China's Medical Device Industry: Growing Market, New Regulations Fuel Competition

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Includes: CMEDQ, FXI, GE, MDT, MR, PHG
by: China Market Research Group

This first appeared in Knowledge Wharton China

Looking to address shortfalls in its current health care system, the Chinese government is implementing large-scale health care reforms. In April, the State Council announced an allocation of 850 billion RMB (US$123 billion) as part of its New Medical Reform Plan to improve health care through 2011. The plan promises to cover 90% of China’s population under a universal health care system by 2010 as well as to significantly improve care facilities and expand health related infrastructure.

Within three years, the government aims to rebuild and restructure 3,700 existing urban community health centers and 11,000 community health clinics, and build 2,400 new urban health centers. The goal is to move away from an overreliance on large magnet hospitals towards smaller, more utilitarian clinics. These measures will address the overcrowding and lack of hospital beds in big cities, and foster the development of infrastructure needed to cope with China’s aging population.

Beijing has placed an even greater emphasis on improving medical services for the 800 million rural poor in China who have little or no access to basic health care facilities and poor health coverage. The China Rural Cooperative Medical System Plan entails bringing clinics to every village and a hospital to every county in the country by 2011. If the plan’s objectives are met, this adds up to at least 2,000 new county hospitals and 29,000 village clinics.

One potential beneficiary of these changes is China’s medical device industry. According to pharmaceutical market researcher Episcom, by 2014, the expected value of China’s medical device market will reach US$28 billion -- more than double the figure from 2006. According to experts, growth in the sector is largely due to the increasing portion of the population who can afford high-quality implants or home-use devices, new regulations regarding the purchase of equipment, and the government’s growing emphasis on health coverage in rural areas.

Impact of Recent Regulation

As Beijing works to improve health care capacity, it is also aiming to develop the level of care available at smaller clinics and Tier 1 and Tier 2 hospitals (hospitals with less than 500 beds) while reducing costs.

The Ministry of Health has tightened controls on purchases of high-priced "Group A" medical devices -- those costing more than 5 million RMB (about US$710,000) -- arguing that such equipment could contribute to rising medical expenses. However the government is still encouraging spending and has allocated 8.3 billion RMB (US$1.2 billion) until 2010 for the purchase of X-ray machines, patient monitoring devices and ultrasounds for rural areas. The government is also offering hospital equipment subsidies that favor domestically made, low-cost products -- part of its “buy China” stance when disbursing stimulus funds.

In addition to regulations related to the purchase of medical devices, Beijing is also funneling money towards research and development. Through the recent stimulus package, the Central Government plans to invest 62.8 billion RMB (US$9.2 billion) in technology R&D. Chinese firms have traditionally competed for the low-end of the market while foreign firms have occupied the high-end, but government support for research and development and an ambition by many Chinese firms to become global players is changing the playing field.

Meanwhile, new care facilities will need to be equipped and existing hospitals are demanding new devices, as 60% to 70% of current hardware is from the 1970s or 1980s.

Domestic Companies Are Investing

The domestic market for medical devices is still highly fragmented. At present, China boasts some 3,000 medical device manufacturers but most of these have limited market share and function on a small scale with only a handful of profitable products. Compared to the Chinese pharmaceutical industry that has 62 companies traded on global exchanges, only four Chinese medical device companies are publicly traded, with Gol Golden Meditech Co. Ltd. and Shandong Weigao Group Medical Polymer Co. Ltd. listed in Hong Kong, and Mindray Medical International Ltd. (NYSE:MR) and China Medical Technologies Inc. (CMED) listed on NASDAQ.

However, domestic players are investing heavily to gain market share. According to a marketing manager from Beijing Wandong Medical Equipment Co. Ltd., one of the largest domestic medical equipment manufacturers producing products from diagnostic imaging devices to dental units, “There is still plenty of room to expand in the market and we are very optimistic on the outlook despite the financial crisis.”

Domestic device makers are working to develop high-quality devices at a cost basis 30% lower than that of foreign competitors. China’s largest medical device manufacturer, Mindray Medical International, generated revenues of nearly US$550 million in 2008, growing 36% over the previous year. Current estimates peg the company’s minimum growth for 2009 at 22%.

Mindray’s marketing Manager, Mr. Xu, firmly believes there are still more opportunities to explore.

Our company has already established a solid base in the domestic market and is currently looking into expanding globally. Recently, we have made large scale investments both in research and sales in order to grasp some coming opportunities.

Government reforms and the rise of domestic companies like Mindray are putting pressure on foreign firms to act quickly to cement their positions in the China market. But foreign device makers still have a massive opportunity for growth in China because of their technological advantages and because of hospitals’ and consumers’ preference for foreign products.

Demand for High-end Products

Demands on China’s health care system have ballooned in recent years. Growing prosperity and changing dietary habits mean that more and more Chinese are confronted with the same health issues that plague patients in developed nations. The top 3 most deadly diseases in China are cancer (28.53%), cerebrovascular disease (18.04%), and cardiovascular disease (16.29%).

Increasingly, patients are seeking out advanced medical techniques to treat these illnesses and there is a heavy reliance on Western technology for treatments.

Yao Hong Quan, manager of Shanghai MEHECO’s medical device division, one of the largest pharmaceutical and medical equipment import-export companies in China, says:

The most demanded foreign products are those that use the most advanced technology. Many Tier-3, first class hospitals specifically require imports to serve their wealthier clients who are willing to pay a fortune to be treated with only the best gadget.

Price is also less of an issue to patients who are suffering from serious illnesses, and there is strong demand for high-end cardiovascular devices that are used in lieu of complicated heart surgery. Interventional cardiology, non-surgical procedures for treating cardiovascular diseases, is gaining mainstream acceptance in China. High costs -- treatment ranges from 10,000 RMB (US$1,232) to 90,000 RMB (US$11,084) -- slowed the acceptance of such procedures but demand is growing. The market for angioplasty and stents, especially drug-eluting stents, is taking off and there are already several domestic companies seeking to gain market share. Every year, the number of cardiac patients is expected to grow around 20% to 30%. The stent market, on the other hand, has shown growth rates reaching up to 40%.

Until recently, the lack of a comprehensive health care system has made stent treatments unaffordable for the majority of patients. In 2003, only 5.8% of patients hospitalized for cardiovascular diseases were treated with stents. However, China’s recent health care reform and specific regulations on medical devices should provide better reimbursement for patients and lead to growing demand for the use of stents and other advanced treatment methods.

Foreign companies, especially large medical device manufacturers from Japan, Germany, and the USA, still have a comparative advantage in terms of technology and presently control 90% of the high-end device market. While the government is emphasizing low cost devices for rural projects, major hospitals in China still demand the best foreign equipment. Chinese consumers are also wary of the “made in China” label and continue to demand foreign brands when considering treatment.

We found in a recent survey that the majority of Chinese consumers trust Western medical device brands over domestic ones and are willing to pay 20% more for them because they believe them to be more reliable and less likely to malfunction.

Owen Tang, an analyst for InMedica, summarizes the situation:

The demand for low-end X-ray equipment, such as analog general radiography, will remain fairly stable over the next few years because the Chinese government will keep investing in rural health care, which often lacks basic medical equipment. However, there is tremendous demand for high-end X-ray equipment…. In fact, shipments of digital radiography systems … in China are forecast to almost triple over the period 2007 to 2012.

Domestic producers will have to work hard to build an image of reliability and shatter the negative connotations of the “made in China” label even within their home country. Foreign medical device manufacturers have an opportunity to take advantage of this perceived brand value to build presence in the market.

The issue for foreign device manufacturers is that the reforms mean they will have trouble accessing China’s rural markets with their high-end premium branded products. Domestic companies have the government behind them and will use growth in these markets to get a leg up on foreign brands. To combat this trend and to continue to grow in China, many foreign brands are choosing to form partnerships with domestic companies so that they can gain access to developing markets, improve sales channels, and benefit from government health care funding.

Forming Partnerships

In order to stay competitive in both the high and mid-range markets, many foreign investors have chosen to create joint ventures with local Chinese medical device manufacturers. In addition to reducing costs, joint ventures can also help overcome sales hurdles by taking advantage of strong distributor relationships and connections to hospitals or affiliated bodies.

Marketing products under a domestic company’s name can also help foreign investors benefit from the government’s new reimbursement scheme. Recently, the National Development and Reform Commission announced that Chinese companies are to be contracted for government stimulus projects, unless they cannot provide the good or service within a reasonable price and time frame.

Most likely this decree will not affect high-end medical devices, as domestic firms still lack the know-how to provide such products. Yao from Shanghai MEHECO notes,

Large hospitals with good reputations will continue to request high-end equipment from foreign suppliers simply because the majority of domestic devices still do not meet the requirements.

The situation at the low-end of the market is more difficult, and foreign manufacturers will need to be creative to gain momentum. Partnerships with domestic firms allow foreign companies to sell cheaper products and take advantage of government funding for rural health care development.

A recent example of a potentially successful joint venture is the partnership of U.S.-based medical device company Medtronic (NYSE:MDT) with Shandong Weigao Co Ltd. to market Medtronic’s spinal products and Weigao’s orthopedic devices. Weigao’s network, covering 100 Chinese cities, will greatly accelerate the process of introducing Medtronic’s products into the market, and due to the complementary nature of their products, will also establish a more efficient marketing system.

Likewise, other big players have also formed partnerships. In April 2008, Philips (NYSE:PHG) acquired the second-largest domestic patient monitoring device manufacturer in China, Shenzhen Goldway Industrial Inc., allowing Philips to solidify its position at both the high and low-ends of the market.

General Electric (NYSE:GE) helped to pioneer this approach. It recently launched a program to develop low-cost products to supply rural hospitals in China. GE’s main strategy was to establish a local base in China and use Chinese resources and technology to produce low cost devices at a price 15% below imported products. To achieve this goal, it teamed up with a local partner, Shinva Medical Instrument Co., to form Shinva GE Medical Systems. Under the partnership, it plans to introduce 50 low-cost products into the market, primarily X-ray machines and auxiliary equipment for rural hospitals. Meanwhile, GE is continuing to fund R&D projects at its U.S. base.

A two-tiered market is emerging that requires fine adjustment from foreign suppliers. On one hand, premium products in the area of implants and cardiovascular devices are gaining popularity due to the emerging wealthy in large metropolitan areas like Beijing, Shanghai, Shenzhen, and Guangzhou as well as in fast growing second tier cities. This market will further expand once the new health care system is in place.

At the same time, the rural market covering 80% of China’s population is seeing the bulk of the health care reform stimulus package. To target the rural poor, companies need to develop low to mid-level diagnostic and imaging devices for hospitals and simple diagnostic devices for home use.

The challenge for companies is how to maintain a high quality brand image despite catering to the lower end. To accomplish this, Ben Cavender, a Senior Analyst at the China Market Research Group (CMR), notes that companies can

sell low-end and high-end products by marketing them under completely different brand name in order to shield the premium product from brand erosion while still being able to generate price sensitive sales.

China’s push to develop rural health care has created a massive opportunity for both foreign and local players, but regulations on how hospitals and clinics can purchase products and the rise of domestic device manufacturers mean that foreign companies need to act fast in order to solidify their position in the market.