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ELECTRONICALLY REPRINTED FROM FEBRUARY 26, 2014
How to Prepare for New Pricing Rules and Consolidation in
China’s Medical Device Distribution System
These changes will create an imperative for distributors to improve performance as well as bring new
opportunities for device makers that can properly build and manage their commercial models and
partnerships with the right channel partners.
By Kelly Wang, ZS Associates
1. Clarify Distributor Roles in a Fragmented Market
China is a hospital-based healthcare market, dominated by government-owned, public hospitals. To break in, manufacturers need
the help of distributors that have good relationships with hospitals,
which account for the bulk of device purchasing. Attempts to sell
directly to hospitals have not worked out well, and clarifying distributors’ roles and responsibilities by customer segments will be
critical in aligning channels and capturing opportunities for de-
image courtesy of OHMEGA1982/FREEDIGITALPHOTOS.NET
M
ultinational medical device companies have a long history of driving growth through patented products, strong
brands, and direct sales force in the United States and Europe. In China, however, multinational medical device companies
have not seen much success with the direct sales model and rely
instead on distributors.
But changes afoot in the country will require many medical device producers to rethink their channel strategies in the country.
New pricing rules for medical services are being imposed in the
near-term, and in the longer term, consolidation is coming to the
fragmented Chinese device distribution system. These changes
will create an imperative for distributors to improve performance
as well as bring new opportunities for device makers that can
properly build and manage their commercial models and partnerships with the right channel partners.
Multinational medical device companies would do well to address the following action points for success:
vice companies in the future.
China’s medical device distribution base is intensely fragmented. At the end of 2011, there were more than 180,000 medical device distributors in China, compared with about 13,000 pharmaceutical distributors. Beijing alone has about 8000 medical device
distributors, and Shanghai has about 6000.
Most medical device distributors are highly specialized in certain product categories and provide access only to a single local
market or even one or two hospitals. The ratio between medical device distributors and manufacturer sales representatives is nearly 1
to 1—about four times the ratio for pharmaceutical manufacturers.
For large equipment, the number of distributors can even exceed
the number of sales representatives a manufacturer can deploy.
When most medical device manufacturers first entered China,
they relied on distributors to develop the market. Multinational
device companies needed distributors that could have a strong impact on their ability to drive sales, expand penetration, and defend
against competitive and local products.
As these companies expanded, many built their own direct sales
forces and transitioned to a hybrid go-to-market model with increased direct sales involvement and internalized local insights.
In this model, direct sales forces focus on covering large hospitals
and big cities, while distributors play more of a supporting role.
Today, companies struggle with issues such as which accounts
to cover with a direct sales force and which ones require only distributors. Given that companies have a limited number of direct
sales representatives, which accounts should be the initial focus?
In different account segments, what roles should the distributors
play? As companies institute standardized processes for this kind
of decision-making, outcomes will improve.
2. Revisit Distributor Trade Term and Channel Margin
Medical device distributors in China preserve high margins of
30%–60%—significantly higher than the Chinese pharmaceutical
distribution sector, whose gross profit margin was 6.9 percent in
2012, according to the Ministry of Commerce.
Eager to cut healthcare costs, the Chinese government is expected to pressure medical device distributors to consolidate and
reduce their margins much as it successfully did with pharmaceutical distributors in the past. To stay ahead of the game, manufacturers will need to reassess their channel strategies.
The channel’s high mark up is viewed as contributing to the
high cost of medical devices and corruption within the system, and
authorities have already taken action on some devices. The impact
can be seen in cardiovascular stents, where the mandated central
tendering that began in 2011 has forced prices down, squeezed the
channel margin, and flattened the distribution channel.
In a recent manifestation of this intention, the Commerce Ministry’s antimonopoly bureau sent a survey seeking extensive information about pricing to most of the companies involved in the
medical devices industry. (reported in Reuters, August 21, 2013 ).
In May 2012, the National Pricing Guideline for Medical
Services was coissued by the National Development Reform
Commission (NDRC), Ministry of Health (MoH), and State Administration of Traditional Chinese Medicine (SATCM). Exact
implementation details are still under consideration and will likely
vary across provinces, but it is clear that stricter rules will be applied to medical service pricing—a change that will impact manufacturers of innovative medical devices the most. In the face of
price reduction, manufacturers will be obliged to reallocate profit
along the value chain and rethink the conditions of generous distributor margins and the somewhat opaque hospital mark-up.
Compared with the stance it took with the pharmaceutical industry, where a fixed hospital markup of up to 15% was enforced
and the channel margin was capped, the Chinese government has
taken a more gradual approach to rationalize the channel margin
in the medical device industry. Still, MNCs should not underestimate the force of the government’s effort.
3. Upgrade Channel Management Capability Building
Within medical device companies, the commercial department, a kind of management department unique to companies
in China, is responsible for managing distributors. The changing
marketplace and increasingly complicated distribution channel
management have required commercial departments to evolve
from a more operational role to become a more strategic channel
manager. But these departments lack the experience needed to rationalize distribution, and the sales force itself too often handles
selection and management.
The need to work with large numbers of distributors places a
strain on the commercial departments at some manufacturers.
One manufacturer’s business team of more than 100 sales people
currently coordinates more than 200 distributors of varying scale
and capabilities. But with the increased capability of some visionary distributors, the manufacturer is running a pilot with a smaller
number of directly managed (Tier 1) distributors and constructing
a more structured tiered distribution channel, as is more common
in the pharmaceutical industry.
The commercial team must be able to create productive working relationships, manage complex coverage models, and implement targeted growth initiatives. This ensures targeted returns on
distributors’ compensation and incentives will be achieved. Without strong channel management capabilities, multinational medical device companies are in danger of ceding initiative and control
to distributors, which places sales and growth goals at risk.
The Chinese Ministry of Health’s newly revised Good Supply
Practice of Pharmaceutical Products (GSP) went into effect June
1, 2013. The revised GSP standards set high requirements, and
pharmaceutical distributors with an expired GSP certification or
pharmaceutical distributor license will need to be inspected and
recertified in accordance with the new provisions. This forces
small and less qualified players to upgrade or drop out.
The timeline for pharmaceutical distributors to upgrade to new
GSP requirements is five years. By then, it is expected that about
30–50% of pharmaceutical distributors will be forced out of business.
A similar scenario, albeit over a longer period, is expected to
play out for device distributors. This will oblige multinational
medical device companies to manage their distributors more efficiently. Market conditions and distributor channel composition
vary significantly across markets and cities, but this does not mean
that multinational medical device companies should not use a disciplined, fact-based process to make channel decisions. In fact,
outcomes will be stronger if standardized processes are used to
help make local decisions. Using standardized processes also gives
management improved visibility and performance measures.
Most medical device distributors in China lack the level of infor-
mation technology practice to support distributor data interchange
implementation. Some companies even struggle to have all their
distributors place orders online through their distributor management system. As a result, medical device distributor sales and inventory data are still mostly manually collected using third-party
data services or internal teams. One manufacturer maintains a
team of about 30 people who manually check every invoice for
hospital sales crediting. This limits manufacturers’ ability to plan
efficiently and effectively for importation and promotional activities, as well as to control inventory and monitor performance.
Pharmaceutical manufacturers in China already have worked
out a more integrated form of managing distributors. This starts
with the identification and selection of the distributors the company wants to work with, so that they can enable, engage, retain,
pay, and, of course, terminate the distributors.
As a result, the commercial departments of these pharmaceutical
producers have taken on new strategic roles. Because they work
closely with distributors, they are now also able to take responsibility for pricing and bidding, enhancing their companies’ abilities to react to healthcare reform. It is likely that medical device
manufacturers will develop their commercial departments along
the same pattern. Even so, there are clear differences between the
pharmaceutical and medical devices sectors, which should lead to
a slightly altered pattern of development.
4. Offer Differentiated Distributor Partnership Programs
Multinational medical device companies should react to inconsistent distributor performance and create performance and
structure tiers while making some adjustments for local market
conditions.
The medical device distribution base is far more fragmented
than that of pharmaceuticals, and the market potential available
to different distributors varies much more widely. Distributor
performance gaps are much wider as well, and multinational
medical device companes need to recognize that one size will
not fit all.
Different manufacturers will naturally have different expectations, and only some distributors will have the capabilities to
support a company’s current and future businesses. Device manufacturers need distributor segmentation and tiered partnership programs that allow manufacturers to optimize resource allocation.
If the model developed by the pharmaceutical industry indeed
acts as a paradigm, there will be new partnership opportunities
created for device makers as a result of this restructuring of distribution channels. We have seen that accelerated consolidation
of pharmaceutical distributors and deteriorated channel margins
have prompted several strong national and regional pharmaceuticals distributors to express interest in entering the medical device
distribution business. This offers considerable new partnership
opportunities for medical device companies.
Broad coverage, existing hospital relationship, strong logistics,
and management capabilities make these pharmaceutical distributors perfect partners for medical device manufacturers. This is
especially true for consumables and implantables, for which distributor roles are more like those in pharmaceuticals channels, and
for which manufacturers will continue to face price pressure due
to strengthened central tendering and price control regulations.
Pharmaceutical distributors also offer another model that medical device distributors are expected to adopt. Medical device
distributors have not taken all the necessary steps to complement
manufacturers’ own sales and services teams. In pharma, companies are moving toward pay-for-performance incentives for distributors that offer value-added services such as bidding/hospital
listing assistance, broad market expansion, and information gathering, to name a few.
The Outlook
The process of channel structure reassessment will take longer
in the medical device sector than it has taken in the pharmaceutical space. While pharma companies shorten the route-to-market,
medical device manufacturers need to revisit the legacy practice
and directly manage most of their distributors (large and small).
Multinational medical device companies should consider to
what extent the medical service price will be adjusted as the regulatory measures are applied. They will have to give careful consideration to the effect on sales, and adjust for lower margins.
As the channel margin gets squeezed and larger medical device
distributors emerge, device producers must forge closer strategic
ties with the ones they choose to work with. Sales representatives should take over a large part of the distributor role, and they
should increase their geographic and functional responsibilities.
In another five to 10 years, a modern channel structure is likely to
exist in China, thanks in part to government pressure and in part to
change coming from the manufacturers themselves.
Kelly Wang is a manager at ZS Associates, based in the firm’s
Shanghai office. She leads ZS’s medical device practice area
in China. Wang has worked with more than 20 medical device
and pharma companies on more than 50 engagements on various sales and marketing issues, including channel strategy, sales
force effectiveness, and opportunity assessment.
Posted with permissions from the February 26, 2014 issue of Medical Device & Diagnostic Industry, United Business Media LLC. Copyright 2014. All rights reserved.
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