Thursday, November 28, 2019

Adapting to China’s Changing Medical Device Market

More government investment will create new opportunities for medical device suppliers, but producers must be patient and creative to overcome obstacles.Developments in China's domestic policies—particularly its massive healthcare reform effort and stimulus spending to offset the global economic downturn—have cast a spotlight on its medical device market. Exactly how China's stimulus programs may affect this market remains unclear, but suppliers that understand the current and future challenges will be better able to adapt their strategies to the changing market.

Slow but steady growth

Though the PRC government has not published official figures, most other sources estimate the size of China's medical device market at $8-$10 billion in 2008, with an average annual growth rate of about 30 percent in recent years. According to industry watchers, the market could grow to $16 billion by the end of 2010. The economic slowdown has affected this market, however. Official statistics gathered by the China Medical Devices Review, a Transmedia publication based in Chongqing, show that the growth rate of China's medical device production slowed to under 13 percent in the first seven months of 2009, compared with the same period in 2008. Purchasing and tendering delays due to uncertainty about the immediate direction of China's healthcare reform and stimulus programs, rather than a new trend, are the likely cause of the slowdown.

Forecasts show that China's medical device market will likely grow 15 percent to 25 percent annually. Imports, which were valued at about $5.2 billion in 2008, will likely grow at a slower rate of 12 percent to 15 percent over the near term. This does not mean that the market for high-tech imported devices is shrinking or being displaced by mid-level or mass-market products. Rather, the slower growth of import sales indicates that many multinational corporations (MNCs) have adopted integrated market solutions—including producing in China and acquiring Chinese manufacturers—to serve the domestic market comprehensively and compete in the lower end of the market in China and abroad. Today, MNC products account for a significant portion of China's domestic medical device output (see Figure).

China's medical device market consists of many different tiers, ranging from high-end to mass-market equipment. High-end equipment includes the latest diagnostic and treatment technologies, which are generally contained only in imported products, while mass-market equipment incorporates older technology used for basic screening and treatment. Most mass-market equipment purchased in China is made there, as domestic manufacturers produce competitive technologies at relatively low costs. Mid-level equipment often comes from overseas producers, but as quality and technological levels improve, domestic devices (including those manufactured by MNCs through joint ventures, technology partnerships, and wholly owned subsidiaries) are gradually supplanting imports. Imported products dominate the top tier of China's hospital market and are primarily found in the roughly 3,500 Grade II and III hospitals in China's larger cities that have the foreign capital resources to purchase high-end equipment regularly. (For more information on China's hospital system, see the CBR, July-August 2009.)

Imports lead the high-end market

Though the quality of China's domestic (non-MNC) medical devices has improved significantly over the past several years, these products—even the most highly evolved models that have a strong market outside of China—have advanced only enough to reach global users at the mass-market level. For example, Shenzhen Mindray Bio-Medical Electronics Co., Ltd., China's largest medical device manufacturer, makes 14 ultrasound models for domestic and foreign markets. It has firmly established its place as a strong player in the global market for basic ultrasound technology. Some Chinese medical technicians and doctors view Mindray's top-of-the-line technology as equivalent to some lower-end imported products, as well as mass-market and mid-level products manufactured locally by MNCs. But even the most advanced Mindray ultrasound systems are used primarily in Grade I hospitals or community health centers for basic screening purposes or as backup products in higher-level institutions. For advanced screening and diagnosis, doctors generally refer their patients to the larger Grade II and III hospitals that use more advanced, imported equipment. Domestic medical device manufacturers are making substantial investments in research and development (R&D) to improve their technological competitiveness, but their current competitive niche is—and will be for the foreseeable future—limited primarily to mass-market applications.

Perhaps surprisingly, distribution and service is another area where domestic companies in the medical device market lag behind MNCs. Many MNC exporters and producers operating in China have built—or gained through an acquisition or strategic partnership—a reliable domestic distribution and service infrastructure. In contrast, many domestic manufacturers, especially those that focus on export markets outside of China, lack strong distribution and service networks within China. These manufacturers often have stronger distribution networks abroad where, much like the MNCs operating in China, they have become full-service providers through alliances and partnerships.

Challenges for medical device suppliers

Despite the opportunities offered by this growing market, medical device suppliers must contend with government-mandated processes and restrictions that hinder sales in China.


China has adopted formal tendering processes for nearly all medical equipment purchases to ensure fairness, reduce overall purchase costs, and limit the influence of individuals and companies in swaying the preferences of doctors and hospitals. The outcomes of these processes are questionable, however.

Tendering requires writing specifications, expert reviews, and an adjudication process—all of which greatly extends the purchasing cycle and increases suppliers' expenses. But the extra cost and effort does not always lead to better outcomes. For instance, many tenders for bulk purchases have resulted in sales of far fewer units than the original bid proposed. In these cases, suppliers that offered discounted pricing based on the promise of a specific quantity purchase are unable to force the conclusion of the remaining sales and must execute the contracts at a lower profit margin or a loss.

Another problem is that minimum technological criteria tend to be low, allowing too wide a range of products to qualify for tenders. This affects high-tech products or research-focused equipment in particular, because more sophisticated specifications are needed to determine whether the product can be used for basic clinical diagnosis or more cutting-edge applications. In these cases, high-end producers must engage in lengthy negotiations. These negotiations are similar to normal sales negotiations but come with the added costs of a tendering process and the added complications of attempting to explain why a high-end product costs so much more than a seemingly similar product—all because the original bid criteria were too simple.

The PRC Ministry of Health has been refining the tendering process, but tenders take place largely at the provincial and local levels, and improvements advocated by the central government are not always implemented at lower levels (see Drug Procurement Bidding).

Price controls

To reduce healthcare costs, the PRC government has considered controlling the prices that suppliers can charge hospitals for medical consumables and the markup at which hospitals can resell these devices. Tenders that restrict the free bidding process and impose price ceilings tend to discourage R&D investment and fail to recognize the R&D costs that are inherent in new technologies. These price ceilings limit purchases of newer, more effective, and more efficient products that have higher unit prices but, in the long run, could lower the overall cost of healthcare for patients. Furthermore, if the price cap for domestic goods is set according to a percentage-based markup from an ex-factory price, but the cap for imported products is set according to a cost, insurance, and freight (CIF) price, suppliers of imported products have little flexibility to include adequate margins in China to cover local promotion and distribution costs. In contrast, domestic manufacturers can factor these costs into their ex-factory pricing.

Technology restrictions

Since 2005, hospitals have been required to obtain PRC Ministry of Health approval to purchase certain high-value (Type A) devices. This category includes large medical equipment, such as PET-CT scanners, gamma knives, and tomotherapy and robotic endoscopic surgical systems. The restrictions are managed by the PRC central government, which appoints expert panels that help develop and review the policies. Unfortunately, the experts sometimes lack direct experience with new technologies or favor current medical approaches over new technologies. In some cases, if doctors have a strong relationship with one of the experts, their hospitals may have an advantage in receiving approval to purchase new technologies. These central-government limitations also unintentionally deter Chinese doctors from keeping up-to-date on new equipment and gaining a leading edge among their international peers.

Regulatory challenges

Despite some recent improvements in execution, inefficiencies in China's regulation of medical devices, specifically the State Food and Drug Administration and China Quality Certification registration processes, create significant barriers to market entry and slow the introduction of new imported technologies into China. In particular, sellers of imported equipment face long wait times for testing reports and approvals, duplicative testing, and China-specific standards protocols. China's requirement for testing product quality is inflexible and inefficient, as well as redundant to the testing that foreign-manufactured products undergo to register in other markets. In contrast, the quality systems approach used in many foreign markets is widely recognized internationally, supports continuous design improvement, and does not hamper the introduction and sale of medical devices. Domestically made products face similar challenges within China's regulatory framework. Market-entry delays are less severe for Class I and II domestic products, which require only provincial-level regulatory approval, whereas Class I and II imported products must receive central-government approval.

Impacts of China's healthcare reform and stimulus spending

The PRC government plans to spend ¥850 billion ($124 billion)—in addition to normal budget allocations for healthcare—over the next three years to implement its healthcare reform plan, which includes building 2,000 county hospitals and implementing a new set of health insurance programs. Though it is unclear what portion of the funds will be allocated to equipment purchases, the investment will fuel demand for medical equipment and have the greatest impact on the low- to mid-levels of the market. The increased investment should also boost overall demand, as some new hospitals will purchase mid-level and high-end equipment, and many existing Grade II and III hospitals will seek to offer more advanced services. MNCs that focus primarily on exports and mid-level and high-end markets, however, will benefit less from the healthcare reforms than local manufacturers of basic equipment.

MNCs looking to sell imports through healthcare reform programs may be limited by the "Buy China" policy in the PRC Government Procurement Law. The policy requires central and local governments to purchase all goods and services from domestic companies, unless a committee of experts attests that no suitable domestic alternative exists. Though PRC officials agreed at the October 2009 Joint Commission on Commerce and Trade to formally clarify that goods manufactured in China by MNCs qualify as "domestic" for government procurement purposes, no official clarification had been released as CBR went to press. Whether foreign-invested enterprises will gain access to government procurement programs under China's healthcare reform remains uncertain.

Separate from the healthcare reform funds, the PRC government's ¥4 trillion ($585 billion) stimulus package announced in 2008 may also affect the medical device market. Government investment in technology R&D could help China's large medical equipment manufacturers—such as Beijing Wandong Medical Equipment Co., Ltd.; Mindray; Shandong Shinva Medical Instrument Co., Ltd.; and Weigao Group Co., Ltd.—advance the technological level of their products and increase their competitiveness beyond the basic device markets.

China's healthcare reform funds and stimulus spending funneled to healthcare R&D will boost the sales of domestic medical device manufacturers. Much of this spending will focus on mass-market technologies to improve rural and low-end urban healthcare. MNCs that export high-end devices to China will likely be unaffected, but those with domestic production may find themselves with a larger piece of a larger pie.

Planning for the future

In addition to China's healthcare reform and stimulus spending, which will likely boost market growth and benefit domestic and foreign medical device companies in the long term, a variety of other factors is driving short-term market growth for all tiers of medical equipment. As demand for the latest top-quality technologies and the prevalence of "developed nation" diseases such as certain cancers, cardiovascular disease, and diabetes grow in China, the appetite for advanced Western technologies is increasing. The demand for basic equipment is also growing, primarily at the rural and grassroots level, bolstered by healthcare reform spending

To maximize benefits from this growth, high-end medical equipment exporters must take advantage of attractive, government-sponsored financing packages and convince the PRC government to encourage new county hospitals to use foreign-government-sponsored loans to purchase imported devices (see Box). Demand for imported products will rise as Grade II and III hospitals upgrade and expand their diagnostic and treatment capabilities to compete for referrals from county hospitals, as well as for business from the growing middle- and upper-class patient base in China's cities. In this high-end market segment, MNCs seeking export sales to China are not yet affected by domestic competition or "Buy China" policies because equivalent domestic products are unavailable. They therefore are also unaffected by potential restrictions on purchases that use healthcare reform or stimulus funds.

Though an export-based strategy is still relevant for high-end equipment, foreign manufacturers should be prepared to incorporate some degree of in-country operations. Foreign manufacturers looking to compete with China's increasingly mature and competitive domestic manufacturers in lower levels of the market should follow the lead of the larger MNCs and adopt a more diversified strategy that includes local production.

Foreign Financing for Chinese Hospital Equipment Purchases

Financing sponsored by foreign governments provides an excellent opportunity for Chinese hospitals to stretch medical equipment purchasing funds, especially when buying imported high-end equipment. Such programs offer Chinese hospitals attractive financing and repayment terms to purchase imported and domestic equipment through loans and loan guarantees from government development agencies, such as Germany's KfW Development Bank, and export credit agencies, such as the Export-Import Bank of the United States. Imports financed by these programs are exempt from PRC duty and value-added tax and can lower the hospitals' final cost by more than 20 percent.

Most of the hospitals that have used foreign government-sponsored funds are county hospitals in second- and third-tier cities—precisely the types of hospitals that will be developed under the healthcare reform plan. Unfortunately, county hospitals have been informally prohibited from using these funds since the PRC healthcare reform plan was announced. Nevertheless, foreign government-sponsored financing will remain an attractive option for China's other hospitals as they develop and upgrade their technologies.

—Judy Zakreski

 Judy Zakreski is vice president, US Operations, at Chindex International, Inc. She is based in Bethesda, Maryland.

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