Reshaping the business operation model: the next winning point for Chinese medical technology companies

Today, this model is no longer the best choice. New business operating models must adapt to the increasingly complex market competition landscape. Medical technology companies should consider reallocating resources to maintain growth, improve efficiency, and provide customers and patients with better products and services. The industry is facing a new competition and pricing environment, not only to deal with more diverse stakeholders, comply with stricter regulatory requirements, but also to have stronger innovation capabilities.

Local companies have made significant improvements in overall performance. In 2022, China's 150 listed medical technology companies achieved total revenue (including overseas revenue) of approximately RMB 360 billion, with a compound annual growth rate of approximately 30% since 2019. However, the growth has slowed down compared to the 35% compound annual growth rate from 2019 to 2021. As of June 2023, 16 Chinese companies have obtained breakthrough medical device certification from the US Food and Drug Administration (FDA), which is twice as many as in June 2022.

Medical reform is disrupting existing business models

In 2022, China's GDP growth slowed to 3%, and is expected to gradually recover to 5.0-5.5% in 2023 [3]. Over the past 20 years, the high prices paid by the government for medical technology and services have attracted many of the world's leading multinational companies to operate in China. However, recent centralized procurement and reforms to the medical insurance system have broken the existing model. For example, after the 2021 volume-based procurement, the price of drug-eluting stents used in cardiac interventional surgery fell by more than 90%, from an average of RMB 8,400 to RMB 645 [4]. Products with less differentiation and higher degree of commoditization have been hit more significantly.

Five strategies to help reshape business operation models

To maintain or accelerate growth in the Chinese market, both multinational and local medical technology companies should re-examine their business models and focus on the following five interrelated operational strategies:

1. Reshape the commercial channel architecture : prepare for a price-sensitive environment and expand market coverage to maintain growth momentum;
2. Reassess business resource allocation : product portfolio and corresponding resource allocation need to adapt to changing strategic priorities and strive to lead the market;
3. Expand omni-channel customer interaction : improve sales efficiency, expand market reach, and optimize customer experience;
4. Expand ecosystem collaboration : Develop new innovation engines to provide integrated solutions to a wider customer base;
5. Return to basic business principles : Re-examine cost-effectiveness, dynamically adjust marketing strategies based on strategic priorities, and respond to profit pressure and the rise of competitors.

Among these five strategies, which one is the most difficult to implement? For companies that have already started channel reform or looking for partners, which one can be a source of competitive advantage? The answer varies from field to field and company to company. Business leaders need to explore the strategy that suits them, give it the appropriate level of attention, and execute it.

In our view, companies that are heavily reliant on distributors and whose product portfolios are most affected by government price reduction policies (such as volume-based procurement [5]) will have to completely reshape their channels. However, volume-based procurement also creates opportunities to expand market coverage. To seize these opportunities, companies need to effectively acquire new customers and retain existing customers efficiently through an omnichannel model. In addition, innovation through licensing and partnership agreements will drive sustainable growth in the medium and long term. Due to the combined effects of macroeconomic trends and policies such as volume-based procurement, the overall revenue growth rate of the medical technology industry has slowed down. In view of this, companies need to make targeted plans now to avoid hasty response when the time comes.

Companies should also strengthen their capabilities to match these strategies. For example, if they have focused on medical consumables in the past and now want to enter the medical device field, they need to recruit sales teams and distributors with experience in interacting with non-clinical stakeholders. In addition, they need to re-evaluate their sales capabilities and resource allocation.

Excellent companies are usually good at doing this kind of analysis, evaluating the development needs of each strategy as early as possible, accurately grasping the real source of their own advantages, efficiently adjusting their business capabilities and business models, and ultimately successfully exceeding market growth.

Strategy 1

Reshape the business channel architecture

In a country with more than 37,000 hospitals and a population of 1.4 billion [6], the market landscape for medical technology companies and distributors is inevitably fragmented. Manufacturers’ internal sales teams, together with distributors, mainly serve as a bridge between manufacturers and medical institutions.

Two major forces are disrupting the roles of these players in the new economic landscape of China’s healthcare system. First, volume-based procurement has significantly squeezed the profit margins of distributors. Bidders are expected to reduce the hospital price [7] by more than 50% to have a chance of winning the bid. Second, policy reforms related to medical insurance payment [8], such as the Diagnosis Related Groups or Diagnosis Intervention Groups (DRGs/DIPs), have further squeezed the profit margins of manufacturers and distributors.

In some product categories, smaller distributors that have been unable to adapt to these changes have already exited the market. The trend of consolidation in the distribution market is visible, with leading companies growing stronger. For example, China's largest medical device distributor, Sinopharm Holdings' medical device division, has seen revenue growth of more than 10% for three consecutive years [9], reaching RMB 120.9 billion in 2022. Its customer base continues to grow, including leading global medical technology manufacturers such as Medtronic, Johnson & Johnson, Danaher, Becton Dickinson, Stryker, and Smith+Nephew.

Medtech companies are adapting to the changes by reevaluating their relationships with distributors. As more companies adapt to the new economic situation and significantly reduce the fees they pay to distributors, the roles and responsibilities of each party are gradually changing (see Figure 2). For example, some companies have narrowed the scope of responsibilities of platform distributors to only managing logistics and handling accounts receivable.

As volume-based procurement is expected to bring companies larger orders and expand access to hospitals in more down-market markets, major companies have begun to reassess how to expand their channels. Some companies have expanded their dealer networks in the hope of obtaining larger orders from hospitals, or invested in expanding sales coverage, recruiting and training sales teams suitable for the broad market to serve previously unreachable customers. Other companies have internalized the functions of dealers, integrated provincial warehouse operations, and clarified their roles by assessing their capabilities—and then reaching an agreement on how to share limited profits. In general, companies are more actively managing dealers and evaluating the economic benefits of channels.

Re-evaluating the relationship with dealers requires a systematic approach. First, it is necessary to redefine the future sustainable dealer business and cost structure according to the new market environment, or to re-sort and define the business scope and responsibilities of future dealers with MVB (Minimum Viable Business) as the core concept. Secondly, based on the newly defined future dealer model, evaluate the capabilities and endowments required for success, and make an objective assessment of dealers in the existing dealer network to determine which ones need to be retained, developed and co-built for future business, which ones need to be eliminated, and more importantly, which new partners will be more suitable for the future dealer model. Finally, the adjustment and transformation of the entire dealer network is painful, and systematic internal and external change management needs to be promoted simultaneously to ensure the successful reconstruction of the dealer network.

Strategy 2

Reassess business resource allocation

Despite the slowdown, China’s medtech market still holds great potential. Companies that can flexibly redeploy management and sales resources to emerging high-growth innovative categories are likely to outperform competitors that are too focused on existing categories.

Take Boston Scientific as an example. In 2022, the company launched a series of innovative products, such as the Rezūm water vapor system for the treatment of prostate hyperplasia. At the same time, it increased its support for new products [10]. Another example is Abbott Laboratories. After the national volume-based procurement classified the coronary artery drug-eluting stent as a medical consumable with a high level of homogeneity, the company cut the sales staff assigned to the product. In addition, by focusing on innovative continuous blood glucose monitoring equipment, the annual sales of this product exceeded 700 million yuan [11].

Divesting commercialized assets or outsourcing them to a new company for distribution is also a viable idea. In the context of cost reduction in the pharmaceutical industry, if a certain type of product has a low degree of differentiation and its profits are declining, revenue can be increased by licensing the product out. For example, Eli Lilly sold two mature antibiotic products and their corresponding Suzhou factories to Shanghai-based specialty medicine manufacturer Yitong Pharmaceutical. In either case, it is necessary to carefully evaluate the synergy of the sales team, the feasibility of the partnership, and the financial potential. In the case where manufacturers need to share more profits with their partners, divesting or outsourcing assets may lead to reduced revenue. In contrast, if these assets are retained according to the existing model, the profit prospects may be better.

In summary, bottom-up sales and marketing analysis is essential to reassess commercial performance, understand the service costs of the product portfolio, and reallocate resources and investments at a strategic level. Since the specific adjustments will determine the workload of the internal sales team, these adjustments need to be considered in conjunction with channel restructuring measures.

Strategy Three

Expand omnichannel customer engagement

Strengthening the coordination of customer interactions across different channels through data and analysis is conducive to improving sales operation efficiency [12], expanding coverage and optimizing customer experience. Most domestic medical technology companies establish connections with customers through diversified online and offline channels. The marketing department, sales department, after-sales department and distribution team are all carrying out multi-channel activities, but rarely share data and coordinate interactions between teams. Therefore, although each team continues to interact with customers and obtain valuable insights, they are often unable to share and communicate in a timely manner.

A typical problem is that although the marketing team strengthens the interaction with key customers through online conferences and live events, it often fails to properly track, evaluate and convert the potential value generated by digital marketing. As a result, opportunities are wasted and the front-line sales team fails to better follow up, meet customer needs or answer customer questions in a timely manner.

Companies need to update and improve the way different departments communicate and collaborate. The key to strengthening omnichannel customer interaction includes timely cross-functional data sharing and promoting collaboration between cross-functional teams to jointly analyze the meaning of big data. These changes will fundamentally change the way organizations operate.

The limited capabilities and number of sales teams are also challenges faced by medical technology companies, especially when expanding to smaller cities or large markets affected by volume purchases. In general, companies need to take two important measures in this situation. First, learn from customer interactions in various channels and archive them for easy access. Second, use data and analytical engines to better improve the efficiency and effectiveness of customer interactions.

In the medium and long term, companies can also focus on the application of generative AI in medical-related fields, and use large models of medical-specific content and natural language interaction capabilities to quickly empower sales representatives and doctors. Through internal or external partner cooperation, selective input of the company's omni-channel data, product and procedure education resources, external medical journals, etc., to generate insights that can guide commercial marketing, and through virtual sales or medical specialists to customize interactive content for doctors, enhance the omni-channel, high-quality interactive experience, and at the same time release part of the time of offline sales and dealers to form a wider and deeper customer coverage.

Strategy 4

Expanding ecosystem collaboration

Medical technology companies in China are establishing partnerships that leverage their respective strengths and are committed to creating value across the entire patient journey, from prevention, diagnosis, treatment, to post-treatment disease management at home or in the clinic. These new partnerships create network effects, and as the number of participants grows, more attractive opportunities emerge (see sidebar).

More partners, diverse stakeholders and solution sources

Traditional healthcare industry players are expanding their businesses by establishing new alliances, adopting various forms of cooperation, and in many cases joining hands with domestic and foreign medical technology companies to pursue high-growth markets.

Ecosystem 1.0 — The Era of Expansion — is a pragmatic alliance involving traditional stakeholders including government organizations, academic institutions, healthcare providers, payers, investors, distributors, R&D or manufacturing outsourcers, and other manufacturers.

As partnerships are formed, companies can accelerate access to innovative products, broaden customer coverage through diversified business models, and gain new manufacturing capabilities. For example, Germany's Siemens Healthineers has established a strategic partnership with Shanghai Electric. The two parties will jointly develop and localize medical equipment in China, while accelerating penetration into primary medical institutions. Another example is that Illumina, a global leader in gene sequencing and chip technology, has partnered with Sequoia Capital to launch a genomics incubator in China.

A wider and more diverse group of stakeholders in medical technology have come together to shape Ecosystem 2.0, the Era of Transformation, with medical technology companies. The 14th Five-Year Plan emphasizes the urgency of promoting cooperation by integrating global resources and breakthrough digital technologies, including 5G, artificial intelligence, and the Internet of Things.

Local companies and multinational corporations in China are expanding their high-growth product lines by introducing proven innovations from overseas companies. Medical technology licensing deals, once rare, have become increasingly common over the past three years.

New solutions are increasingly coming from collaborations with digital or AI companies, as well as data analysts of actual clinical outcomes. For example, Koninklijke Philips has created a telemedicine platform with Hongyun Rongtong, a domestic telemedicine solution and service provider, to facilitate the use of high-quality medical resources in small city hospitals. Medical technology companies can also draw lessons from other industries, as innovators in many industries do. For example, an executive of Chinese technology giant Tencent said at a recent conference that its smart travel business has built a rich in-car service ecosystem with about 40 auto companies and has benefited a lot.

However, not all collaborations bring rich returns. How to find the best balance between investment decisions and profit returns? This remains an important question. Comprehensively evaluating and correctly prioritizing ecosystem projects is crucial to the success of medical technology companies.

Strategy Five

Back to basic business principles

As profit pressures continue to increase and domestic companies continue to grow, the basic principles of commercial excellence become increasingly important. Setting priorities for different customer groups and allocating resources in an innovative and organized manner are critical to consolidating market position. Admittedly, the landscape of domestic medical institutions has been changing, but to some extent, the expansion of the patient volume of the largest customer group - large medical institutions - has not changed. More than 3,000 tertiary hospitals accounted for 58% of the total number of consultations in 37,000 hospitals in 2022 [13]. This proportion has maintained a slow growth in the past five years. Recent policies, such as the tiered diagnosis and treatment reform and corresponding financial support, aim to divert more patients to large and medium-sized medical institutions in small cities and counties.

Other fundamental principles that are prioritized include differentiating business models by product category, optimizing sales responsibilities and coverage, and pursuing pricing excellence. These fundamental principles have often not received the attention they deserve in the past due to the rapid development of the market. In addition, for products with less differentiation, cost efficiency is critical. As mentioned earlier, these products are often sold or discontinued after evaluating the trade-offs.

Before beginning to evaluate these fundamentals, business leaders can first conduct a systematic, value-oriented assessment: What are our distribution channel costs? Are our resource allocations aligned with strategic priorities?

If medical technology companies want to seize future growth opportunities in the Chinese market, they must fundamentally rethink their business models. Considering the five strategies listed in this article will lay a solid foundation for long-term success.

Notes:

[1] Based on McKinsey analysis of data from China’s National Health Commission and domestic revenue and market share of more than 150 medical technology companies.

[2] Ibid.

[3] “Director of the National Bureau of Statistics answers reporters’ questions on the national economic performance in 2022”, National Bureau of Statistics, January 17, 2023. The baseline forecast is based on McKinsey’s analysis of data from multiple analytical institutions, June 31, 2023.

[4] “China’s high-value consumables industry officially enters the era of volume-based procurement”, China Association of Medical Devices Industry, July 22, 2021.

[5] Procurement contracts under the government volume-based procurement reform involve all levels of national, provincial and municipal governments and all types of consumables and in vitro diagnostic products.

[6] “Health, Health and Sports 2022”, National Bureau of Statistics, February 28, 2023.

[7] Hospital price refers to the price set by distributors when selling medical devices directly to hospitals.

[8] Based on the "Three-Year Action Plan for DRG/DIP Payment Method Reform" formulated and issued by the National Healthcare Security Administration in December 2021, the establishment of an effective and efficient medical insurance payment mechanism will be accelerated. By 2025, DRG/DIP payment medical insurance fund expenditures will account for 70% of all inpatient medical insurance fund expenditures in the pooling area, and basically achieve full coverage of diseases and medical insurance funds.

[9] Data on Sinopharm Medical Devices comes from Sinopharm Medical’s annual report.

[10] “Two products of Boston Scientific approved for registration using real-world data from Lecheng”, People’s Daily Online, March 5, 2022.

[11] “The “disappearing” medical device distributors”, MedTrend, February 18, 2022; “Blood sugar market explodes, Abbott’s single product sells for 20 billion, and the four domestic little dragons compete for the 10 billion market”, written by Yang Xue, July 6, 2022.

[12] “Omnichannel engagement in medtech: The time is now”, McKinsey, May 19, 2021.

[13] McKinsey analysis of data from the National Health Commission’s Statistics Center.

Source: McKinsey

Authors: Tian Yunying, Wei Wei, Wu Yongxian, Delphine Zurkiya