies, fearing that most senior positions will be held by expatriates, according to a Harvard Business Review article, “The Battle for Chinese Talent” (March 2011).
Anecdotally, chemists, who might get paid the equivalent of $10,000 or $15,000 per year, expect a 30 to 40 percent raise. And if they don’t get a significant raise, they go somewhere else. The result: lots of turnover and wage inflation. (In contrast, U.S.-based chemists would not have the expectation that they can leave one job and get a 40 percent increase at their next job.)
An issue often related to turnover is that local employees will take knowledge of processes, techniques, etc. from their current job and bring them to their next job. This puts a company’s intellectual property at significant risk. An additional challenge is that IP laws, protections and expectations in India, China and elsewhere can be vastly different from those in the U.S. Protecting your company’s IP by suing companies in India and China can be daunting at best, given language and cultural issues. At worst, it can be expensive, time consuming and frustrating – since, as a foreign company, you are more likely to lose.
Under the generic drug user fee act (GDUFA), intended to “ensure that participants in the U.S. generic drug system comply with U.S. quality standards, the FDA is raising the bar on laboratory requirements, both in the U.S. and overseas. Some of the processes that may pass muster in other countries – like relabeling drums or re-writing original data – are not acceptable under FDA regulations, and it may be difficult to change that culture in other countries.
The top labs in India and China will likely not have much of a challenge to meet FDA regulations, but the bottom two-thirds are likely to struggle in terms of systems and regulatory adherence – and struggle to meet U.S. standards. Establishing processes to meet FDA standards is expensive, and will certainly increase the costs to U.S. consumers. But it will be even more expensive for U.S. companies if their materials, developed in India and China, do not meet FDA standards – added costs from having to redo necessary steps and added costs from the delays before getting FDA-approved ingredients, for example.
The need to retrain new employees can lead to delays in meeting project deadlines. This can be worse if new hires turn out to be wrong hires, necessitating yet another replacement employee who must be trained. And, as noted immediately above, not meeting FDA standards will likely lead to delays – and the costs not to be able to import your active ingredient (because it doesn’t meet FDA standards) could be significant. This can be true even in imports to the U.S. of raw materials, which have been held up by Customs and the FDA for weeks, so imagine the delays and resulting costs if labeling on your active ingredients don’t meet FDA standards. Missteps and quality control issues represent significant risks in delays and costs.
To address this, U.S. companies will have to maintain closer supervision of the project to make sure all processes, ingredients and the labs themselves are in compliance with FDA regulations. If a change needs to be made to ensure compliance, that change needs to be blessed by the Quality Assurance teams from both companies.
Additionally, operational efficiency can also be hampered by working across different time zones and across different languages and culture. In some cases, providers will take on as much work as possible, overextending themselves, resulting in missed deadlines. In other cases, due to differences in cultural expectations, you might sign an agreement, only to find out that your partner wants to renegotiate the contract on a regular basis. Sometimes prices change in the middle of a project, without the offer of an explanation.
The days when Indian and Chinese providers had a clear price advantage has passed. Outsourcing research and development to other countries will make less sense because the cost differential between U.S. R&D and foreign R&D is narrowing all the time – especially when you factor in the potential for delays and missteps. Labor costs in India and China are continuing to increase faster than U.S. costs. It will be interesting to see how things play out when the world is not only flat but level.