Why domestic pharma companies are the only investors in new private hospitals in China

by Benjamin Shobert
Earlier this year I had the opportunity to connect with someone who has a front-row seat to China’s hospital privatization.  Positioned to see deal-flow in real time, I asked the question of whether the actual inbound investments were what either the Chinese government or institutional investors expected after China’s recent attempts to prime the privatization engine.  The person very carefully but candidly pointed out that thus far, actual deal flow had not been what they were expecting.
Some of this reflects unrealistic expectations on the part of foreign capital who misread changes to China's FDI catalogue that allowed foreign ownership of hospitals and healthcare institutions.  These disappointed investors misunderstood that China’s process of opening this sector to foreign capital would be gradual and would initially favor private investment and ownership by domestic players over foreign entrants.  Regardless, my contact noted that results thus far were not what many had expected.

Recently, the leading Chinese think tank covering the country’s healthcare system, CN Healthcare, published its results on investment in China’s hospital space.  Bai Liping, the lead researcher and author of the report, shared with me that her objective was to address what she as misinformation about what was happening relative to private capital coming into China’s hospital sector.  She added, “no one actually knows what the entire picture is like.  There is no good overview, [which means that] everyone is operating in the dark with small pieces of information but without a comprehensive overview.”  What CN found was private investment over $1.716 billion (USD), the majority of which was coming from domestic Chinese investors who were targeting China’s growing middle class.  Most foreign capital that had made its way to China’s hospital sector has thus far been directed towards the high-end consumer, fed initially by the expat market, but now increasingly catering to China’s own upper class who want western healthcare and service.
Liping noted that one of their most surprising findings was who had made most of the investments thus far:  “in China, so far it is the [domestic Chinese] pharmaceutical companies that are building and managing hospitals.”  Why is this?  Because thus far, the primary way investors have been able to make money in China’s healthcare economy is not through the delivery of healthcare, but the profits from the purchase and sale of pharmaceuticals and devices to the consumer.  CN’s research suggests that, as Liping pointed out, “there is not much money to be made so far on the management of hospitals … the opportunity is in the supply chain where the hospital can establish a separate company that purchases pharmaceuticals or disposable medical products directly from the manufacturer at the wholesale price.”  With the middleman out of the way, the hospital becomes a profitable enterprise by capturing a portion of the margin that previously would have gone to the distributor.  If this sounds perverse, it is another reminder that in China the money to be made thus far in healthcare is heavily weighted towards goods, and much less so towards services.  Among the many reasons private foreign capital is not racing into China may not only be regulatory barriers, but the inability of private hospitals to make money on the delivery of care versus the sale of products.
The overall amount of invested capital that CN Healthcare identified will need to go up dramatically if China is to accomplish its goal of seeing 20% of all in-and-out patient traffic be routed through private healthcare institutions by 2020.  For this goal to be achieved, inbound investment will need to go up by an order of magnitude, something that will only happen if several things happen.  First, the remaining restrictions on foreign capital need to be relaxed.  While it is conceptually possible for hospital Wholly Foreign Owned Enterprises (WFOEs) to exist, and a handful already do in China’s the space, there are too many roadblocks between what is possible in theory and what is achievable in practice.
Second, if China’s Ministry of Health is at all serious about its privatization scheme, which allows private capital to take over a public hospital, then the government needs to make sure the newly privatized entity can operate as a truly private, for-profit enterprise and not some intermediate sort of entity that comes up short of what both the government and the private-sector investors hope.  This would mean as a starting point, making it easier for the private operator to change pensions and employment regulations specific to doctors and nurses within the hospital.
Third, China needs to expand the country’s yi bao program to cover more procedures and at the same time, to ensure this spending can be applied towards procedures completed within a privately owned hospital.  This sort of flexibility in payment would be an important signal to the private sector and institutional investors abroad that China is serious about setting in motion a viable for-profit hospital sector and is willing to see government reimbursement get directed towards private operators.  This step would also help hospitals get rid of their over-reliance on pharmaceutical and device sales as a means of generating revenue, something that desperately needs to happen.
The last two years have seen a marked increase on the part of domestic Chinese and foreign investors to deploy capital within China’s hospital sector.  The country’s policy makers are eager and willing to make this happen, even if their efforts thus far have fallen short.  As CN Healthcare’s recent research makes clear, the amount of capital going to work in this area is increasing, even if so far it is being used in ways that seem to reinforce old habits around over-prescribing and over-utilization of un-necessary diagnostics.
Source: Forbes