Ten years ago, Medtronic’s sales in China amounted to $50 million. Today, the company will sell more than $900 million across China during 2014. The strategy Medtronic has embraced to achieve this stunning amount of growth has been multi-faceted: exporting innovative products from the US to China, establishing a R&D facility in China to design products specifically for the unique needs of the Chinese market, crafting partnerships with government to educate patients around under-served therapeutic areas, and acquiring domestic Chinese medical device manufacturers such as Medtronic’s 2012 purchase of Kanghui Medical for $816 million. Taken together, Medtronic’s China ambitions point towards a company confident in their ability to navigate one of the most complex and turbulent healthcare economies in the world.
The last two years have introduced some turbulence to foreign device manufacturers working in China. Earlier this year, China’s National Health and Planning Commission (NHPC) put in place a new policy that said it would “pursue policies explicitly designed to favor domestic manufacturers over foreign manufacturers.” Since the summer of 2013, when the GSK scandal broke, the device community has kept a watchful eye on whether a similar crackdown would take place within the device space.
Thus far, beyond a survey initiated during the summer of 2013 by the China Association for Medical Devices Industry (CAMDI), this has not transpired. Because device sales within hospitals do not appear to be vulnerable to the same sort of economic-rent seeking behavior by doctors and hospital administrators as pharmaceuticals have been, it is likely any issues device foreign device companies will face are likely to involve anti-monopoly (price fixing) questions versus the particularly toxic bribery allegations the pharmaceutical sector has been forced to work through.
In the midst of these uncertainties, device manufacturers can take great solace in a handful of undeniable facts, each of which is a reason to remain positive about the opportunity in China. First, China’s demographics mean demand for cardiovascular, cerebrovascular, and orthopedic goods is going to explode. The numbers may be familiar to some readers, but they bear repeating here: by 2050, one-third of all China’s population will be 65 or older. Beijing already has over 1.7 million people living within the city who are 65 or older; Shanghai has over 2.3 million. This aging population means that by 2015, China will be the world’s second largest orthopedic market. The country has upwards of 350 million people who are active smokers, and the combination of tainted air, food and water all point towards significant demand for surgical procedures specific to cancer, heart disease and, thanks to the Chinese appetite for western food, growing rates of obesity and diabetes.
Second, device companies working in China know that the Chinese government is rapidly moving to expand reimbursement for procedures that use foreign manufactured devices. Huang Wei, Medtronic’s Director of Channel Management for all of China, recently shared with me that “government reimbursement is crucial to Medtronic’s future successes, particularly in disease states such as diabetes.” The move to get basic healthcare insurance coverage to greater than 95% of the Chinese populace was the first step in this direction. Discussions underway between industry groups, business and the Chinese government all suggest that coverage for additional services is likely to continue, an important trigger for overall market demand of devices, diagnostics and pharmaceuticals.
Third, regardless of the intrigue that has characterized the Chinese pharmaceutical market for the last two years, the fact remains that China’s government understands it needs strong partnerships with pharma and device manufacturers in order to deal with the onslaught of healthcare needs that will grow in China over the next several decades. However, the onus is on the private sector to make sure a viable and sustainable partnership exists between the Chinese government and business. During interviews for this column, Medtronic’s spokesman pointed to one specific partnership the company believes is the sort that will allow the needs of patients, the government as payer, and business to all work together productively: the 3-year partnership Medtronic has had with the Ministry of Health and the NHFPC. The partnership will focus on the optimization of care both in and outside the hospital for Type-1 diabetes, as well as the role insulin pumps may play in delivery of care. To make sure that the economic and clinical value of therapies is understood by physicians, patients and government officials, Medtronic is partnering with the National Institute of Hospital Administration, a think tank linked to the NHFPC, to carry out a series of research projects focused on building an integrated care pathway for people in China with Type 1 diabetes.
This sort of care pathway has become an accepted way to evaluate treatment protocols that may utilize more expensive therapies and products in the short-term, but have proven their ability to lower overall costs long-term if these pathways are maintained. This sort of total-cost approach for specific population health management may be new to China, but it will be extremely important if the government is to bend the cost curve down in ways that ensure foreign medical device and pharmaceutical companies view the China market positively.
The project, which is supported by the China Ministry of Health, will engage a panel of expert Chinese endocrinologists as advisors and include pilots at roughly a dozen regional hospitals of various sizes across China. The goal is to gather insight that will support a Chinese nationwide system leveraging Medtronic's expertise to improve treatment of Type 1 diabetes patients and reduce the likelihood of costly complications. This sort of public-private partnership may be new in China, but it is an important way to educate everyone on the potential benefits of technologies and therapies whose value may require a longer-term view.
It may seem all but certain that a company such as Medtronic has every reason to be confident in its ability to be successful in China; however, there are challenges beyond those touched on earlier. Distribution partnerships remain critical in China, and these relationships are rife with compliance risks. China’s highly fragmented pharmaceutical and medical device distribution network relies on thousands of dealers.
Medtronic has over 700 independent distributors in China alone. Many distributors have an intermediary – commonly referred to as a dealer – who acts as the interface between the distributor and the hospital’s purchasing agent. The further away from the manufacturer the product gets, the more difficult it can be to ensure compliant sales behaviors are taking place. In a market like China where extraordinary growth also means strained government budgets to pay for newly demanded medical services, political pressures to identify non-compliant behavior and tie that back to a larger entity are always a concern.
In addition, a company like Medtronic is coming to terms with how quickly Chinese medical device manufacturers have proven themselves capable of building medical devices that, if not as of today world-class, are definitely on-par with the needs of the domestic Chinese market. Why is this? One possible explanation for not only how quickly Chinese device makers have been able to close the gap between their best-in-class and the offerings from western device manufacturers is that medical devices (unlike pharmaceuticals) do not rely on intensive R&D and bench science. Medical device designs and manufacturing are inherently mechanical, reliant on processes, which are familiar to the Chinese manufacturing world. As complicated as they may be, medical device manufacturing is driven by injection molding, plastic extrusion, specialty metal treatment and fabrication, and assembly methods that Chinese manufacturers have proven themselves world-class in for complex electronics, to name just one analog industry.
What could handicap a company like Medtronic’s Chinese ambitions? Certainly un-friendly government policies that favor domestic manufacturers over foreign-owned companies. Absolutely reimbursement policies that stagnate and never speak for more of the patient’s out of pocket expenditures. But one of the easiest to overlook ways that Medtronic’s China ambitions could struggle would be to see domestic manufacturers close the gap between the best-in-class product offering from Medtronic and what the domestic owned companies are capable of producing.
This recognition in no small way illuminates the reasoning behind Medtronic’s various acquisitions within the Chinese device sector, but it also shows the ways in which Chinese companies are winnowing down the competitive advantages that established western businesses have long assumed would be their best protection and ultimate competitive advantage. Today, the pressure to innovate and allow frugal engineering to drive costs down for medical devices is creating a new standard of excellence that western device companies will have to embrace if they are to be successful in China over the next decade.
