U.S. President Donald Trump announced that Eastman Kodak will receive a loan to manufacture ... [+] ingredients used in pharmaceuticals. (Photo by Alex Wong/Getty Images)

The news that Eastman Kodak Company had received a U.S. government loan to begin the production of active pharmaceutical ingredients (APIs) domestically is recognition of the risks associated with the far-flung supply chain for these critical materials. The Europeans have recognized these risks as well. But that doesnt make the economic challenge of doing this successfully any easier. The problem is that most APIs are commodities.

I spent seven and a half years at Kodak beginning in 1997 running their consumer digital operation, and during that time I got to know the manufacturing people in film and chemicals. The synthetic chemicals team, or Syn Chem as it was known, was an extremely capable crew. They knew what it meant to take a chemical synthesis from the laboratory to an industrial scale, and they practiced their trade on extremely complex materials photochemicals, dyes, couplers complicated molecules that are difficult to make. They knew what solvents (the liquids that you ran the reactions in) you used were important, because when youre done you had to get rid of all the waste products. You couldnt just dump the waste in the local river. You also liked to optimize reaction times (known as reaction kinetics), the amount of energy consumed, the use of dangerous intermediates, all things that were of lesser concern when you were operating at lab scale than when you were doing them at industrial scale. So there is little doubt in my mind that the Kodak team (I hope they havent lost too many of the Syn Chem crew) could make just about anything.

A chemical mixing machine in an Eastman Kodak Corp. manufacturing facility in Rochester, New York. ... [+] Photographer: Daniel Acker/Bloomberg News

But as I said, the first problem with APIs is that most of them are commodities, which means that batches of them are readily substitutable for one another regardless of where they came from. Chemicals are easy to characterize. Modern analytical techniques such as gas chromatography (GC), liquid chromatography (LC), and mass spectrometry (MS), often combined as GC/MS or LC/MS instruments, can be used to analyze a drum or a tank car load of chemical, and tell you exactly what is inside, along with what kinds of impurities and how much of each are mixed in. So if you have the choice among multiple batches that all have a high enough purity level and none of the contaminants that you cant deal with, the only difference is the price.

The second problem with domestic production of APIs is that they are largely tradable. A good is tradable to the extent that it doesnt need to be manufactured close to where it is consumed. Most products are tradable because the cost of shipping them is a relatively small percentage of their value, so if it costs less to make something in China and the shipping cost is less than the difference, it makes economic sense to make it there and ship it. Thats why the U.S. imports so much of everything from China the production costs differentials historically have been much higher than the shipping costs.

The third problem is drug pricing, especially for generics. No consumer likes higher prices, and the President himself have been putting pressure on manufacturers to lower drug prices. But if drugs are made from tradable commodities, that means the companies who formulate the drugs are driven to use the lowest cost sourcing, and that is generally not domestic (usually this means China or India). Once again we face the dilemma we want to make it in the U.S., but we dont want to pay for the higher costs.

Invest in process innovations. Employing newer manufacturing processes historically has been one of the most effective ways to disrupt incumbent manufacturers by offering lower costs. After World War II, European and Japanese steel manufacturers who had to rebuild their industries from scratch were the first to employ new manufacturing processes like basic oxygen and continuous casting. The new processes were more efficient, and their low-cost exports of steel to the U.S. started the long decline of the American steel industry. Korean and Taiwanese flat-panel display manufacturers were able to employ newer, more efficient equipment than the Japanese producers who started the industry, and now the same Korean and Taiwanese companies are under pressure from Chinese companies who are using even newer equipment.

A coming revolution is continuous flow chemical manufacturing, in which compact, continuous flow reactors promise far more efficient reaction processes. I had the opportunity to visit Snapdragon Chemistry two weeks ago, and it is amazing what they are doing. I had to rush back to the Baker Library at HBS and read up on chemical synthesis route design, which is the term used to describe a strategic development process for APIs. I have about 20 more scientific papers to read on this topic to get a better understanding, then you can ask me more. The Defense Advanced Research Projects Agency (DARPA) has been beating this drum for some time now. Once again DARPA is one of the more visionary agencies we have.

Invest in biomanufacturing. Biomanufacturing uses living systems to produce chemicals and biomaterials. Living things already produce the most complex chemicals imaginable, so the idea is to harness cells by using genetic engineering to make new things. This is already used for many biopharmaceuticals, vaccines, and industrial enzymes, but researchers in the field think much more can be done. DARPAs Living Foundries: 1000 Molecules program is funding a lot of research in this area, so the possibilities are intriguing.

One country we might look to for an example is Denmark, where there is a strong cluster of firms who use fermentation to produce a wide range of products. Novozymes, based inBagsvrd outside of Copenhagen, is the world leader in industrial enzymes. Industrial enzymes have been the source of many advances in household laundry detergents like Tide, and are widely used in industries like textiles. Denmarks cluster of fermentation expertise traces back to the Carlsberg brewing company. The Carlsberg Laboratory, established in 1875, was chartered to develop a scientific basis for malting, brewing, and fermenting operations, and ongoing research there and knowledge spillovers have made the region a world leading cluster.

Where in America might we find people who know how to do this? According to the Brewers Association, the COVID-19 pandemic has been hard on many breweries, and it reports that A majority of breweries do not think their business can last three months given current conditions, suggesting thousands of closings. Brewers were the foundation of a lot of pharmaceutical manufacturing in India. As longs as the U.S. government is spending money at such a prodigious rate, maybe we could fund an agency to help brewers move into manufacturing chemicals.

Leverage FDA certification processes. One other thing the U.S. could consider is the FDA certification process for pharmaceutical manufacturing. How far back in the supply chain should it require certification? It probably doesnt need to start all the way back at earth, wind, fire, and water, but by strategically picking where it requires inspection, it could shape behavior along the supply chain. We would call that a non-tariff barrier.

The global pandemic is reshaping supply chains in many industries. The economics on some of the new designs havent been tested yet, but with some strategic thinking and actions, we could end up in a better place.

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Companies That Want To Make Pharmaceutical APIs Will Be Producing Commodities. Heres What They Should Consider - Forbes