by Stephen D. Simpson, CFA
In recent years, medical device companies in the U.S. and Europe have woken up to what pharmaceutical, industrial, and consumer goods companies have known for some time – China is a major growth opportunity. Even more recently, we’ve seen several well-known device companies step into the market more directly by buying domestic Chinese device companies. While China is indeed a huge potential device market, the realities of the market mean that companies who can focus on value may in fact be the ones best-positioned for growth.
A Large Market, But With Serious Questions About Capacity To Pay
To say that the Chinese healthcare system is confusing would be a gross understatement. About 90% of the country’s population is theoretically covered by a system of urban and rural government-sponsored insurance programs, but the actual effective coverage rate for the nearly 900 million rural Chinese is quite a bit lower.
Patient co-pays vary with the wealth of the city/province in question, and patients in China may be called on to pay anywhere from 20% to 60% of the price of a procedure. Worse still, the standard model in China is for the patient to pay 1st, receive treatment, and then seek reimbursement from the insurance system (though this model has been changing).
Device reimbursement is likewise a bit strange. While high-value devices like stents or orthopedic implants are still often reimbursed separately, the reimbursement rates can vary with the source of the device (domestic devices often get 70% reimbursement of list price, while imports get about 50%). More and more, though, the system is migrating towards one where devices are reimbursed as part of an overall procedure reimbursement – giving hospitals more and more incentive to push back on pricing. At the same time, the government has become more expansive in its efforts to limit and control high-value device/consumable pricing through national/regional tenders.
Price Gaps Create Value Opportunities
It can be difficult to directly compare device prices in China, as the data can be murky and does not always include the effects of wealthier clients paying the price difference of imported devices out of pocket. That said, a few general conclusions/observations may be helpful.
Large Chinese device makers like Mindray (NYSE:MR) and Weigao often price their hospital equipment and devices some 20% to 35% below the prices charged by Philips (NYSE:PHG), General Electric (NYSE:GE), Sysmex, and the like. For disposables with very low complexity (needles, IV tubing, and so on), the prices can be as much as ⅔ lower than comparable imports.
In the case of stents, local companies like Microport and Biosensors (PINK:BSNRY) frequently price as much as 50% below the stents imported by Medtronic (NYSE:MDT), Abbott (NYSE:ABT), and Boston Scientific (NYSE:BSX), and the price differentials on orthopedic devices can range from 20% (on higher-value devices) to well over 50% on more mundane implants like plates and screws.
As the quality of domestic Chinese medical technology has improved (both Mindray and Biosensors sell product in the U.S. and EU), this is has led to some significant changes in the market. The combination of cheaper domestic devices/consumables and increased government spending on healthcare has led to procedure volume growth well into the teens, greatly accelerating the growth of the Chinese medical device market.
The key question now, though, is how U.S. and European multinationals go about targeting this growth. In many cases, it looks like growth in China will have to be about acquiring the means to manufacture and distribute products at price points that are competitive with what domestic producers charge.
I believe this is an under-appreciated aspect of recent acquisitions in China. When Zimmer (NYSE:ZMH) acquired Montagne, it wasn’t just about acquiring distribution in China, but rather also the means of expanding the addressable market. Prior to the deal, Zimmer was mostly just focused on premium-priced knee implants, but adding Montagne (and its R&D and manufacturing facilities) not only diversified Zimmer into China’s hip implant market, but also added significant value-priced products, leading to a doubling of Zimmer’s sales in China one year after the deal.
The same is likely to prove true for Stryker‘s (NYSE:SYK) deal for Trauson. Much was made at the time the deal was announced about Stryker’s relatively low exposure to emerging markets and the fact that Trauson was a large player in China’s trauma, spine, and orthopedics market. While that was all true, it is also true that Trauson is a leader in the value segment of China’s orthopedics industry – a market segment that is seeing considerably faster growth than the overall orthopedic market in China.
And it may not just be the value opportunity in China that matters. The reality is that much of the healthcare market in emerging markets is self-pay – basic care may be subsidized by the government, but more advanced care requires sizable contributions from the patient, and most people in Brazil, India, Indonesia, and so on simply cannot afford U.S. medical device prices. But just as Mindray as managed to take share in the global market on the basis of its ability to profitably develop, manufacture, and market equipment for 20-30% less than GE or Philips, so too might Stryker, Medtronic, Zimmer and other multinationals be able to use their experience and facilities in China to eventually open up these other markets with value-priced implants, devices, and consumables.
Will China Eventually Set The Standard?
One aspect about device pricing in China that could be very interesting to watch is what, if any, impact it has on pricing in the United States over the long term. Certainly Mindray as benefited in the here and now – many American hospitals have made exploratory purchases of Mindray equipment and then enthusiastically bought more when they realized they were getting a 20-30% price break with no discernible drop in quality or performance.
Will the same be true with other devices? If Microport’s biodegradable drug-eluting stent proves just as effective as Abbott’s, will Abbott encounter any difficulties in arguing that it is entitled to premium pricing in the U.S.?
Odds are that the answer will be “no” for the foreseeable future. It’s long been known that U.S. drug companies charge less in markets like Canada, and that hasn’t led to any sustained pressure on pricing in the U.S. Likewise, while it may annoy policymakers to know that there are Chinese stents or implants that are just as good and 30% cheaper, it’s largely a moot point if those companies cannot/will not go through the U.S. approval process and actually try to market them in the U.S. at those lower price points.
The Bottom Line
Foreign companies still represent 80-90% of the high-end Chinese device market, and capture about 60-70% of total device spending. But the times are changing – hospitals are increasingly being incentivized to turn to cheaper domestic devices and these domestic manufacturers are quickly closing the gaps in product performance and reliability.
To their credit, it seems that Zimmer, Medtronic, and Stryker have seen the future, and realize that success in China is not only going to be about having a large China-based sales force with the right connections and distribution assets in place. Instead, it is going to be increasingly important to have manufacturing and R&D assets on the ground in China so as to better compete in a market with 20-30% lower prices without wrecking their margins.
In short, then, realizing the growth opportunity in China will likely come down to a company’s ability to compete on value.