Washington State Life Science Business Investment Mission to China - October 2014

www.HealthIntelAsia.com

THE PROMISE & PERIL OF CHINA’S HEALTHCARE ECONOMY

Washington State Life Science Business Investment Mission to ChinaBeijing, China – Sunday, October 12, 2014

CONTEXT



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Global Healthcare Context

• Rapidly maturing pharma pipeline w/ key drivers of revenue and profit coming off patent.

• Commercial impact of key new research, such as the human genome getting “cracked,” has thus-far been illusive.

• Conquering communicable disease has extended life times, but increased overall cost as more chronic diseases become long-term, treatable conditions.

• Role of government in healthcare unclear (Regulator only? Payer? Provider? Both?)

• Globally emerging middle class.

China-Specific Healthcare Context

• Access and affordability continue to be problems.

• Healthcare, environment and corruption vie for the top three concerns of Chinese people and their government.

• Healthcare in any society is a political good, but problems in China’s healthcare economy embody many of the frustrations Chinese have about what they have given up in exchange for economic growth.

• Many of the inputs to a healthcare system are targets of China’s 12th Five Year Plan.

• Foreign companies need to understand, and incorporate, these realities.


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Organizing China’s Healthcare Context

Accessing Healthcare in China

• While today China’s government can accurately state that >95% of the country’s rural dwellers have government provided healthcare insurance, in 1999 only 7% did.

• Divides between rich/poor/middle class and urban/rural persist.• Inadequate clinical capabilities in rural areas forces people to China’s larger cities, creating

greater burden on an already strained public hospital system.

Affording Healthcare in China

• In 2000, the WHO ranked China 188 of 191 countries globally regarding “fairness of healthcare finance.”

• 56% of rural Chinese do not bother to follow up on doctor recommendations because of expense.

• WHO estimates that 50% of China’s rural poor find themselves in “entrenched poverty” due to healthcare costs.

• Ubiquitous “red envelope” practices reflect a broken funding mechanism that places enormous financial strain on families.

• This same broken funding mechanism has led to hospital administrators and doctors prescribing un-necessary medicine, diagnostic procedures and medical interventions.

• 2012 Pew Global Attitudes Project found that between 2008 and 2012 anxieties over China’s healthcare system had more than doubled.

But, why?


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Why Healthcare in China Deteriorated Over the Last 30 Years

• Christina Ho, Fellow and Project Director of the China Health Law Initiative at Georgetown and Yanzhong Huang of the Council on Foreign Relations have written on how China’s modernization did not result in the same sort of improvements in healthcare outcomes as other emerging economies w/ lower rates of GDP growth experienced.

• When China’s “Barefoot Doctor Brigades” were disbanded, China’s only functioning primary care system was eviscerated.

• The Barefoot Doctors were not sophisticated, but they created better outcomes for the average Chinese than what they have today.


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Breaking the “Iron Rice Bowl”

• China’s economic reforms resulted in the dismantling of large parts of the state’s involvement in the economy.

• State Owned Enterprises (SOEs) were shut down, privatized, or modernized.

• Many of the healthcare benefits and pensions the average Chinese once received from the government were severed.

• These good and necessary steps had a bad and unintentional effect: the “broken rice bowl” was not replaced by similar investments from the private sector.

• China’s central government was so focused on modernization and its many down-stream implications that it overlooked healthcare.


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The Trade China’s People Have Made

Water Pollution70% of China’s rivers are too polluted to provide safe drinking water.

Air QualityPM2.5 poses immediate cardiovascular and long-term cancer problems.

SmokingBetween 300-350m smokers.

Western DietsHypertension, cerebrovascular disease rates, diabetes, etc. are all on the rise.

DemographicsNo country will get as old or as rich as fast as China will.

By 2050, 1/3 of China’s population will be 60+. Ratio of elderly in need of support today is 16:100, by 2050 that will be 64:100.


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China’s Priorities - 1980

1. Economic development.2. Economic development.3. Economic development.4. Economic development.

China’s Priorities - 2014

1. Transition from infrastructure and export-led economic growth,• Towards domestic

consumption and,• Capturing higher value-

added, technology-rich industries.

2. Healthcare access & affordability.

3. Environment.4. Corruption.

What happens to an industry within China during this sort of re-prioritization?


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The Lifecycle of Foreign Direct Investment (FDI) In China

China Recognizes It

Needs Foreign Investment &

Expertise

China Tentatively

Opens – FDI Catalog Is Revised

Foreign Participation

Limited, Largely Via Hong Kong

& Macao Entities

JVs Practically Necessary, Even

Though FDI Catalog Says

WFOEs Permissible

JVs Dissolve, Domestic and

Foreign Former Partners Now

Compete

WFOEs Complain of

Rules in China Being Designed

to Favor Domestic Firms

WFOEs Re-Calibrate

Expectations, Or, In Special

Cases, Exit ChinaLife Sciences,

Today

Senior Care,

Today

Hospitals, 2012 Revision


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Applying This Life Cycle to Bio-Tech

China Recognizes It Needs Foreign Investment &

Expertise

MNC Pharma Gets Protected Status to Engage China (early

90s)

Life Science Companies Agree to More Actively

Participate in China, But w/ Older

Technologies

China Begins to Move into API,

Generics, Lower Technology Niches

in the Global Supply Chain

Product Offerings of MNCs Get

Market Acceptance,

Utilization Goes Up, Price Pressures

Intensify

China’s Domestic Technology

Development Goals Begin to

Fundamentally Change the

Landscape in China

WFOEs Re-Calibrate

Expectations, Or, In Special Cases, Exit

China

What do the life sciences mean to China today?

1. Control: Captive Domestic Manufacturing

2. Cost: Price Controls3. National Economic

Development: Moving Up the Global Value Chain


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Context Take-Aways

• Access and Affordability will drive China’s policies.• Healthcare in China will remain an extremely political issue.

• In America, our conflict is over the role of government in healthcare. • Few in China question the government’s responsibility for healthcare.• In China, their conflict is about whether modernity was worth the price

average families are having to pay, the much greater costs they will have to face tomorrow, and why the government has been so ineffective addressing these concerns.

• Foreign companies that fail to recognize the role of domestic political forces in how China’s government responds to business are in for some nasty surprises.

• Because the reimbursement scheme in China remains broken, economic rent will continue to be extracted in unconventional ways.

• Foreign companies need to understand that compliance issues are not going away. The market’s current structure has too many incentives built into it that foster corruption. Uneven application of compliance standards will result in a “tax” on foreign businesses.

• China plays a unique role in life science MNCs revenue and profitability.• And China wants its own domestic champions in these same sectors.

THE PROMISE



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The Promise Within China’s Healthcare Economy

1. The Scale & Scope of the Need2. Massive Government-Led Infrastructure Spending3. A Growing Middle Class4. China’s Government Is A Motivated Partner


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The Promise – Massive Government Led Infrastructure Investment

• 2009 investment by China’s central government of RMB 1.13 trillion into healthcare.

• 12th 5 Year Plan (5YP) has RMB 4.4 trillion specifically planned for healthcare.

• Government plans to add:• 150,000 primary care physicians in

next 5 years.• 2,000 new county hospitals.• 29,000 new township hospitals.• 5,000 existing hospitals upgraded.• 95% of all Chinese covered by

expanded national insurance.• Expanded national drug formulary

(EDL), access to new diagnostics and medical devices for treatment of chronic diseases.


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2003 2004 2005 2006 2007 2008 2009 2010 20110.00

500.00

1,000.00

1,500.00

2,000.00

2,500.00

0

5

10

15

20

25

30

35

40

China Government Healthcare Spending – Actual Spending Growth & Year-Over-Year Percentage (%) Increase

Billion RMB YOY Growth (%)


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45%

1%2%

9%

24%

7% 12%

Where China's 2009 Healthcare Reform Went

New Rural Co-Op and Urban Residents InsuranceInsurance Subsidies for Enterprises in Dif-ficultyIndigent Patients Medical AidPublic Health Awareness InvestmentPrimary Care & Public Hospitals Upgrade & ConstructionDrug SubsidiesOther


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The Promise – A Growing Middle Class

• Middle class, as defined by between $10-60,000 USD per year income.

• Roughly 300 million person market today.

• The most bullish projections suggest that between 700-800 million people in China could ultimately work their way into this group.

• Strong preference for spending on healthcare and education.


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The Promise – China’s Government Is A Motivated Partner

• Enormous pilot activity within China’s healthcare delivery sector.

• Community Healthcare• Home Healthcare• Long Term Care Insurance• Public/Private Hospital

Partnerships• Offering incentives to privatize public

hospitals (“20% by 2020”).• Around 4,000 company owned

& run hospitals to be privatized this decade.

• Wants to sell off VIP wards at public hospitals.

• Overall FDI friendly environment – particularly for healthcare service providers and life science companies.

• Changes to FDI catalog.• Relaxing WFOE in healthcare

delivery.

THE PERIL



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The Perils Within China’s Healthcare Economy

1. Misplaced Economic Enthusiasm2. Misunderstanding Where Profit Resides3. Excessive Fixed Asset Investment4. Market Acceptance of Private Healthcare5. Rising Technology Transfer Expectations6. Uneven Application of Rules & Regulations


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The Peril – Misplaced Economic Enthusiasm

• “Trees do not grow to the sky.”• China has successfully defended itself

against the 1997 Asian and 2008 US/EU financial crises; but,

• The country has yet to face a structural financial crisis of its own making.

• Lots and lots and lots of bad debt floating around the country – everywhere (businesses, central government, municipalities).

• China is in the midst of a very awkward economic transition.

• There are very real dangers about getting caught up in the “Middle Income Trap.”

• These possibilities would alter many of the economic projections specific to China’s middle class, and the government’s ability to continue expanding healthcare reimbursement.


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The Peril – Where Profit Resides

• Roughly $1.7 billion invested capital into China’s domestic hospital sector last year.

• Why?• CN Healthcare’s research found that

almost all of the profit that China’s privately-owned hospitals generate – regardless of the market segment they serve – is made in the sale of pharmaceuticals and devices.

• Today, even in the high-end private VIP niche, profit does not reside in the delivery of healthcare services.

• Paying for services – even healthcare – remains a challenge in China.

• What do your organization’s clinical pathways, pharma-econometrics look like if the only variable is input cost of the consumables?


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The Peril – Excessive Infrastructure Spending

• There is a lot of fixed asset spending taking place across China.

• New hospitals are directly tied to political advancement within local government.

• Already reports of massive under-utilized capacity;

• Not because the demand is not there, but because the hospitals do not have staff; and,

• Because healthcare continues to be a consciously rationalized expenditure by Chinese consumers.


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The Peril – Market Acceptance

General Medicine (Check-Up)

Cosmetic Surgery (Eyelid Surgery)

OB/GYN Pediatrics Oncology Cardiology0%

5%

10%

15%

20%

25%

McKinsey: What Drives Affluent Chinese into Private Healthcare

Private ≠ BetterHigher Acuity = Public Hospital


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The Peril – Technology Transfer

• Could China achieve in the life sciences what it did in clean-tech?

• Create the most amenable location in the world for innovation to be trialed.

• Foster public/private, academic/industry partnerships to accelerate key technologies.

• Fill the western financial capital gap between government, VCs, and industry.

• What will China’s technology transfer expectations be for market access?

• Are today’s WTO protocols adequate to address both the needs of China and its trading partners in the life science sector?


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The Peril – Uneven Application of Rules & Regulations

• This past summer’s GSK scandal:• GSK is alleged to have

routed $489 million to bribe hospital officials and doctors.

• Use of 700 travel agencies to wash the money.

• Peter Humphrey and his wife arrested on charges of violating China’s data privacy act.

• Sinopharm, the largest pharmaceutical distributor in China, just charged w/ same thing GSK was this summer.

• But what are these companies really guilty of?


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The Peril – Uneven Application of Rules & Regulations

• How should industry interpret this past summer’s GSK scandal?

• Reforming the Healthcare Economy• When is the broken

reimbursement system going to get fixed?

• When are doctors going to be paid more?

• Xi Jinping’s Anti-Corruption Drive• Why disproportionately crack

down on foreign vs. domestic players?

• China Is Becoming a Less Hospitable Place for MNCs to do Business• Certainly fits w/ critiques of

China by other business groups.

• What really are your options?

WHAT SHOULD BUSINESSES & INVESTORS DO?



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What Should Businesses & Investors Do?

• Reframe your expectations about growth in China.• Be clear-eyed about the political risks you will face.• Recognize the un-even application of standards will continue.

• Compliance, compliance, compliance.• That means for you and your distribution channel.

• Distinguish between what you can do yourself, and what you need government partners to accomplish.

• Businesses can address issues like the Anhui Pricing Model.• Businesses are less powerful to address changes such as:

• revisions to China’s IP laws specific to life sciences, • compulsory licensing, • compliance standards being un-evenly applied to foreign versus domestic

firms,• technology transfer for market access expectations, and• what it takes to actually get a therapy on the EDL.• These issues are all on the radar screen in Washington DC.

• Meet China as it is, not how you want it – or perhaps even need it – to be.• Get back to the basics: new ways of talking to your market, new products, new

models, new disruptive innovations.

QUESTIONS?

For more information:Rubicon Strategy Group, LLCTwo Union Square601 Union Street, Suite 601Seattle, WA 98101www.RubiconStrategyGroup.comwww.HealthIntelAsia.comPhone: 206-652-3572


http://www.RubiconStrategyGroup.com/

http://www.HealthIntelAsia.com/

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Washington State Life Science Business Investment Mission to China - October 2014

Health & Medicine