Mindray Medical

Medical Devices (China)

Prepared by: Clement Aw (G2)
Scope of Research
The coverage of this piece will focus on high-end medical devices with a focus on in-vitro diagnostic
products (hematology analyzers blood sampling devices) in China. The timeframe of the analysis
will be from 2008 - 2014. The focal company, Mindray, is one of the leading local medical device
manufacturers in China and has had success internationally.

Summary of Mindray Medical

Mindray Medical International Ltd (established in 1991) is a leading developer, manufacturer and
marketer of medical devices in China with a significant and growing global presence. It prides itself in
providing high quality, cost effective products and was the first manufacturer to successfully adopt a
vertically integrated model covering product development, manufacturing and distribution. It offers a
broad range of products across three primary business segments: patient monitoring devices,
diagnostic laboratory instruments, and ultrasound imaging systems (refer to Exhibit 1). Mindray is
headquartered in Shenzhen, China, and has 29 local sales and services offices in China, as well as in
Boston, Istanbul, London and Vancouver. The company was listed on the NASDAQ in 2006 and delisted
10 years later in 2015 through a management buyout.

Industry Overview
The Chinese medical device industry has grown tremendously over the course of Chinas economic
growth story alongside rising healthcare expenditures. This surge can be attributable to 3 key factors:

An increasing middle class (preference for quality healthcare) and higher rates of chronic
diseases
Healthcare reform (state funding and universal healthcare coverage by 2020)
Medical devices a priority sector in the Made in China 2025 initiative government protection for
local companies (tariffs on foreign medical device imports)

The value of the entire high-end medical device market surged to US$14.2billion in 2014 and is projected
to grow at a CAGR of 9.9% over the next 5 years1. The market size for in-vitro diagnostic equipment
(hematology analyzers) amounted to US$1.6billion in 2014. Mindray managed to capture 24% of total
market share in 2014 with its key product line consisting of 4 key hematology analyzers- two for premium
hospitals and two for lower tiered hospitals).

Deep-dive (Industry Structure)

The medical device industry is currently in the shakeout stage of the industry life cycle. Key signs of this
include strategic acquisitions of competitors, decreasing profitability and a growing focus on price
competition across the industry. In the early 2000s, the industry was highly fragmented with up to 15 key
players producing/importing a similar product- the only clear leaders then were General Electric and
Siemens. However, the industry has consolidated significantly with the top 5 manufacturers of in-vitro
diagnostic products capturing an estimated 54% of total market share (compared to the global average
of (23%)1.

The in-vitro diagnostics market can be segmented into two segments premium and non-premium.
Foreign companies such as Abbott, Siemens and Beckman Coulter dominate the premium2 market while
local Chinese companies focus on low to mid-end, price sensitive products and equipment. In recent
years, key local players Mindray, Edan Tech and Lepu Medical have crept into the premium equipment
space despite lacking the R&D capabilities at the onset. Exhibit 2 reflects the competitive positioning of
the key players and displays the distinct gap between local and foreign players. Local firms face the
challenge of moving upwards in perceived quality while foreign players struggle with lowering their prices
(due to distribution and manufacturing costs).

Porters 5 Analysis (Exhibit 3)

There is a low threat of substitutes for hematology analyzers as it is the only instrument capable of
analyzing blood samples in the mass market accurately and efficiently. The marginal cost of developing

1
BMI Research, 2017
another machine that can rival the hematology analyzer is high and any real breakthrough has yet to be
reached, therefore, the dominant design has not changed much since its invention in 1957. Because of
this, manufacturers have focused on developing the existing hematology analyzer and varying them in
terms of capacity, quality and price to cater to a wide range of the needs of Chinese medical institutions.
The large size of the Chinese market has forced manufacturing firms to compete in either quality or price-
most manufacturers do not position themselves across both areas (they display either cost leadership or
adopt a differentiation strategy).

Threat of new entrants in this industry is moderate. There is a significant initial fixed capital investment
required to conduct R&D and establish production this also comes with a time element of 4-5 years for
development. For firms to be profitable, they must reach sufficient scale to spread these fixed R&D costs
out. However, other high-tech medical device companies that manufacture products such as bio-
chemistry analyzers eg. Weigao, are well positioned to enter the industry through horizontal integration
due to synergistic manufacturing capabilities. This poses a significant threat to existing players. Patents
also offer limited protection from new entrants as IP laws are not well enforced in China. This has led to
several small Chinese manufacturers producing knock-off models and severely undercutting existing
players. However, since 2010, the Chinese Food and Drug Administration (CFDA) has begun to clamp
down on such rogue manufacturers.

The key customers of hematology analyzers are hospitals and health centres or clinics. Hospitals make
up the bulk of purchases (>90%) and are segmented into 3 tiers (refer to Exhibit 4):
First-grade hospitals (Class 1) Lowest capabilities (6,853 hospitals)
Second-grade hospitals (Class 2) Medium capabilities (6,807 hospitals)
Third-grade hospitals (Class 3) Highest capabilities (1,898 hospitals)

Foreign manufacturers typically sell to Class 3 hospitals due to high government funding and the
enhanced perception of quality when a hospital utilizes foreign imported medical devices. For Class 1
and 2 hospitals, government funding is significantly lower which results in high price sensitivity when
considering the purchase of hematology analyzers. Most hospitals are public, tend to purchase in bulk
and often award tenders based on price; giving them significant leverage over medical device
manufacturers. The buyer switching cost is also low as operational features across brands are
symmetrical and hospitals do not sign long-term vendor contracts with hematology suppliers. This leads
to a high buyer bargaining power position.

Supplier bargaining power is moderate-high in this industry because key inputs (resin, chemicals, metals
and plastics) are commodities and are readily supplied by multiple suppliers. Key components such as
electrical motherboards and optical detectors are manufactured in-house to ensure that quality is
maintained. While some manufacturers sell directly, most rely heavily on distributors to market and sell
their products to hospitals. Because of this, even cost competitive brands are sold at significant mark-
ups to compensate distributors.

Rules of the game

At the shakeout stage of the industry life cycle, only the strongest competitors survive and firms survive
by increasing the level of services offered and cutting prices- this is especially so for large tenders
by major hospitals. The winners at this phase of industry growth are often firms that have strong existing
R&D and engineering capabilities to drive costs down (to compete on price).

Mindray competes based on factors such as price, value, customer support, brand recognition,
reputation, and product functionality. In its early beginnings, the company identified its niche: mid-market
medical devices. Developing technology from scratch would take 3-4 years even for mid-market medical
devices, however, the company persevered and by 2007 had the largest R&D team of any medical device
manufacturer in China. Through continuous learning and an immense focus on cultivating its scientific
research team, Mindray has developed a core competency of designing and manufacturing highly
reliable hematology analyzers at a very low cost. Mindrays strategy mirrors that of a blue-ocean
strategy, however, because it neither creates, raises, eliminates or reduces but merely improves its
product and lowers costs it is still pursuing a red ocean strategy.
Mindray has also managed to capture the market for both the high-end and mid-low end hematology
analyzers. Its established domestic distribution network, customer support and service support grants it
significantly better access to Chinas small and medium tier hospitals. While its strong investment
in R&D and low-cost operating model has allowed it to outprice foreign competitors in its sales to large-
sized hospitals in recent years.

Key drivers of Profitability3 (Value & Cost)

Edan Instruments is a local manufacturer of hematology analyzers and is a key rival of Mindray. It
competes in a similar segment and leverages on its low-cost production to target mid-low tier hospitals.
To compete more effectively, Edan Instruments also acquired Unitelab in 2012 - gaining access to its
R&D and distribution capabilities. In terms of performance, Mindrays market share doubled from 12% in
2008 to 24% in 2014 while Edans remained at 11% over the same period (Exhibit 5) we will identify the
differences in key drivers of profitability in both companies.

There are 3 key levers that drive value for manufacturers:

Product Quality (accuracy, durability, regulatory approval) directly linked to R&D and
manufacturing capabilities
Brand Image
Post-sales services (training, repair/maintenance)

Edan and Mindray both rely on post-sales services as a key driver of value for their product. Post-sales
services such as repair are essential and the quality of it is a key consideration for all hospitals. Both
firms provide similar post-sales services they provide on-site servicing via in-house technicians and
conduct free monthly training courses at their offices. In terms of brand image, Mindray, has a more
established brand because it has had a longer presence (24 years vs 15 years) and was the first to
penetrate Class 3 (highest tier) hospitals.

In terms of product quality Mindray also has the edge, achieving 100% China FDA approvals for all its
products, Edan Instruments achieved only 80% (4 out of 5 hematology analyzers) in 2013. Mindrays
high product quality was achieved through its strong investment in R&D in its early years and its strong
ability to attract and retain its top researchers. Because of key advantages in two out of three key value
drivers, Mindrays prices are at a 15% premium over comparable products manufactured by Edan
Instruments.

The key cost drivers are:

Research & Development costs
Distribution costs
Direct manufacturing costs

Mindray and Edan both have comparable direct manufacturing and distribution costs (SG&A) refer to
Exhibit 6 for cost breakdown. The major divergence is in R&D costs as a % of revenue Mindray (11.1%)
and Edan (26.5%). The major factor that has boosted its profitability is the scale that Mindray has
achieved which allows it to spread out its R&D costs over a larger revenue base (Mindray
US$184m vs Edan US$90m). This in turn, allows Mindray to allocate more resources towards
distribution (SG&A Margins, Mindray 30.1% vs Edan 25.4%) and penetrate more hospitals (Mindrays
products penetrated 40% of Class 3 hospitals while Edan penetrated 21%) while maintaining profitability.

Mindrays Approach to Sustaining Advantages in Profitability Drivers

The typical value chain (refer to Exhibit 7) for high-end medical devices spans across R&D to post-sales
servicing. Most local companies cover the entire spectrum of the value chain which is often highly costly
(due to high fixed R&D costs). Foreign companies on the other hand typically adopt a 3rd party lead
distributor/agent to distribute their products and focus on the front end of the value chain because they
do not have direct distribution capabilities. Mindray has secured key advantages in each portion of the

3
Segment data is scarce- any quantitative measures of key drivers of profitability have been used when possible
value chain to compete more effectively against both local and foreign competitors. A key question
moving forward is whether it can sustain its advantage moving into the future as the competitive climate
becomes more hostile.

Research & Development

High-end medical device manufacturers typically invest heavily (approximately 15-20% of revenue4) in
research & development to ensure a functional product that is both patented and approved by local
authorities. For all firms, R&D is both a cost and value driver that must be balanced to develop a quality
product at the lowest possible R&D expense. Unlike foreign manufacturers that have global expertise
and top-notch international research labs, local manufacturers have had to spend significantly more in
the R&D phase hiring talent and establishing newly patented product lines. To tackle the challenge of
high R&D costs that local companies face, Mindray focused on expanding its market share across all its
products while limiting its annual R&D expenditure to 10% of total sales after 2008. All the while
expanding its global R&D headcount (>1,600) and presence to enhance every R&D dollar spent. When
compared to other domestic firms, Mindray has the lowest R&D expense as a % of revenue and yet is
capable of churning products of exceeding quality that can rival foreign brands5.

Manufacturing & Assembly

As we move along the value chain to key processes such as components manufacturing and assembly,
local companies dominate the foreign firms and possess a significant cost advantage. This can
be directly attributed to both favorable relationships with local suppliers and better operational capabilities
in 2nd tier cities like Shenzhen and Chengdu. However, value capture in this area of the value chain is
limited and most local firms achieve COGS/Revenue of 53-55%. Mindray does not have a significant
advantage in this portion of the value chain when compared to other local competitors. It does however,
ensure that its manufacturing costs are well controlled through the adoption of strict supplier management
and by merging similar manufacturing processes across different products.

Distribution & Post Sales Servicing

Distribution plays a key factor in determining the cost of the final product Mindray leverages on its
local knowledge and relationships with key customers to sell direct and bypass distributors
unlike many foreign and local manufacturers (refer to Exhibit 8). This strategy has paid off, Mindrays
selling and marketing expenses amounted to 18.96% as compared to local firms such as Lepu 28.5%
and foreign firms 30-40%6. In China, hospitals account for 90% of sales and health centres/retail account
for the remaining 10%. Mindrays strategy is to focus on Class 1 and 2 hospitals who are typically cost
conscious consumers that are unwilling to pay for premium foreign brands. Geographically, Mindray has
concentrated its efforts to penetrate 2nd tier cities, recognizing that a larger proportion of lower tier
hospitals are located within these cities. This targeted approach concentrates its consumer base within
a short proximity of its factories/offices and allows for more timely post-sales servicing.

The Future?
Over the course of the last 5 years, hospitals have tightened their procurement processes and are slowly
becoming more price sensitive. This has forced all manufacturers both foreign and local to revamp pricing
and placed more pressure on margins. The climate has been extremely unfavorable especially for local
Chinese producers who have seen their margins shrink on average by 8 percentage points over a 5-year
period since 2010. There are also additional regulatory pressures in the form of tighter IP controls and
greater price standardizing pressures (to reduce kickbacks amongst distributors). Mindray is not shielded
from these external trends but is extremely well positioned to survive the onslaught. This is a perfect case
study of a good firm strategy in an increasingly challenging industry and only the future will tell.

4
McKinsey & Co, 2014
5
A key factor that drove Mindrays success in this area was the policy of hiring foreign educated Chinese scientists and paying them above
industry standards. Many of these scientists were poached from larger foreign firms and contributed to the rapid development of products for
Mindray in the early 2000s
6
BMI Research, Mindray Annual Report
Appendix:

Exhibit 1: Mindray Business Segments (as of 2014)

Exhibit 2: Competitive Positioning of major firms

Exhibit 3: Diagrammatic Porters 5 Analysis

Threat of new
entrants into the
industry
5
4
3
Threat of 2 Level of
substitutes 1 Competition
0

Supplier Buyer
bargaining bargaining
power power

Exhibit 4: Hospital Segmentation

 Exhibit 5: Market Share (hematology analyzer)

Exhibit 6: Key Profitability & Cost Drivers

Exhibit 7: Value Chain of In-Vitro Diagnostic Products

 Exhibit 8: Distribution Model

Exhibit 9: Mindray Global R&D Presence

Exhibit 10: Mindray Financial Statements

(USD '000s) 2010 2011 2012 2013 2014 CAGR (%)
Revenues 704,309 880,743 1,060,054 1,213,987 1,322,814 13.4%
Domestic Sales 293,435 374,312 472,991 551,155 606,745 15.6%
International Sales 410,874 506,431 587,063 662,832 716,069 11.8%
Cost of Sales 303,334 394,302 459,389 527,402 584,310 14.0%
Gross Profit Margin (%) 56.9 55.2 56.7 56.6 55.8 -
R&D Expenses 60,316 82,024 104,302 127,464 146,997 19.5%
R&D Ratio (%) 8.6 9.3 9.8 10.5 11.1 -
Income from operations 155,587 167,038 191,331 210,224 192,526 4.4%
Net Profit 155,466 166,629 180,209 224,754 198,989 5.1%
References:

1. Design to value in medical devices: McKinsey & Co. 2015 (Sastry, Gordon, Musso, Ramaswamy)

2. McKinsey & Co. 2015

Retrieved from: http://www.mckinsey.com/industries/pharmaceuticals-and-medical-products/our-
insights/capturing-the-new-value-segment-in-medical-devices

3. Mindray Annual Report 2014

Retrieved from: http://media.corporate-
ir.net/media_files/IROL/20/203167/MindrayMedicalInternationalLimited_20F_20150416.pdf

4. Price competitor to value competitor: INSEAD 2015

Retrieved from: http://knowledge.insead.edu/blog/insead-blog/price-competitor-to-value-
competitor-3192

5. Mindray company presentation, 2013

Retrieved from: http://media.corporate-
ir.net/media_files/IROL/20/203167/Mindray_Corporate%20PPT_2015Q2_081115.pdf

6. The Peoples Republic of China Market for Medical Devices. Opportunities & Challenges for Swiss
Corporations (2013). Medtech Switzerland

7. China Medical Devices, BMI Research, 2017

8. The battle over Chinas medical device market. 2015

Retrieved from: http://www.pacificbridgemedical.com/publication/the-battle-over-chinas-medical-
device-market/

9. Financial and regulatory trends in China And their implications for Med Device Companies
Retrieved from: https://www.meddeviceonline.com/doc/financial-and-regulatory-trends-in-china-
and-their-implications-for-med-device-companies-0001