Why health care? With medical equipment sales of approximately $11 billion in 2005, China is the world's third-largest market for such gear, behind the United States and Japan, according to the China Association of the Medical Device Industry. And with a projected annual growth rate of 15 percent, double the worldwide average, China will surpass Japan in a few years to become the second-largest market.

The growth is driven by several factors, including the increasing affluence of urbanites and an aging population. China's middle class exceeds 200 million people today and is rapidly growing. By 2030, nearly 25 percent of China's population will be over the age of 60, double what it was in 2004.

There's no official government data on the number of hospitals and clinics, but China Outlook Consulting estimates that there are approximately 11,500 across China. That includes 550 tier-one provincial hospitals, 1,550 tier-two municipal hospitals and 9,450 tier-three county hospitals. Most tier-three hospitals lack the necessary medical systems to adequately serve patients.

Building infrastructure in rural areas is a priority for the central government and is part of the Communist Party's 11th five-year plan, which began this year. In addition to setting GDP growth targets and providing industrial incentives, the five-year plan sets guidelines for the development of medical and telecommunication systems for rural areas.

"China urgently needs international players like Philips to develop medical systems to serve the rural areas," said Jianpu Dai, vice minister of the Beijing Olympic Medical Department.

No surprise
The potential of China's medical market is hardly news to Philips. Since taking the helm in 2001, Gerard Kleisterlee, Philips' chairman, president and chief executive, has been focusing the company's professional-products and services business sector in three areas: medical equipment, semiconductors and lighting.

In the past six years, Philips has spent over $5 billion to acquire seven medical equipment manufacturing companies around the world to enhance its strength in the medical area. In 2005, its worldwide medical equipment manufacturing business unit accounted for 19 percent of the company's total revenue. Profitability of this unit is the highest of all of Philips' businesses.

Kleisterlee is optimistic about the company's future for medical equipment manufacturing in China, in large part because of the number of hospitals and the aging population. China is a key market for the overall growth of Philips' medical business, and the medical business is core to Philips' future.

Philips has had a presence in the country for more than 20 years, and Kleisterlee himself held management positions for Philips' businesses in both Taiwan and China in the 1990s. In all, Philips has set up 35 businesses in China at a cost of $3.4 billion.

It's this deep knowledge of the local market plus a lot of hard-nosed analysis that has led Kleisterlee to project double-digit growth for Philips' three businesses in China this year: consumer electronics, which accounts for about 33 percent of Philips' China revenue, lighting — 15 percent — and medical equipment, which contributes 20 percent. The remaining 32 percent is split among Philips' other operations.

Achievable goals
Next year, Philips' China revenue will top $12 billion, according to Kleisterlee, at which time China will overtake the United States as the company's largest market.

Analysts believe that Philips' 2007 revenue target for China is achievable. Revenue in 2005 exceeded $10 billion. In the first quarter of 2006, year-on-year growth was 14 percent. The medical equipment business grew at the same rate.

"Philips' medical sector has shown stable growth in China, which should be sustainable," said Song Jiang, president at Frost & Sullivan (China).

Philips' medical products offering for the China market centers on mid- and low-cost devices. The business unit produces equipment for both China's domestic market and other developing countries.

This is in line with the country's demand. About 75 percent of China's medical equipment market is for mid- and lower-range products, said David Jin, chief executive officer of Philips Medical Systems China. Given China's call for more affordable medical services and the government's pledge to increase investment in this sector, these low-cost categories of products offer huge market opportunities.

Philips' midrange products account for 30 percent of total medical equipment sales while the low-cost devices contribute 45 percent, according to the company. This compares with its global averages of 19 percent and 26 percent, respectively. Because the lower-cost products have higher margins, Philips foresees profitability in China's medical business being higher than the global average.

Philips isn't the only top-tier OEM eyeing China's medical market. General Electric Co. also plans to target the low- and mid-end markets, while Siemens AG has set up medical operations in Shanghai to focus on China's rural market.

While Philips' strategy for both its IT and consumer products in China is to outsource 100 percent of its manufacturing (see "Philips' other China strategy," below), the company is choosing to keep control of the manufacture of its medical and lighting systems.

The joint venture approach
One important element of Philips' medical equipment business in China is a joint-venture company called Philips and Neusoft Medical Systems Co. Ltd., headquartered in Shenyang, Liaoning, in northeast China.

Philips and Shenyang-based China Neusoft Group set up the joint venture in 2004 with a $30 million initial investment. Philips is the majority shareholder, with 51 percent of the company. Neusoft Group, one of the leading software solution companies in China, got its start at Northeastern University in Shenyang in 1991.

The joint venture manufactures medical imaging equipment for China's domestic market as well as customers in Southeast Asia, South Korea, the Middle East and Africa. Philips' only joint venture outside the United States and Europe developing these products, it is is expected to maintain growth serving China and emerging overseas markets.

Some of the joint venture's products have received CE markings and certifications from the U.S. Food and Drug Administration, allowing them to be sold in the United States and Europe. And the company has received ISO 9000 and 14835 qualification.

Philips plans to boost investment at Neusoft Medical Systems this year.

"Philips will not only increase the volume but also the number of products we manufacture," said T.L.V. Kumar, chief operations officer of Philips Medical Systems Asia Pacific. "This is in step with the Chinese government's initiative of improving medical systems in the developing area in China."

Amy Wang is a vice president at China Outlook Consulting. She can be reached at amywang@china-outlook.com.

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