By Matt Young

Even as some of the largest pharmaceutical multinationals are busily laying brick in China for new R&D centers, Eli Lilly & Co is relying on one toddler-aged Shanghai company for much of its research lifeblood.

Lilly is putting a great deal of trust into ChemExplorer Co Ltd, a company founded in June 2002. ChemExplorer's work is preclinical, testing chemical compounds that could eventually turn into blockbuster drugs such as the company's Prozac, one of the most commercially successful drugs in history. "Basically our model has been one partner in one relationship," said Robert Armstrong, Lilly's vice president of discovery chemistry research and technology. "We really have been very impressed all along."

After years of skittishness over developing R&D centers in China, knowing full well the country's poor record with respect to intellectual property protection, Big Pharma is throwing caution to the dragon. GlaxoSmithKline, Hoffman-La Roche Ltd, and Pfizer Inc all have established R&D centers in China, using the cheap local research talent.

To understand the significance of Lilly's move, realize that new drug R&D is not just another corporate function for Big Pharma, like packaging or human resources - research is the soul of a drug company and the ultimate source of all its future profits. To stay alive, drug companies must continually find new agents to replace the existing ones, which typically go "off patent" after 15-20 years, and can then legally be produced by anyone.

What Lilly has done with ChemExplorer has gone beyond relocating its R&D "soul" to another country: it has literally outsourced its soul, entrusting a significant portion of its research to its Chinese partner (although the company maintains that "long-term" research will continue to be located mostly at its Indianapolis headquarters). "Lilly is one of the earliest among the multinational pharmaceutical companies to outsource R&D projects to a Chinese company, and the first to do so on such a scale," according to a Lilly media release.

As for ChemExplorer, it didn't just start recently - it started small. The company had only five employees when it began in 2002, according to a recent report by the Asian Technology Information Program (ATIP), a not-for-profit organization that seeks to help the United States communicate with Asia about technology advancements. Since then, ChemExplorer has expanded to employ more than 200 people, 15% with doctoral degrees and 15% with master's degrees, the report said. "We have had a superb track record of being able to attract and retain really some of the best talents in China in the area of synthetic chemistry," Armstrong said.

That's due in part to ChemExplorer's location, Zhangjiang Hi-Tech Park in Pudong, Shanghai. This high-tech area, established in 1992, is considered to be the most successful park among the 53 national high-technology parks in China that have arisen from the Torch Program initiative, the ATIP report said. (The Torch Program is a 1988 government initiative to develop new high-tech industries in China.) Preliminary statistics show that Zhangjiang's total sales for the year 2004 reached 200 billion yuan (US$24.16 billion). The report mentioned another curious item: "ChemExplorer can only carry out R&D activities that are directly related to the interests of Lilly."

Every two weeks, meetings are held with Lilly counterparts, the report said. When asked what goes on in those meetings, Armstrong said the meetings take place by e-mail and that "we are constantly evaluating our needs," declining to comment further due to the "competitive nature of the marketplace". Michael Hui, co-founder and CEO of ChemExplorer, declined to comment on the company's relationship with Lilly except to say, "Lilly and us always prefer to keep [a] very low profile on our collaboration within the public domain."

Jonathan Wang, general manager of Burrill Greater China Group at life science merchant bank Burrill & Company, may have a better idea of what exactly is going on. Wang said he is close friends with both Hui and a vice president at Eli Lilly Asia in charge of business development. "At the very beginning stage, it's a service-provider versus client relationship," Wang said. "However, if ChemExplorer meets certain milestones, then Eli Lilly will have the option to buy the entire [business] for a preset price."

Wang acknowledged that he had not seen the business contract between Lilly and ChemExplorer, but said his information came from his friends at both companies. He characterized this relationship as build-operate-transfer, a term often used to refer to projects such as highways or bridges, which once constructed by private companies are transferred back to the government. Except in this case, ChemExplorer would be transferred via purchase to Lilly if it meets preset milestones, Wang said. Generally speaking, such milestones could consist of certain revenue figures, a specific number of employees or other thresholds that could trigger a sale.

The advantage of such a relationship is that it is much deeper than a client/service provider one, but avoids the risk of the traditional bricks-and-mortar method of setting up shop and hoping for the best. Since a purchase of ChemExplorer would essentially mean that the company is thriving, the risk of failure is minimized, Wang said. If Lilly's relationship with ChemExplorer is an entirely private version of the build-operate-transfer model, it's even more innovative than Lilly is willing to admit. "We clearly are not involved in that model in terms of a transfer at some future time in this collaboration," Armstrong said. Asked if Lilly intends to acquire ChemExplorer at a future date, he replied, "I can't comment on that in terms of what our future plans would be, but that has never been part of our plan originally."

What is for certain, though, is that ChemExplorer is saving Lilly money, lots of it. According to Armstrong, ChemExplorer is saving Lilly roughly 40% of what it would cost to do the same basic research in Indianapolis. For a full-time PhD employee, a US company would have to spend $250,000 to $300,000 annually. "For the same PhD and above-level chemist in China, it costs about $30,000," Wang said. Savings aren't necessarily that substantial for every company though, especially when relationships emerge, he added. "At [the] beginning you have a learning curve ... the two sides may not understand each other that well. Protocols have to be transferred. People have to train. Equipment has to be [bought]. So you can imagine that at different phases of the learning curve, the cost [savings] will be different." But Wang thinks Lilly's relationship with ChemExplorer is, on the whole, smart. "If the unit is not performing well, Lilly can just walk away," he said.

Armstrong declined to say whether ChemExplorer has yet found any promising compounds, but he noted that it is in its third year of operations. It typically takes five years to go from the identification of a candidate compound to clinical drug testing, he said. He also said the company is trying to sort out very high-level gene-family relationships to compounds. "It is so early in the drug-discovery process," Armstrong said. "We're working with them to build something that is really at the global pharmaceutical standard."