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Delicate Operation
Medical Companies
See Troubling Side
Of Chinese Market

SHANGHAI -- For more than a decade, Diagnostic Products Corp.'s employees in China bribed doctors to buy laboratory-testing kits from the Los Angeles company. In May the company paid the price: U.S. authorities fined Diagnostic Products $2 million for violating U.S. antibribery laws.

It's an example of the danger lurking behind China's booming health-care business. As the Chinese middle class expands, the nation is spending nearly $100 billion a year on health care. Medical devices and hospital products are a particularly fast-growing market, spurring top names such as Johnson & Johnson and Medtronic Inc. to expand in China.

But foreigners seeking to cash in are discovering rampant corruption and questionable ethical practices. China's health system encourages doctors to push expensive procedures on patients, many of whom pay out of pocket for health care.

In a system lubricated by money, U.S. companies often face pressure to play along. Boston Scientific Corp., a Natick, Mass., medical-devices company, used outside distributors for years even though it suspected them of providing unethical incentives to doctors. Fearful of getting into trouble, "we really blew up the entire business," says China country manager Shankar Kaul. Boston Scientific dropped all its distributors at the same time and switched to direct sales.

U.S. health-care companies see big opportunities because research suggests that China is experiencing a rise in heart problems and other diseases of wealthy societies. Heavy pollution, private cars and smoking are taking a toll on health. Rates of obesity, high cholesterol and high blood pressure have soared.

A study in the Sept. 15 New England Journal of Medicine found that heart attacks, strokes and other cardiovascular problems accounted for 44% of all deaths during the 1990s in a sample of nearly 160,000 Chinese. Heart disease is now the No. 1 killer of Chinese women, according to the study. Despite China's vast increase in wealth since market reforms began in the late 1970s and improved treatment of infectious diseases, its life expectancy has only grown about five years and now stands at 72 years.

Gao Runlin, chairman of the Chinese Society of Cardiology and a surgeon at Fuwai Hospital in Beijing, says even young people are developing cardiac problems. "Now I am seeing people in their 40s, 30s, even 20s," he says.

The trend is prodding U.S. companies to bring to China the same cardiac devices that have transformed the treatment of heart disease in the U.S. Along with implanted pacemakers and diagnostic equipment, these devices include the stent, a wire and mesh tube that is inserted into clogged arteries to pry them open.

Johnson & Johnson and Boston Scientific both export to China advanced stents that contain drugs to prevent scar tissue from reblocking the passageway to the heart after surgery. J&J has opened surgical centers to train doctors in Shanghai and Beijing.

With growth in the U.S. expected to subside eventually, China is a strategically important market, although it currently accounts for only 2% of global medical-device sales. The U.S. accounts for 42%, according to a report in August by Dublin-based Research and Markets.

But several U.S. companies are brushing up against trouble in China. This partly reflects the growing role of money in the Chinese health-care system, in which doctors have an incentive to exaggerate the illnesses of their patients in order to create demand for high-priced procedures.

Subsidized Care

Until the 1980s, China offered heavily subsidized health care through state-owned enterprises and farming communes. Clinics received an annual budget from the state and weren't allowed to accept other payment. Given the meager funds available, doctors focused on treating contagious diseases and used whatever cheap medicines they could find for heart disease and other chronic ailments.

As part of a push to make hospitals more commercial, the Chinese government in the 1980s allowed them to charge patients. The payment system changed too, so that doctors and hospitals got paid for individual procedures rather than getting a lump-sum annual subsidy from the state. This is similar to the payment system that often prevails in the U.S. and other developed nations.

As a result, Chinese state-run hospitals and doctors scrambled to generate revenue. For insured patients, that meant promoting procedures and drugs with high reimbursement rates. As the economy grew, many families became able to pay for Western-style surgery with their own money. During the 1990s, private health spending in China grew 20% a year, according to an April 2005 study by World Bank specialists. China's policy changes have resulted in many doctors and hospitals "overdelivering sophisticated care on which they make a profit," the study says.

Hoping to tap China's demand, Minneapolis-based Medtronic has long used local distributors to sell its products to doctors. One of those distributors used to be a company called Shanghai Boyi Medical Devices Co. A 2002 Boyi sales ledger reviewed by The Wall Street Journal says a Boyi salesperson made payments of $60 to $1,200 to cardiologists at 14 Shanghai hospitals.

Hang Min, a former Boyi saleswoman, says the payments were made to get the doctors to use Medtronic pacemakers and averaged 15% of the sale price. Ms. Hang says she was fired by Boyi after telling two patients about Boyi's alleged use of smuggled pacemakers to get around paying import duty. Boyi was later dissolved and is no longer in existence.

Some prominent surgeons appear on the Boyi list. It says the chief of cardiology at Shanghai No. 10 Hospital accepted 33 payments in one six-month period in 2002 in return for the purchase of Medtronic pacemakers. The cardiology chief then and now is Xu Yawei, who is known as a national leader in surgical techniques that restore blood flow to the heart. Dr. Xu appears on television shows performing heart surgery, and last year his group led all Shanghai hospitals in performing 500 coronary interventional procedures.

Dr. Xu says he doesn't know anything about the sales agent's records. "I have never accepted kickbacks," he says, chain-smoking Zhonghua-brand cigarettes in a windowless office next to his cardiology lab.

Yvan Deurbroeck, a Medtronic spokesman, says the company learned of Boyi's sales practices in 2003 and "immediately terminated our contract." Medtronic subsequently overhauled its sales network in China. It now monitors hospital purchases to prevent sales agents from excessively inflating prices. Unusually high prices can be a sign that they are kicking back some of the revenue to doctors. Medtronic also boosted production at its Shanghai plant to undercut smuggling, according to country manager Victor Tsui.

In a statement, Johnson & Johnson says it has "taken disciplinary actions against a few distributors" and last year introduced "flying inspections" to audit them randomly. Both J&J and Medtronic say they intend to continue using outside distributors in China. Mr. Tsui says that's the best way to ensure that patients across China have access to Medtronic's products.

A Unit's Troubles

Diagnostic Products, the Los Angeles testing-products company, got into trouble because of its own subsidiary in China rather than an outside distributor. In May, the Department of Justice and the U.S. Securities and Exchange Commission ordered Diagnostic Products to pay a $4.8 million penalty, which included a $2 million fine and the return of $2.8 million in profits. Authorities said that between 1991 and 2002, a subsidiary in Tianjin paid $1.6 million in bribes to get hospital business for its laboratory tests of heart disease, diabetes and other ailments.

The bribes were mostly hand-delivered to hospital workers responsible for purchasing decisions and amounted to between 3% and 11% of a product's price, according to a statement by the Department of Justice. U.S. federal law bars American companies from bribing officials of foreign governments, a ban that includes doctors at state-owned Chinese hospitals.

Chief Financial Officer James Brill says Diagnostic Products' headquarters voluntarily disclosed the payments to U.S. authorities after detecting them. Mr. Brill says the company doesn't condone kickbacks but notes that Chinese employees may have viewed them in a different light. "We weren't paying hundreds of thousands of dollars to some Chinese official to get a contract," he says. "Each was probably the amount of a good dinner in Los Angeles."

Boston Scientific has sworn off distributors. "There were doubts about the ethics of some of the distributors," says Henrik Glarbo, who was country manager until 2003 and now works for a pharmaceutical company. He declined to discuss details but a Boston Scientific sales manager at the time says distributors commonly paid for Chinese physicians to attend conferences in the U.S. The gifts would include all meals and sightseeing trips, this former employee says.

Mr. Glarbo says Boston Scientific wanted to sell directly to hospitals so it could use its own salespeople and have better control of inventory. Although foreign companies were technically barred from direct sales of medical devices until last year, Chinese authorities allowed Boston Scientific to use a loophole by selling the devices from a duty-free zone in Shanghai.

At the beginning of 2003, Boston Scientific fired all its distributors. Since then it says it has applied the same rules it uses in other countries. Boston Scientific has barred gifts over $25 and required menus to be submitted with restaurant receipts for meals, according to current and former executives. The switch to direct sales came just ahead of the launch in China of the company's Taxus stent, which goes head-to-head in many hospitals with J&J's latest stent, the Cypher.

While many Chinese cardiologists initially balked at dealing with unfamiliar salespeople, Mr. Kaul, who arrived as Boston Scientific's country manager in early 2004, stuck with the plan. He says the distributors were a disaster waiting to happen. "If you see a train coming, you don't want to be standing in the middle of the tracks," says the 44-year-old Indian-born executive, a former rug salesman who fled his home in Kashmir in 1990 after Muslim militants torched his house.

Mr. Kaul doubled the size of his sales team and visited doctors to assure them that Boston Scientific would help train them in using stents. Boston Scientific also priced its Taxus stent around 30% below Johnson & Johnson's Cypher. In Shanghai hospitals, the Taxus stent costs about $2,300, while the Cypher costs about $3,400.

By the end of 2004, the company almost doubled cardiac-product sales compared with 2003's figures, according to Mr. Kaul, who declined to provide specific numbers.

In January of this year, China's health authorities rolled out to eight provinces and cities a new system for setting the prices of stents, pacemakers and artificial joints. Under the system, qualified suppliers submit suggested prices to a panel of experts, which after negotiations sets and publishes a final price. Since then, prices for stents and pacemakers have dropped an average of 25%, according to the Medical Instruments Trade Association of Shanghai, which jointly supervised hospital bidding with Shanghai health authorities.

Regulators figure that if patients know what a device costs, it will be harder to gouge them on surgical procedures -- which in turn will discourage corruption by making it harder for distributors to jack up prices and give kickbacks. Until recently, says Deng Xiaohong, deputy director of Beijing Health, "We didn't know how much companies were selling their products for to hospitals. And they didn't want us to know, either."

Write to Peter Wonacott at peter.wonacott@wsj.com

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