Biotechnological Innovation

Abstract

Biotechnological innovations are rapidly reforming the pharmaceutical and agriculture sectors at home and abroad. With leading technological advances in the US and Europe, Chinese industries have been quick to follow with scientific discoveries, industrial applications, supply chain, legislation reforms, and administrative support.

Despite high pharmaceutical demand, China’s manufacturing capability on the supply side is not yet globally competitive. The global pharmaceutical market is built upon the demand of unmet medical needs, health insurance, and extensive investment in new drug development. China is a leading pharmaceutical market in absolute size, but its pharmaceutical spending per capita is relatively low. Nevertheless, Chinese companies are catching up, and China’s contribution to global pharma R&D has started to shift from high-quality generics to gradual innovation.

As for the agriculture sector, the overall supply in China is stable, but other countries’ experience in agricultural innovation is also worth studying. China typically maintains steady output growth and a relatively high self-sufficiency ratio. However, there remains room for improvement in the supply of some agricultural varieties and in the front-end sector of the meat value chain. We think China's overall biotech innovation in the agriculture industry is characterized by incremental innovation. Judging by China’s successful innovations in rice cultivation, we think policy support, appropriate government mechanisms, and public–private cooperation are important for agricultural R&D.

Agriculture and pharmaceutical sectors are now at different stages of innovation, and therefore need different types of policy support. Major factors affecting China’s pharmaceutical innovation and status quo are basic science development, clinical R&D, and standardized production capability. Policy-wise, we believe: (1) Funds from the public sector could be used to support the development of basic and translational sciences, which are the foundation for innovation; (2) pharmaceutical payment reform could be accelerated, and incremental funds from commercial insurance be introduced (3) a tiered financing system could be built to enhance risk-resistance capacity; and (4) a new drug approval system could be optimized to encourage innovation.

As for biotech innovation in agriculture, policy support may include the following. (1) Legislative supervision: We suggest that the government enhance the protection of agricultural intellectual rights and step up efforts in combating infringements. (2) Capital investment: We suggest that public sector investment in R&D be increased and cooperation enhanced with the private sector. (3) Talent education: We propose strengthening whole-procedure education and the cooperation between companies and research institutes.

5.1 Challenges and Opportunities in China’s Biotech Innovation

Biotech innovations are vital for advances in both the pharmaceutical and agricultural sectors. Developed countries are still leading in pharmaceutical innovation, but China is catching up. As for agriculture, food supply is overall stable, but bottlenecks remain.

5.1.1 Biopharmaceutical Innovation: Chinese Companies Catching Up

5.1.1.1 Pharmaceutical Market from a Global Perspective

The US is now the world’s largest pharmaceutical market, and a majority of drug spending in the US is directed toward innovative drugs with clinical value. As assessed by Institute for Clinical and Economic Review (ICER), US consumers are on average willing to pay US$100,000–150,000 for a quality-adjusted year of life. In 2019, drug sales revenue in the US reached US$495bn, the highest in the world. In 2020, 67% of the top 5 global medicines by sales value were sold in the US. According to Pharmaceutical Research and Manufacturers of America (PhRMA) and IQVIA, original medicines accounted for 10% of prescription volume and 80% of sales value in the US in 2020, and the share of original medicines with patent protection and prescription medicines reached 66% in 2018 (Fig. 5.1).

Fig. 5.1

Source FDA, CICC Research

Global pharmaceutical market. Note ROW refers to rest of the world.

China is a leading pharmaceutical market in absolute size, only smaller than the US and EU, but its pharmaceutical spending per capita is relatively low. According to China Health Statistics Yearbook and OECD, in 2019, health spending and medicine spending per capita in China stood at around US$700 (6.67% of GDP) and US$260, while those in the US reached US$12,000 (17.6% of GDP) and US$1,128 (only considering prescription medicines). However, China’s medicine spending mix has been changing since reforms on drug approval and the medical insurance system started in 2015. We see great potential for innovative medications as the spending mix and payment system shift away from generic drugs, traditional Chinese medicine (TCM) injections, and adjuvant drugs due to the evolving commercial insurance system in China.

New medicine R&D and commercialization are key focuses of the pharmaceutical industry, which are now dominated by European and US multinationals. Developing new drugs requires extensive investment. In Europe and the US, after completing proof-of-concept work, small and medium-sized pharmaceutical companies often choose to collaborate with multinationals boasting ample cash, clinical experience, and commercialization platforms, either through joint development or authorization. This leads to further domination of new drugs by European and US multinationals. According to PharmExec and Torreya, revenue at global top 20 pharmaceutical firms reached close to US$600bn in 2020.

Chinese pharmaceutical manufacturers are catching up. Compared with European countries and the US, the pharmaceutical manufacturing industry started late in China, and its pharmaceutical market remains segmented. Domestic leading pharmaceutical manufacturers mainly provide generics, and most of their new drugs cannot compete with international rivals. Biomedicine and biotech companies focusing on innovative drugs are also in the growth stage.

5.1.1.2 Chinese Companies Catching up in R&D and Marketing

Developing a new drug involves various academic disciplines such as basic science, translational medicine, pharmaceutical science, and clinical medicine. After the drug targeting strategy is decided, scientists conduct preliminary screenings to select a single molecule from thousands or millions of candidates, on which clinical research will be conducted. The clinical phase I, II, and III research on candidate molecules are also necessary to verify their effectiveness and safety for adaption diseases. The new drug may then enter the market after gaining approval from regulators and an expert committee (Fig. 5.2).

Fig. 5.2

Source Frost & Sullivan, CICC Research

New drug R&D. Note DMPK refers to drug metabolism and pharmacokinetics.

New drug R&D features extensive investment, long periods of time, and low success rates. Trial-and-error efficiency is the core competency after drug screening begins. For innovative medicine R&D projects launched after 2010, it may take 8–10 years of R&D of 5,000–10,000 types of compounds to roll out one new drug. Average R&D cost per drug is over US$1bn, most of which is spent on clinical trials.

The US is a major contributor to global medicine innovation. According to the 2021 PhRMA member annual survey, this trade group’s member companies invested US$91.1bn (21.4% of sales income) in R&D in 2020, accounting for 49% of global medicine R&D spending. In addition to large pharmaceutical firms, private sector investments and government-led US National Institutes of Health funding are also major sources of R&D spending in the US. High-quality, proactive innovation gave rise to innovative biotech companies and pharmaceutical giants in the US. In 2020, 51% of new drug molecules and nine of the global top 10 best-selling drugs were launched by US companies, and nine of the global top-20 pharmaceutical companies were headquartered in the US. As of March 22, 2021, 46% of biotech companies were based in the US (Figs. 5.3 and 5.4).

Fig. 5.3

Source OECD, IQVIA, CICC Research

Share of R&D spending in drug sales.

Fig. 5.4

Source Deloitte, CICC Research

Country of origin for companies developing new drugs (2021).

Chinese pharmaceutical companies used to spend more on marketing than on R&D due to the high cost of gaining approval for new drugs and a lack of policy support. While drug approval reform has brought significant changes, the share of R&D spending at leading domestic pharmaceutical companies remains lower in China than in Europe and the US. Beigene invested Rmb8.45bn in R&D in 2020, a record for Chinese pharmaceutical companies. Meanwhile, traditional large pharmaceutical companies such as Hengrui also started stepping up innovation in 2016.

Chinese pharmaceutical companies see opportunities to catch up with foreign rivals. Domestic companies are competitive in drug discovery technologies including drug screening platforms and drug screening AI technologies. In addition, new modalities including cell therapies, gene therapies, and bispecific antibodies are making significant progress in drug discovery. China is only second to the US in terms of the number of clinical trials of cell and gene therapies. Legend Biotech achieved an agreement with J&J to jointly develop BCMA CAR-T Carvykti in 2017, and it was approved by the US Food and Drug Administration (FDA) and the European Commission (EC) in 2022. China’s biotech companies have rich experience in biomedicine and tumor immunology, and many were deployed in the bispecific antibody for tumor immunology. Domestic company AkesoBio released positive results of its PD-1/CTLA-4 bispecific antibody AK104, and the drug was approved for the treatment of cervical cancer in 2022 by the National Medical Products Administration (NMPA).

The large population and strong demand potential in China provide a solid foundation for domestic innovative drug companies to achieve commercialization and expand into the larger overseas market. Since joining the International Council for Harmonisation of Technical Requirements for Pharmaceuticals for Human Use (ICH) in 2017, China has gradually switched to international standards for the regulation and development of innovative drugs, and domestic innovative drug companies are also entering the global market.

Chinese companies are expanding overseas teams for clinical research and marketing. More and more domestic companies began to conduct clinical research abroad to better support product launches and sales in global markets. The number of overseas countries in which Chinese pharma companies conducted clinical trials and the total overseas clinical trial projects rose from 14 and 48 in 2015 to over 50 and 340 in 2019. Beigene gained approval for marketing Zanubrutinib in the US in 2019, and other Chinese companies such as Hengrui are also developing overseas marketing systems. We expect more domestic pharma companies to go global.

5.1.2 Agriculture Supply in China: Stable Overall, but Capacity is Weak in Front-End Sectors

China's agricultural production is characterized by its large scale and stable supply. However, conditions vary for specific varieties. For example, although the supply of major grains is stable, feed grains supply is less secure. In addition, although China is able to secure its meat supply, there are front-end weaknesses in areas such as breeding. As a result, we see higher risks in front-end sectors of the agricultural value chain.

5.1.2.1 Overall Supply Stable; Conditions Vary Among Varieties

China is the world's biggest grain and meat producer, with its share of grain and meat produced accounting for 21% and 23% of global output in 2019 (Figs. 5.5 and 5.6). Output of grain and meat has grown steadily. Data from the National Bureau of Statistics (NBS) shows that the country's total grain output in 2020 was 669 mn tonnes, growing at a 10-year CAGR of 1.8%. Total meat output in 2020 was 77.48 mn tonnes, corresponding to a CAGR of -0.31%. Total meat output in China dropped 10% YoY in 2020, dragging CAGR, as African swine fever (ASF) harmed hog production capacity.

Fig. 5.5

Source FAO, CICC Research

Share of global grain output by country.

Fig. 5.6

Source FAO, CICC Research

Share of global meat output by country.

Agricultural supply in China is guaranteed. First, per-capita grain and meat supply is high. According to the Ministry of Agricultural and Rural Affairs, China's grain supply per capita reached about 480 kg in 2020, exceeding the international safety standard of 400 kg by 20%. The Food and Agriculture Organization of the United Nations (FAO) said China's annual meat supply per capita was 54.4 kg in 2020, surpassing the global average by 28%. Second, self-sufficiency rates are high. The Organization for Economic Co-operation and Development (OECD) and FAO estimated China's grain and meat self-sufficiency rates at 81.0% and 90.6% in 2020, which suggests domestic supply could fully meet demand. Third, the inventory to consumption ratio is high. China's inventory to consumption ratio is 56.2%, exceeding the world average by 29.1 ppt.

The production structures of grain and meat are concentrated, while supply capacities differ. Rice, wheat, and corn are the main grain products in China, but soybean output is low. Pork and poultry are China's major meat products, while the production of ruminant meat is low. The supply capacity of different agricultural products varies, in our view:

First, supply of rice and wheat (main staples) is ample and stable. China’s self-sufficiency rate is almost 100% for both rice and wheat, while rice and wheat supply per capita meets or exceeds the world average. As for rice and wheat yields, China not only outperforms the global average, but also surpasses average levels of major global rice and wheat producers. Overall, China has secured the supply chain of rice and wheat.

Second, supply of corn and soybean (main animal feeds) is relatively weak. The situation is better for the supply of corn than it is for soybean, but there are problems in corn seed breeding. China's self-sufficiency rate for corn stands at 89%, and its per-capita corn supply beats the world average. However, corn's inventory to consumption ratio is low compared with that of other grain products, which confirms that corn supply is weaker than for rice or wheat. Meanwhile, the corn yield is lower than main producers, and thus we believe China still has weaknesses in corn seed breeding. Soybean sector faces weak supply and front-end bottlenecks. China's soybean self-sufficiency rate is 18%, while its soybean yield meets or exceeds 70% of the global average. Thus, we see weaknesses in soybean supply and seed breeding.

Third, supply of hog and poultry is strong, but breeding capacity is weak. In China, hog and poultry self-sufficiency rates both exceed 90%, and per-capita supply is high. However, China underperforms the global average and major hog and poultry producers in terms of yields, and its share of global hog and poultry breeding markets is relatively small. In our view, this highlights China's inefficiency in hog and poultry breeding.¹

5.1.2.2 Supply is Weak at the Front End

Risks in China's agricultural supply chain may be classified into vertical and horizontal risks, both of which call for biotech innovations. Vertical risks refer to risks in seed production and breeding, which may be offset through technological upgrades. Horizontal risks mainly include low efficiency and disease-related risks. We attribute the low production efficiency in the agriculture sector to small business scale, and suggest that the country support business expansion with favorable policies and engage in technological innovation on economies of scale. To reduce risks related to animal diseases, we think the sector could innovate in disease control-related technologies and expand operating scale to improve disease resistance.

Vertical risks in seed production and breeding could be reduced by improving competitiveness and innovation. China's competitiveness in agriculture's front-end sectors (seed production, seed breeding, hog and poultry breeding, for example) is relatively weak. For grain, yields of feed products in China are lower than the average of global leaders. We believe that Chinese companies in this sector could be better at innovation. For meat, China has to improve the genetic qualities of its sows because piglets weaned per sow per year (PSY) and average carcass weight are lower than animals from European countries and the US. We think technological R&D is crucial, and that innovation will bolster front-end supply first, and then the supply along the entire agricultural value chain.

Low efficiency caused by small business scale is a kind of horizontal risk. To fuel innovation and reduce such risk, favorable policies that promote business expansion are needed. Small farms dominate the agricultural production market in China. Results of the third agricultural census of Ministry of Agricultural and Rural Affairs shows that around 98% of producers in China are small farms, but arable land per farm only averages 7.8 mu (1 mu equals around 666.67 m²). According to China Animal Husbandry and Veterinary Yearbook, per farm hog inventory stands at nine, and around 57% of farms operate a large-scale hog business. In recent years, China dealt with problems such as arable land fragmentation by deepening land reform. It also stepped up efforts to promote the transfer of land operating rights and improve farming efficiency. We think business expansion will likely accelerate in the agriculture sector, and economies of scale will bolster technological innovation.

Disease-related risk, as another kind of horizontal risk, could also be reduced through business expansion and biotech innovation. In our view, large-scale business operations could enhance companies’ disease control and prevention capability, as well as management. In addition, we expect companies to strengthen technological innovation in fields such as insect-resistant traits and animal vaccines.

China could improve supply in its seed production sector, and biotech innovation could play a vital role. Our estimation for the average gross margin (GM) of seed production and fertilizer industries in major economies was 43% and 47% in 2020, significantly higher than the GM for pesticides and crop production sectors. We calculate that the R&D expense ratio of seed production sectors in major economies is 14%, the highest along the industry chain. This shows that R&D and innovation play important roles in the development of the seed production business. The industry in China faces smaller-scale business and uncertainties in supply, and the R&D expense ratio of China's seed production sector is low. We think China needs to catch up with other countries in terms of seed production.

Also, China could strengthen the competitiveness of the breeding industry through R&D. We estimate the average GM of the animal breeding and health care sectors in major economies to be 53% and 59%, significantly higher than the GM of the feed and farming businesses. The average R&D expense ratios of the breeding and animal health care businesses reached 12% and 8% in 2020, which are the highest in the animal farming industrial value chain. We think these two sectors are driven by R&D. Compared with peers elsewhere, Chinese breeding companies record relatively lower revenue, reflecting their weak competitiveness and supply. The total revenue of China's animal health care sector is also low, but China is competitive due to its strengths in hog vaccines (overseas peers mainly focus on ruminate vaccine R&D).

China's low supply in seed production and animal breeding sectors affects market stability. Cropping value chain: Supply is weak in the seed production sector while demand is stable. To analyze the supply stability of China’s cropping sector, we use demand stability factor α (α = China's share in the global grain production market/China's share in the global grain consumption market) and supply stability factor β (β = China's share in the global seed production market/China's share in the global grain production market) to reflect the country's capability to meet grain demand and add support to grain production in the seed production process. According to our calculations, the US and France have α values exceeding 1, reflecting strong demand stability. The α value for China is less than 1 due to the reliance on soybean imports. We think overall grain demand in China is stable, given that demand for the main grains is stable. The β value in the Netherlands, France, and the US exceeds 1. China underperforms these seed production leaders in terms of supply, but its β stands at a relatively high level due to low R&D expenses. We expect Chinese companies in the industry to step up R&D efforts. Overall, demand is stable in China's cropping sector, but stability of supply in the seed production sector needs further improvement.

Animal farming value chain: Demand is solid while supply in the breeding sector is relatively weak. We use the same calculation method for this sector. Most countries have similar α values, which are close to 1. In contrast, China's α value is less than 1 due to its reliance on imported beef. Thanks to its large-scale hog and poultry production, the overall demand in the animal farming sector is secured, in our view. The β values of the US, Germany, the UK, and the Netherlands are significantly higher than 1, but China's is 0.38. This reflects relatively unstable supply along the animal farming value chain, which should be mainly attributed to the low sow capacity. Overall, we think demand is stable in the animal farming sector, while breeding capacity should be improved.

5.2 Insights into China’s Innovation in Pharmaceutical and Agriculture Sectors

We look into China’s biotech innovations in the pharmaceutical and agriculture sectors, and provide policy suggestions accordingly. Major factors affecting China’s pharmaceutical innovation and status quo are the level of basic science, clinical R&D, and standardized production capability. To encourage innovation in pharmaceutical manufacturing, the government could focus on building value-oriented incentive mechanisms and an efficient capital market, in our view. Regarding the agriculture sector, the government could mainly focus on incremental innovation while occasionally introducing radical innovations. Favorable policies, governmental mechanisms, and cooperation between the public and private sectors are conducive to biotech innovation in agriculture, especially for seed production, breeding, and vaccine development.

5.2.1 Analysis of Factors Affecting China’s Pharmaceutical Manufacturing Innovation: From Labs to Production and Supply

Development of basic disciplines, pharmaceutical R&D spending, and trial-and-error efficiency during the development stage are important factors affecting the global competitiveness of pharmaceutical manufacturers. An efficient, standard supply chain is the foundation, in our view. Development of basic disciplines is relatively slow in China. While policy guidance has become increasingly clear since the drug approval reform in 2015, we believe stimulus for drug innovation remains insufficient.

Basic science is decisive for original innovation. Drug R&D is a continual process from basic disciplines to clinical development. Innovation of medicine targets and mechanisms mainly rely on high-quality basic research, and the conversion of basic research results into clinical research requires a mature system. Pharmaceutical companies, however, play an important role in clinical trials and commercialization.

There is room for improvement in basic research and translational science in China. China’s reform of its drug approval system encouraged pharmaceutical companies to recruit more experts in clinical trials and pharmaceutical production. However, China still lags the US in academic research, and the conversion of academic results into actual product rollout is slow. According to OECD, China’s R&D expenditure as a percentage of GDP has remained above 2% for several years, for instance, 2.1% in 2018, close to that of the UK and France. However, most of the expenses were used to fund clinical trials, which accounted for 67% of the expenditure in 2016. Only a small proportion was reserved for basic research in China, well below that of Europe, the US, and Japan, which allocate 10–20% of their R&D expenditure to basic research.

It takes time to catch up. The fast-follower strategy may help strengthen China’s basic research at certain stages, but may in the long run cause low efficiency. We believe the fast-follower strategy is an important way for domestic pharmaceutical manufactures to build an innovation system from scratch, leveraging their late-mover advantage in the medium to long term. In the long run, we think the capability for original innovation and upgrades based on basic and translation sciences is a prerequisite for domestic pharmaceutical firms to establish global competitiveness in new drug R&D (Fig. 5.7).

Fig. 5.7

Source Building a Sustainable Ecosystem for China’s Pharmaceutical Innovation, 2016, China Pharmaceutical Enterprises Association, China Pharmaceutical Industry Association, China Chamber of Commerce of Medicines & Health Products Importers & Exporters, R&D-based Pharmaceutical Association Committee, CICC Research

Three stages of innovation.

The innovation of pharmaceutical manufacturing requires funding and incentives. While the pharmaceutical manufacturing industry has been developing for more than 100 years abroad, China only began to build its own production system for medicine ingredients, preparations, and generics in the twentieth century. The Chinese government has, since 2008, launched major projects such as new drug innovation to encourage innovation in pharmaceutical manufacturing. The innovation ecosystem gradually improved after the drug approval reform started in 2015.

Chinese pharmaceutical companies are rapidly catching up with overseas peers in innovation. Domestic pharmaceutical manufacturers have been expediting new drug innovation since 2015, and some early starters have begun to see rewards for their efforts. As of end-2020, China accounted for 13.9% of the global new drug pipeline by number, ranking No. 2 in the world. Meanwhile, a large number of emerging and transforming pharmaceutical companies are going after similar drug targets against the backdrop of an immature system for basic science and R&D. In order to build a globally competitive innovation pipeline, companies might need to switch to higher-value best-in-class (BIC), and first-in-class (FIC) drugs, in our view.

We believe value-oriented incentive mechanisms and an efficient capital market are major driving forces for pharmaceutical companies to deploy high-risk and high-value advanced innovations. Commercial value is the key factor for drug R&D spending, and developing BIC and FIC medicines usually involves higher risks. As new drugs are mostly first rolled out in the domestic market, we think offering a premium price for high-risk innovations will encourage more pharmaceutical companies to invest in innovative fields. In the realm of the capital market, developing novel drugs entails considerable uncertainty and risk, especially during the initial stages of research and development. This kind of undertaking represents a form of venture capital, and the securitization of these projects could help to distribute the risk.

Pharmaceutical payment system is not diversified in China, and we see upside in domestic pharmaceutical demand. National medical insurance is the largest public medicine payment system, and its priority is to satisfy basic medical needs by ensuring the affordability of medications. New medicines such as PD-1 monoclonal antibody (McAb) are priced markedly lower in China than abroad. In addition, a high proportion of medical expenses in China is not reimbursable, implying domestic patients are not yet fully motivated by the national healthcare payment system to pay for medical treatments and medicines. Commercial insurance is an important supplement to public healthcare funding, but the lack of medical data has impeded the development of commercial insurance in China.

China’s healthcare capital market in rapid boom. Pharmaceutical companies face less difficulty in raising funds following the gradual improvement of the secondary market system, but we think some domestic biotech companies are overvalued. Data from vcbeat.top shows funds raised for healthcare projects from the domestic primary market totaled US$19.35bn in 2018 and US$15.45bn in 2019, close to the levels in the US in the same period. The Hong Kong Main Board Rule Chapter 18A and sci-tech innovation board provides an opportunity for biotech companies to be listed domestically. In 2020, proceeds from domestic pharmaceutical IPOs markedly increased to Rmb62.7bn, but remained lower than in the US.

Preclinical R&D in China features low costs but high efficiency. According to The Ministry of Education of China and National Center for Education Statistics (NCES), biomedicine undergraduates and postgraduates totaled around 0.34 mn in China, higher than in the US in 2019. This makes low-cost but efficient R&D for innovative drugs possible.

Thanks to a visible competitive advantage, domestic contract research organizations (CRO) companies have received abundant overseas orders for preclinical R&D services. After China joined the WTO in 2001, domestic CRO such as Wuxi AppTec began to take on preclinical lab research for overseas innovative drug companies. In 2020, China accounted for 20.4% (US$2bn) of the global preclinical R&D outsourcing market. Providing CRO services also helped domestic firms develop a large number of experienced engineers (Figs. 5.8 and 5.9).

Fig. 5.8

Source Frost & Sullivan, CICC Research

China’s market for drug delivery and clinical CRO services.

Fig. 5.9

Source Frost & Sullivan, CICC Research

China’s share in global market for drug delivery and clinical CRO services.

Improved regulation of clinical trial approval expedites the use of clinical resources. Regulation of clinical trial application began to be loosened in 2015, and scrutiny of clinical data has since been strengthened to avoid stockpiles of low-quality applications. In addition, there is a rising number of clinical trial agencies in China to ensure high efficiency. The time it takes to acquire approval for clinical trials in China was shortened from 6 months to 60 workdays in October 2017. However, the clinical resources are not fully utilized in China due to the duplication of industry development at different stages. In 2019, the US had 550 drug targets in clinical trials (vs. 160 in China).

For production and supply, it is crucial to standardize and expand into high-value added businesses. Chinese pharmaceutical contract development and manufacturing organizations (CDMO) companies enjoy visible cost advantages over their foreign peers. In 2020, labor cost accounted for 12% of the total cost at domestic firm Asymchem, markedly lower than 35% at overseas industry giant Recipharm. This, coupled with high production efficiency, has enabled Chinese CMDOs to acquire more overseas orders, leading to an increase in China’s share in the global CDMO market from 6% in 2011 to 8% in 2017.

Chinese companies used to focus on low-value-added and non-standard businesses, but are now gradually expanding into high-value-added business. Innovative drug manufacturing is a complex process that involves various components such as basic chemicals, starting materials, non-GMP intermediates, GMP intermediates, active pharmaceutical ingredients (API), and preparations, with the greatest added value occurring during the late-stage procedures. European and US CDMOs typically specialize in producing high-value-added products like API and preparations. Conversely, China lacked standardized production capacity in the past, and domestic companies mostly focused on the manufacturing of low-value added intermediates. After China joined the International Council for Harmonization of Technical Requirements for Pharmaceuticals for Human Use (ICH), Chinese CDMO companies started to receive orders for phase III or commercial API and preparations from 2015 onwards, expanding into high-value added businesses.

5.2.2 Insights into Biotech Innovation in Agriculture

We think China's agriculture sector could primarily focus on incremental innovation while occasionally engaging in radical innovations. Given China's success in rice cultivation, we think favorable policies, governmental mechanisms, and cooperation between public and private sectors are conducive to biotech innovation in agriculture.

5.2.2.1 A Combination of Incremental Innovation and Radical Innovation

China’s agriculture industry could mainly focus on incremental innovation, and radical innovation is more effective in some fields. We think innovation-driven technological upgrades in the agriculture sector may drive production efficiency. We believe incremental innovation is the dominant pattern for the agriculture sector. However, we suggest encouraging radical innovation in segments characterized by low return on investment (ROI) and great uncertainty.

In discussion of incremental innovation, seed production serves as a fitting example. Technological R&D in the seed production sector mainly focuses on insect-resistant and stress-tolerant traits which could help improve crop yields. Through hybrid technology, genetically modified seeds develop new stress-tolerant traits. From the evolution of breeding technology, we note that any new technology represents an innovation based on the previous technology.

The H7N9 avian influenza vaccine R&D serves as a prominent example of radical innovation (Fig. 5.10). In 2013, the H7N9 avian influenza virus started to spread in China, and by 2017, it had mutated into a highly pathogenic strain. During this period, the Ministry of Agricultural and Rural Affairs of China developed disease prevention and control strategies and collaborated with scientific research institutes such as the avian influenza reference laboratory of Harbin Veterinary Research Institute to develop vaccines. In 2014, a recombinant inactivated avian influenza virus vaccine (H7 subtype) was released. In 2017, an inactivated bivalent vaccine (H5 + H7) which could completely protect poultry from invasion of H5 and H7 virus subtypes was developed. Afterwards, the Ministry of Agricultural and Rural Affairs encouraged companies to produce and apply the vaccines. In the example above, the government plays a leading role in the early stage of vaccine R&D, while the innovation process shows more radical features.

Fig. 5.10

Source Ministry of Agricultural and Rural Affairs of China, CICC Research

Radical innovation of H7N9 vaccines in China.

5.2.2.2 Drivers of Biotech Innovation in the Agriculture Sector

Methods to incentivize biotech innovation in the agriculture sector include increasing market share and expanding new markets. During the process of incremental innovation, companies could obtain larger market shares by improving production efficiency. For instance, both Yuan Longping Hi-tech Agriculture (YLHA) and Monsanto Company enhanced their presence in the seed production market from the sales of new products. Similarly, Muyuan Foods enjoys cost advantages in the animal farming market from operations. In addition, small farms may exit the market amid the fierce competition. As for radical innovation, launches of new technology and products may open new markets.

R&D is the cornerstone, and accumulation of biotechnologies bolsters innovation. R&D serves as the foundation for both incremental and radical innovation. Through their exclusive R&D system and the technological advancements they acquire during the production process, companies enhance their products in response to customer feedback, resulting in incremental innovations.

Profits are gained through the excess returns formed through market competition and the positive externality of the industrial value chain. In terms of incremental innovation, we think high-quality seed varieties of a seed producer often enjoy higher prices and profit margin. For example, YLHA’s earnings beat the sector average due to its advantages in rice varieties. In contrast, the returns from radical innovation are typically reflected at the public level, which has the potential to stimulate growth for the entire sector.

Companies’ R&D investment fuels incremental innovation, whereas the government plays a leading role in supporting radical innovation. Funds for incremental innovation mainly come from companies’ excess returns (from previous innovation) or financing proceeds, and funds for radical innovation mainly come from funds for national scientific research.

5.2.2.3 Insights from China’s Biotech Innovation in Rice Breeding

China is the world leader in breeding hybrid rice, with its rice yield surpassing that of other countries. China’s success in seed breeding proves that public–private cooperation is beneficial to the establishment of policies, governmental mechanisms, and a commercial system.

Large-scale cooperation mechanism bolsters innovation in the early stage. This was exemplified by Mr. YUAN Longping and his team, who discovered a male sterile rice crop known as “wild-abortive” (WA). Working with the China National Cooperative Hybrid Rice Research Group, which was established by over 30 agriculture-related government departments and companies, they researched three-line hybrid rice breeding technology. Due to their efforts, China cultivated the world's first three-line hybrid rice in 1973 and began to grow the crop in 1976. We note that large-scale cooperation resulted in the efficient use of manpower and resources, fueling research and application of hybrid rice breeding technology.

Intellectual property protection system lays a foundation for breeding innovation. Regulations of The People's Republic of China on the Protection of New Varieties of Plants was introduced in 1997 to protect the intellectual property rights of new plant varieties. Hybrid rice is one of the first 10 varieties listed. Since then, China has continued to strengthen its intellectual property rights protections for rice. In 2007, a DNA fingerprint detection method was introduced to prevent intellectual property infringement of rice varieties, and stricter infringement regulations were implemented compared to other crops. In 2020, the country pioneered an essentially derived varieties (EDV) protection system, bolstering original innovation protection in rice breeding. Overall, we think the strong efforts in the intellectual rights protection contributed to innovation in rice breeding.

The shift in roles between the government and companies empowers commercial seed breeding. We attribute the advanced commercialized rice seed breeding system to efficient cooperation between the government and private sector. First, the government launched favorable policies to encourage the exchange of scientific and technological resources, including human resources. For example, the Ministry of Agricultural and Rural Affairs called for a pilot reform aimed at guaranteeing the rights and interests relating to scientific research achievements in the seed sector in 2014, which accelerated the talent exchange between scientific institutions and seed breeding companies. Second, rice breeding companies continue to enhance competitiveness through M&As. For example, YLHA consolidated Hunan AVA Seeds Co., Ltd. in 2007 and acquired Golden Rice Seeds Co., Ltd. in 2016, enhancing its seed breeding strengths. In addition, the dominant role began to shift from the government to companies during the commercialization process. Among the hybrid rice varieties which applied for national approval, only 15% of them came from the private sector over 2001–2005, according to Ministry of Agriculture (MOA). However, the proportion rose to 91% in 2016–2020, showing that companies began to pursue innovation after the government paved the way for development. We think synergies between the government and companies are catalysts for growth in the rice seed breeding business.

5.3 Experience at Home and Abroad: The Government’s Role in Promoting Biotech Innovation

From our perspective, the Chinese government can learn from overseas experience in stimulating biotech innovations. The US has set a good example for innovations in the pharmaceutical industry, with a diversified fundraising system, reasonable barriers to entry, and a friendly innovation environment. We also explore the potential room for China's agriculture sector to promote biotech innovation, based on our analysis of legislation, mechanisms, and R&D systems in China and other countries.

5.3.1 Innovation in Pharmaceutical Industry: Experience in the US

The boom in the biotech and pharmaceutical industry in the US was closely related to reforms of the pharmaceutical market system. Since the twenty-first century, pharmaceutical reforms have been introduced to offer a guarantee for pharmaceutical companies to benefit from their innovations, thereby encouraging continued investment in drug R&D. This has paved the way for building a competitive market for biotech and pharmaceutical manufacturing.

While the US pharmaceutical market rapidly thrived on the emergence of large numbers of industry giants, it was gradually monopolized by large players, leading to high prices for new drugs. Demand to reduce new drug prices and enhance affordability has been growing in the US in the past few years, and pharma companies such as EQRx aiming to provide more affordable new drugs began to emerge.

Although the US pharmaceutical industry is far from perfect, we believe China can learn from its effective incentives for innovation.

The first measure is to improve the payment system. The US has built a diversified fundraising system and encouraged more payment methods for innovative drugs. Government-led healthcare insurance mainly covers disadvantaged groups in the US. In the US, pharmaceuticals are mainly paid for by government-led basic healthcare insurance, which targets the elderly, children, and the disabled, and accounted for almost 50% of pharmaceutical payments in 2018 (Fig. 5.11). On the other hand, commercial insurance covers over 60% of the employed population and accounted for 39% of pharmaceutical payments in the same year. Individuals are responsible for paying the remaining medical costs as out-of-pocket expenditures. We believe the diversified insurance system in the US can satisfy the needs of different groups of patients, and maximizes payment capability.

Fig. 5.11

Source CMS, CICC Research

US basic healthcare insurance system.

Negotiated pricing is the basic pricing principle in the US pharmaceutical market, but the actual pricing is not transparent due to the involvement of different interested parties. Government-run insurance programs Medicare and Medicaid are the largest payers in the US pharmaceutical market, and their pricing policy is an important reference for commercial insurance companies. Medicare Part D requires government bodies to delegate price negotiation with pharmaceutical firms to third-party pharmacy benefit managers (PBM), but the payments and refunds between all parties are not disclosed, leading to potential implicit costs.

The second measure is to make barriers to entry reasonable. For example, the US has a higher standard for pharmaceutical innovation, but lower regulatory costs. The FDA has gradually set a high standard for new drug approval in the past two decades, strictly restricting the marketing of medicines with unclear clinical significance. Such efforts helped avoid low-quality R&D investment. The US launched a reform of its pharmaceutical patent system in the 1980s, which prolonged the exclusive patent protection for new drugs and enhanced the bargaining power of large pharma companies. According to IQVIA, generic drugs accounted for around 90% of prescription volume in the US, but only 20% of total pharmaceutical sales value in 2020. This supply–demand structure motivated pharmaceutical companies to continue to invest in the R&D of differentiated innovative drugs.

Looking back at China’s reforms of its pharmaceutical approval system since 2015, we believe domestic regulators have learned from the successful experience of overseas regulators such as the FDA. China’s innovative drug industry started to thrive. After joining the ICH in 2017, China has been adapting the R&D, registration, manufacturing, and regulation of drugs to international standards.

The third measure is to enhance the innovation environment. As suggested by US experience, this might include the development of basic research, the search for scientific innovations with no specific commercial objectives, and an efficient capital market for the pharmaceutical sector, and also a coordinated fund management system to ensure efficient use of funds for basic research. The public sector is an important source of funding for basic research. Developed countries generally have an independent management system for R&D funds from the public sector.

A mature system for IP protection facilitates commercialization of R&D results. The US Bayh-Dole Act adopted in 1980 gives researchers rights to intellectual property (IP) generated from federal funding, thus incentivizing academic institutions and researchers to innovate.

An efficient capital market is also important. New drug R&D entails multiple procedures, requires extensive investment, and is often high-risk. This makes venture capital important for the development of biotech sector. The US has ample professional biotech investors, and a relatively mature valuation system. The capital market can share the risk of failed innovation. In addition, secondary markets such as NASDAQ provide a low-cost exit channel for venture capital and equity investors.

5.3.2 Agricultural Innovations: A Global Perspective

We discuss the potential of China's agriculture sector to promote biotech innovation based on our analysis of legislation, mechanisms, and R&D systems in China and other countries. We propose that legislation that prioritizes intellectual property rights may incentivize companies to innovate. Additionally, effective governmental mechanisms can provide critical support for innovation, and balanced public–private relationships in R&D can further enhance sustainable innovation.

5.3.2.1 Legislation for Protection of Intellectual Property Rights

In order to encourage biotech innovation in the seed business, China has been stepping up efforts to enhance legal protection over intellectual property rights. In 1997, it granted intellectual property rights to developers of new plant varieties through the Regulations of The People's Republic of China on the Protection of New Varieties of Plants. In 2000, the Seed Law of the People's Republic of China included general provisions on the protection of intellectual rights for new plant variety developers. In 2005, the amendment to the Seed Law standardized the protection for new plant variety developers. In 2015, the Seed Law was revised for the second time, proposing the approval of applications for main crop varieties and the registration for other crops. In addition, the revised version strengthened efforts in intellectual rights protection and encouraged innovation. We think China is improving its intellectual rights protection laws for the seed sector, which will likely promote sustainable innovation.

5.3.2.2 Innovation-Oriented Mechanisms

Seed certification, germplasm protection and utilization, and land transfer are three effective ways to stimulate biotech innovations in agriculture.

First, the seed certification system guides market-oriented seed breeding. However, China currently adopts a different seed certification system from that of other countries. This leads to lower yields and traits of some seeds in China, including corn and soybean for feed use, compared to other countries. According to FAO, China's corn and soybean yields in 2019 were 6.3 tonne/ha and 1.9 tonne/ha, lagging far behind the US, Canada, and Argentina, among others. We believe this is caused by the differences in seed certification systems. In contrast, companies in the US select high-quality seeds independently and send them to certification institutions for professional tests and reports. We believe this system allows companies to develop seeds with better traits in a competitive market. In contrast, China's seed certification work is headed by the government. Although seed quality is secured, competition in the seed market is relatively inadequate. Under this system, we may see few breakthroughs in seed quality.

A complete certification system could bolster biotech innovation in the seed market. Leaders in the global seed sector developed their seed certification systems at an early stage. For example, the US developed and optimized its seed certification system in the 1950s, and Argentina established its system in 1978. After years of development, these countries now enjoy relatively comprehensive certification systems. Companies send their seeds for certification independently and consumers make choices between different seed products in these countries, which bodes well for market competition and sector improvement, in our view. After the establishment of its seed certification system in the 1950s, the US saw rapid growth of its Seed Cost Index. We think this also reflects the improving quality of seeds. In addition, data from California shows that the planting area of certified rice seeds is positively correlated with the rise of rice yields in the state. We contend that the seed certification system offers farmers high-quality seeds, enhances their earnings growth, and inspires them to continue to sow high-quality seeds, thus fostering innovation in the seed production sector.

China continues to explore and simplify its seed certification procedure to encourage market-oriented business operation. The previous certification system had been in place for a long time, contributing to the development of the seed sector. The Seed Law passed in 2016 proposed a simplification of the certification procedure and increased test channels. According to the big data platform for seed varieties, the number of rice seed varieties certificated rose from 27 in 1978 to more than 1,913 in 2020 as a result. Data from Ministry of Agriculture and Rural Affairs of China shows that the number of hybrid rice varieties involving a planting area of more than 6,666 hectares has dropped in recent years, reflecting the low acceptance from the market and weak quality advantages of new varieties.

Second, systematic germplasm protection and utilization support biotech innovation. Germplasm protection refers to the collection, detection, and reserve of valuable crop genes, while germplasm distribution aims to cultivate varieties with better traits by crossing valuable germplasm with modern germplasm. China has rich germplasm resources, but needs to enhance utilization and protection. China has 520,000 germplasm reserves as of 2020 (only second to the US), as announced at the 2021 Work Conference on Crop Germplasm Resources Protection and Utilization. But the germplasm utilization rate in China is relatively low. In 2020, only 21.2% of the germplasm reserves were distributed to companies and research institutions in China (vs. 41.6% in the US and 55.4% in Japan). In addition, we expect China to step up efforts in germplasm protection. Germplasm resources for main grain seeds in China dropped 72% from 11,590 in 1956 to 3,271 in 2014. Among germplasm reserves in China, only 7% are imported (vs. 62% in the US). We think China still has much work to do in terms of germplasm protection and utilization, and this weakness impedes China from enhancing germplasm diversity or innovation to some extent.

The germplasm protection mechanism empowers seed breeding and innovation. Developed countries have committed considerable effort to protecting germplasm, and have established related mechanisms. The US started to establish its germplasm bank in 1862 and continued to search for new resources at home and abroad. We calculate the correlation between germplasm reserves and grain yields at 0.87. This means that the increase in germplasm reserves could support seed breeding. China began its protection work in the 1980s and lacked experience in establishing a national germplasm bank. At present, China is strengthening its germplasm resource protection and utilization, and formulates systematic solutions correspondingly after launching food security-related policies. We think this bodes well for China's innovation in the seed production sector.

A systematic sow registration mechanism is conducive to breeding, and China has to catch up with overseas peers. The US, Denmark, and Canada have bigger gene banks for hog and poultry breeding than most countries in the world. They have systematic sow registration mechanisms, which include procedures such as the establishment of national sow registration associations, sow quality measurement and evaluation, hog data collection and registration, database establishment, and genetic mapping and gene analysis for breeding. The US and France have registered more than 80% of their sows, whereas China has registered only 16.7%.² We believe this has hindered China's improvement in gene databases and genetic map analysis for breeding, negatively impacting sow fertility. Nonetheless, we acknowledge that the country is making efforts to improve in this area.

Third, land transfer system enables innovation in the cropping value chain. China promotes land transfer as a solution for the fragmentation of arable land. Changes to the land transfer system have created larger farms and rationalized farms, creating economies of scale that have fueled technological innovation in agriculture. China's farming sector is dominated by small farms, and features a low per capita farming area. Fragmented arable land further weighs on cultivation efficiency. In 2014, the country deepened its land reforms, separated land management rights from land ownership rights and contracting rights, and encouraged the transfer of land management rights. In 2020, the confirmation and registration of contractual management rights for rural land was largely completed, and management rights were transferred for over 40% of contracted farmland.

The efficient implementation of the land transfer system enables agricultural innovation. At present, modern technologies can reduce costs and improve efficiency for large-scale planting. We think large-scale planting backed by the land transfer system could also enhance the overall competitiveness of the cropping sector, and bolster the application of new agricultural technologies and further innovation in the sector. We expect to see obvious positive results in the medium to long term.

5.3.2.3 A Balanced Public–Private Relationship in R&D

Commercial seed breeding systems are mature in other countries, while more time is needed for China's efforts to pay off. A well-established commercial seed breeding system facilitates exchange of resources between scientific institutions and companies, which is essential for innovation in the seed production sector. Major seed producers have enjoyed mature seed breeding systems, while China has not seen results due to its late entry in this area. The proportion of commercial projects in total new variety application projects exceeds 95% in the US, France, and Germany. The figure is 55% in China, indicating that China has room to develop its commercial seed breeding system. Additionally, the approval rate of new varieties for commercial breeding exceeds 70% in the US, France, and Germany, compared to just 41% in China. Thus, Chinese companies must improve the quality of their commercial project varieties and increase their efforts in innovation to enhance the approval ratio.

Government's role is crucial in the optimization of commercial seed breeding system. The success of the US, with the introduction of the Federal Technology Transfer Act of 1986, is a good example. This act facilitated the exchange of talent and resources between scientific institutions and companies, and established a mechanism for profit distribution, thus empowering cooperation between the two entities. Meanwhile, the US government gradually shifted its focus from seed production to research so that companies could apply new technologies independently. Thanks to its efforts, the business scale of US companies has increased. According to the USDA, the number of US seed producers reached 329, up 22% from the level in 1982 when the commercial seed breeding system was primarily established in the US. In addition, the number of companies operating breeding businesses increased for all crop varieties, showing the rapid development of the commercial seed breeding in the US.

When discussing public–private cooperation, we expect to see synergies between China's public and private sectors and expect companies to become more powerful in the market. The State Council proposed in 2011 the establishment of a modern seed sector with companies playing the leading role. China has stepped up efforts to strengthen intellectual property rights protection and judicial supervision for the seed sector so as to encourage companies to invest in seed breeding R&D. According to China Statistical Yearbook on Science and Technology 2019, there were more companies and individuals applying for new plant variety projects than scientific institutions in 2011, and the proportion of companies and scientific institutions reached 53% and 40% in 2018 (Fig. 5.12). Despite this progress, overlaps in work between public and private sectors are still observed. Hence, it is essential for China to improve its public–private cooperation in seed breeding R&D.

Fig. 5.12

Source Report on China's agricultural intellectual property index, China Center for Intellectual Property in Agriculture, 2016; China Statistical Yearbook on Science and Technology, National Bureau of Statistics of China, 2016–2019; CICC Research

Application for new plant varieties from companies, individuals, and scientific institutions in China.