The Red Hot Market for Medical Devices in China

Includes: ABT, BEC, DSCP, GE, MR, PHG
by: Evelyn Rubin

Mindray's (NYSE:MR) recent IPO filing has a wealth of information about the medical devices market in China. Intellectual and regulatory issues abound, and are well worth reading up on. The following primer has been excerpted from their F-1 filing, and should be of interest to investors in competitors Abbot Labs (NYSE:ABT), Beckman Coulter (NYSE:BEC), Datascope (DSCP), GE (NYSE:GE), and Philips (NYSE:PHG) among others:

China’s medical device market, as well as the medical device markets in several developing countries, is projected to grow faster than the global medical device market. According to Frost & Sullivan, China’s medical device market is projected to grow from US$7.5 billion in 2004 to US$10.1 billion in 2006. Reasons for this faster growth in China include:

A fast growing domestic economy. According to Frost & Sullivan, China’s GDP is projected to grow from $1.6 trillion in 2004 to $2.5 trillion in 2008.

Increasing expenditures on healthcare as a percentage of GDP. Frost & Sullivan estimates that in 2005, the United States, with a population of approximately 296 million, had healthcare expenditures representing 15.9% of its GDP, compared to just 6.7% of GDP that China, with a population of approximately 1.3 billion, spent on healthcare. China’s healthcare expenditures grew from 5.0% of GDP in 1999 to 6.7% of GDP in 2005, representing a growth rate of approximately 5%. During the same period, US healthcare expenditures grew from 13.2% to 15.9%, representing a growth rate of approximately 3%.

Increasing desire for and utilization of more advanced technologies in Chinese hospitals and clinics. The market penetration of common medical equipment in Chinese hospitals is low when compared to hospitals in more developed countries. However, we believe hospitals in China are purchasing more advanced technology as they attempt to compete for patients and generate additional profits.

Increasing availability of healthcare insurance. The increasing availability of healthcare insurance generally provides coverage for more advanced and extensive healthcare services than were previously available.

Increasing autonomy at the hospital level. Although governmental entities own and control substantially all of the hospitals in China, recent healthcare system reforms have resulted in a trend of greater operating autonomy at local levels. For example, hospitals in China today rely less and less on governmental funding and are generally expected to earn enough revenues on their own to cover 70% to 90% of their operating expenses. This has led to a greater focus on achieving efficiencies and improving services by regional hospital administrators, who now typically have the authority to make decisions regarding equipment purchases.

Increasing government focus on improving quality of care. The outbreak of SARS in 2003 heightened the government’s awareness of the need to improve the country’s healthcare infrastructure, and healthcare has become a priority for the PRC government.

Chinese Healthcare Institutions

According to the PRC Ministry of Health, there were approximately 18,700 hospitals and 41,700 healthcare clinics in China in 2005. The hospitals, which on average had approximately 130 beds, can be further divided into approximately 950 large-sized hospitals, 5,200 medium-sized hospitals and 12,500 small-sized hospitals, commonly referred to as Tier III, Tier II and Tier I and other hospitals, respectively, in China.

Chinese Medical Device Manufacturers
According to Medistat, World Market Analysis 2004, published by Espicom Business Intelligence, an independent market research firm, there were approximately 2,900 medical device manufacturers in China at the end of 2003. However, most domestic manufacturers are state-owned small- and medium-sized companies producing basic medical supplies, such as bandages, patient aids and medical or surgical instruments. Therefore, imported medical equipment accounted for 85% to 90% of the China medical device market in 2002, the most recent year for which data is available. However, more advanced medical products are expected to be produced in China in the next few years. Those China-based companies that are able to develop and manufacture more advanced products at lower costs then their international competitors should be able to capitalize on the growing desire for better quality of care in China and emerge as leaders in domestic medical device manufacturing.

Medical Device Marketing and Distribution in China
Hospitals in China purchase a majority of their medical devices and supplies through distributors. Medical device distribution is highly specialized and localized in China. Most medical device distributors operate within relatively small territories. Few distributors are willing or able to cover the entire country. Most distributors focus on China’s eastern coastal cities, where purchasing power is concentrated, while western China tends to have very limited coverage. In addition, different provinces in China often have their own medical and insurance practices, purchasing policies and regulatory requirements which further increases the complexity of medical device distribution. As a result, most manufacturers need to appoint multiple distributors to effectively cover all of the geographic areas in China. The ability to leverage local contacts and knowledge is vital in creating an effective distribution network in China, creating a significant barrier to entry for both smaller local companies and larger international competitors that lack a meaningful local presence.

The Patient Monitoring Devices Market
Patient monitoring devices measure patient vital signs and provide for patient safety and management of patient care. These devices have evolved from single vital sign monitoring devices, which measured and displayed a specific parameter, to mostly multiparameter monitoring devices. Multi-parameter monitoring devices evolved out of the need for faster set-up by healthcare staff, fewer wires and complex hookups, and the ability to concurrently examine several vital measurements. They take multiple input signals from biosensors, such as thermometers, blood pressure sensors and electrocardiograms and display the output measurements on a monitor, which can be located bedside, on transports, at central stations and other locations. These devices are used throughout hospitals, in particular, in operating rooms, emergency rooms, critical care units, post-anesthesia units and recovery rooms, intensive care units and labor and delivery rooms.

The Diagnostic Laboratory Instruments Market
Diagnostic laboratory instruments, commonly referred to as in-vitro diagnostics, or IVD, instruments test blood, urine, saliva or other bodily fluids, cells and other substances from patients to diagnose and analyze various diseases and disorders. The use of diagnostic laboratory instruments to conduct IVD tests is an integral part of overall patient care. Diagnostic testing is generally viewed as an effective method of reducing healthcare costs and improving the quality of healthcare by reducing the length of hospital stays and complications through accurate and early detection of health disorders.

The diagnostic laboratory market generally includes commercial manufacturing and sales of diagnostic laboratory instruments and reagent kits to hospitals, reference laboratories and physicians’ offices. The major diagnostic fields that comprise the IVD market are clinical chemistry/ biochemistry, immunochemistry, microbiology, hematology, point-of-care testing, diabetes, hemostasis/ coagulation, molecular diagnostics, urine and self-monitoring blood glucose systems.

According to Frost & Sullivan, the worldwide IVD market was estimated to be US$26.8 billion in 2003, and is projected to grow between 5% and 7% per year from 2003 through 2009. However, according to Frost & Sullivan, the Chinese IVD market had an estimated value of US$500 million in 2004 and is projected to grow at a compounded annual growth rate of 14.4% through 2010 to US$1.1 billion, the fastest projected IVD market growth rate globally.

Biochemistry Analyzers
Biochemistry analyzers use electrochemical detection or chemical reactions with patient samples to detect and quantify substances of diagnostic interest, referred to as “analytes,” in blood, urine and other bodily fluids. These analyzers are commonly used to test glucose, cholesterol, triglycerides, electrolytes, proteins and enzymes.

According to Frost & Sullivan, the global biochemistry analyzer market was estimated to be US$6.7 billion in 2004, the second largest segment within the IVD market. The biochemistry analyzer segment is overwhelmingly the largest segment in every country except the United States and Canada. In 2004, China’s biochemistry analyzer market had an estimated value of US$160 million, and is projected to grow at a compounded annual growth rate of 10% through 2010 to US$290 million. China has the fastest projected biochemistry analyzer market growth rate globally.

Hematology Analyzers

Hematology analyzers use the principles of physics, optics, electronics and chemistry to separate cells of diagnostic interest and then quantify and characterize them. These systems allow clinicians to study formed elements in blood such as red and white blood cells and platelets. The most common diagnostic test is a complete blood count, which provides important information about the composition of a patient’s blood and detects potential disorders or deficiencies.

The Ultrasound Imaging Systems Market
Ultrasound imaging systems use low power, high frequency sound waves to provide non-invasive, real-time images of the body’s soft tissue, organs and blood flow. By eliminating the need for more time intensive, invasive and expensive procedures and allowing for earlier diagnosis of diseases and conditions, ultrasound technology offers a cost-effective solution for healthcare providers. Furthermore, ultrasound imaging does not expose the patient to the potentially harmful ionizing radiation present in X-ray and CT scans. To generate an ultrasound image, a clinician places the transducer on the skin or in a body cavity near or by the targeted area of interest. Tissues, organs and bodily fluids reflect the sound waves emitted by the transducer, which then receives these reflections. Based on these reflections, ultrasound technology measures and organizes the sound waves and produces an image for visual examination, using digital or analog signal processing, or a combination of the two.

Standard ultrasound imaging technology produces a grayscale or two-dimensional image, which physicians use to diagnose, stage and monitor disease states and conditions. Color Doppler technology expands standard ultrasound imaging by generating a color image showing the presence and direction of blood flow. Through the use of software in ultrasound imaging devices, clinicians can provide an assessment of anatomical structures and physiological functions, such as blood flow information and heart conditions. According to Global Industry Analysts, the global ultrasound equipment market had an estimated value of US$3.5 billion in 2004 and is projected to grow at a compounded annual growth rate of 5.3% through 2010 to US$4.7 billion. According to Frost & Sullivan, in 2004, China’s ultrasound market had an estimated value of US$277 million, with the color ultrasound segment accounting for US$162 million, and the grayscale ultrasound segment accounting for US$115 million. The Chinese ultrasound market is projected to experience an increasing shift in consumer preference from grayscale systems to color systems. The main factors driving this shift are the availability of lower cost color ultrasound systems and increasing use of ultrasound imaging systems in cardiology applications within the large-sized hospitals. The grayscale ultrasound segment is projected to shrink by an average of 4.3% per year from 2004 through 2010, while the color ultrasound segment is projected to grow by an average of 7.6% per year during the same period.

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