# Presentation: 758079

## Department of Commerce Healthcare Panel

- May 23, 2006

- Presented by Robert Larson
- Director, Business Development and Marketing Asia Pacific

## Questions to Answer

- What does STERIS do?
- Why did STERIS and why do most other US Healthcare companies need an Asia (and specifically China) Strategy?
- How did we set STERIS’s China strategy?
- How is implementation going and what have we learned?

## Vision/ Key Facts

- STERIS is dedicated to creating a healthier today and safer tomorrow
- Founded in 1987 and headquartered in Mentor, Ohio
- 5,000 employees worldwide, sales offices located in 16 countries/dealers in more than 60 countries, but primarily US sales presence
- Annual revenues of over $1 billion and traded on the                              New York Stock Exchange under the symbol STE
- Healthcare is the largest segment:

- US 85%

- International 15%

## Surgical Suite

## Hospital Central Processing

## Questions to Answer

- What does STERIS do?
- Why did STERIS and why do most other US Healthcare companies need an Asia (and specifically China) Strategy?
- How did we set STERIS’s China strategy?
- How is implementation going and what have we learned?

## Why an Asian (China) Strategy?

- Obligation (and self interest) to improve health standards
- Quality of care is unacceptable, need best in class products
- H1N5 is just the latest, source for pandemics: ''You have the ingredients in Asia right now for a public health disaster,'' . . .the region may be brewing a worldwide flu pandemic.- Dr. Tim Uyeki, CDC, NY Times Nov. ‘04
- Take advantage of growing, high return markets
- The 2nd largest healthcare market in the world is in Japan, China and India are dramatically increasing their Healthcare spending
- Returns on investments in Asia for US companies better than in Europe
- Growth is key for company performance and Asia has it
- Meet competition on their own turf
- Our European competitors are penetrating these markets and using profits from them and will use lower cost products from them to to challenge our NA position
- Asian competitors will be arriving too, surgical tables

## Questions to Answer

- What does STERIS do?
- Why did STERIS and why do most other US Healthcare companies need an Asia (and specifically China) Strategy?
- How did we set STERIS’s China strategy?
- How is implementation going and what have we learned?

## The HC market is growing at an accelerated rate (15%) due to the effect of SARS and Avian Flu.  These pandemics have dramatically increased government recognition of the importance of sterilization and disinfection
Growing market strength by local manufacturers who have acquired/ developed technology and low cost designs. They use imported key components to achieve relatively high quality products.  Examples: XXX, XXX
Our global competitors leverage brand and compete via a local presence for distribution.  They are now adding manufacturing:  XXX has $12M in sales and a factory in Suzhou, XXX (JV in Shanghai)
Major opportunity for sourcing.  Successful multinationals have combined local market entry with sourcing: GE Medical

- The HC market is growing at an accelerated rate (15%) due to the effect of SARS and Avian Flu.  These pandemics have dramatically increased government recognition of the importance of sterilization and disinfection
- Growing market strength by local manufacturers who have acquired/ developed technology and low cost designs. They use imported key components to achieve relatively high quality products.  Examples: XXX, XXX
- Our global competitors leverage brand and compete via a local presence for distribution.  They are now adding manufacturing:  XXX has $12M in sales and a factory in Suzhou, XXX (JV in Shanghai)
- Major opportunity for sourcing.  Successful multinationals have combined local market entry with sourcing: GE Medical

- Step 1: Understand the Market: *2004 China Market Dynamics:* *Rapid growth driven by growth of middle class and government health policy*

**Current China hospital market**
**has 3 levels (or classes)**

- 977 hospitals

- 5,198
- hospitals

- 2,674 hospitals
- (+ 8995 others)

**Level I**

**Level II**

**Level III**

- Small, local players dominate Level I and II
- Level II is growing dramatically due to government initiatives to improve healthcare system in response to middle-class growth and SARS/Asian flu concerns

**Notes:**
Here is the basic environment and current status in China.  You will recall that HC is growing at an accelerated rate due to the reaction to SARS and Avian Flu, and an eagerness to assure no disruption to the Beijing Olympics in 2008.  

There is a robust LS market with most multinational setting up operations.   While these players have been our customers historically, they have not always taken their suppliers with them and are increasingly willing to source equipment from the more advanced local players or their other multinational suppliers who have setup local manufacturing.  The best example of a company that has done this successfully is BOC Edwards in the freeze dryer business. 
These local competitors (Chinese or multinational who have localized operations) often start by importing key components to assure quality and high tech features and gradually localize to reduce cost. Some examples of those who have done this successfully are Xinhua in the sterile processing market, Shanghai Medical Equipment (SMEF) in the surgical table and light market and Dongfulong in FDS. 

Our global competitors who are doing well are competing via a similar model and leveraging their brand.  We recently learned that Getinge’s local facility is now running in Nanjing and that they are doing some $12M in business in China. We previously discussed Draeger.A key factor in our multinationals’ success has been their use of local manufacturing to meet global sourcing needs as well as to attack the local market. A good example is GE Medical which does roughly $700M in global sourcing exports and $700M in domestic China business sourcing both from its operations outside Beijing. 
On the left you can see the basic hospital market segmentation based on the government’s standard classifications.  As you can see there are around 9000 hospitals, but really attractive growing segments are in the top level III and the upper half of the Level II where the government is focusing investment due to concern for pandemics and the growth in the middle class.  We are thus targeting some 3600 hospitals.

## Step 2: Set Basic Strategy Framework:  STERIS’s is 3x3x3

**1. Build our own**

**2. Contract**

**3. JV or Acquire**

**3 options to achieve each objective**

- A: Strengthen distribution go more direct in key countries

- B: 	Deliver appropriate products

- C: 	Leverage regional capabilities to address global needs

- Build strong local teams Manage distribution, training, and service, present at trade shows, develop government. relations

- Develop ‘value chain’ capabilities (including design, manufacture and delivery) to sell appropriate products in key countries

- Use China or India as a  base to source components and complete products for other low cost regions and for low- end part of developed country markets

- Step 2: Set Basic Strategy Framework:  *STERIS’s is 3x3x3*

**3 key countries: China, Japan, India**

**Notes:**
This slide is simply to remind us where we are in our overall decision framework.  Key points are that we are looking at three key countries across three basic strategic approaches.  In December we looked at distribution in all three countries, and today we will be focusing on appropriate products and leveraging regional capabilities for China.  

## China:  Levels 2 & 3 to Start  Access Level 2 and 3 Hospitals through combination of “distribution transformation” and “appropriate products”

- China:  Levels 2 & 3 to Start  *Access Level 2 and 3 Hospitals through combination of “distribution transformation” and “appropriate products”*

**Current China hospital market**
**has 3 levels (or classes)**

- 977 hospitals

- 5,198
- hospitals

- 2,674 hospitals
- (+ 8995 others)

**Level I**

**Level II**

**Level III**

- Small, local players dominate Level I and II
- Level II is growing dramatically due to government initiatives to improve healthcare system in response to middle-class growth and SARS/Asian flu concerns

**Alone, “Transform Distribution” plan only reaches top tier**

**. . . but adding “ Appropriate Products” gives access to larger market**

- Existing STERIS product portfolio only appeals to small portion of market

- Appropriate products will target all of Level III and much of Level II hospitals

- 200-300 hospitals

- 100 hospitals

- + “AppropriateProducts” intoLevels 2 & 3

- Also expect Level 2to Grow

**Notes:**
While the export opportunity is very important from a contribution perspective, the team decided that the first step is really to focus on developing appropriate product to meet the  Chinese domestic market opportunity and then the export opportunities will follow.   You will recall our objective is to access Level 2 & 3 hospitals which we can not reach using distribution transformation by targeting our appropriate product at the middle of the Level 2 so we can participate in the growth of the upper level 2 and the lower level 3.  2ndly, as the Chinese hospital network continues to improve will also be able to make inroads into the lower level 2. 

## Distribution Transformation: Common China distribution structures

- Foreign manufacturer

- National distributor

- Local dealer

- Sub-dealer

**HOSPITAL**

***Primary distributor***

***Secondary distributor***

***Tertiary distributor***

**With a closely managed group of quality “local dealers”, the “sub-dealers” can often be eliminated.**

- Usually exclusive
- Provide easy market entry for companies with limited resources
- May have pockets of strength but often leave large regions poorly covered. Weak hospital contacts outside of core territory
- If you use, have a transition strategy upfront

*O*ften non-exclusive
- More complex structure -- Require local management by foreign company
- Far superior geographical coverage by leveraging strong local customer relationships
- Higher quality contacts with local hospitals and decision-makers

- Often mandated by the hospital.
- Handle local transactions, day to day service, etc.

## Distribution Transformation: Typical stages of growth

- “Traveling export manager”

- Asia-Pacific area manager

- Country Manager model

- Direct sales model

- Distributors are managed from a distant HQ. Often a single manager based at HQ covers sales worldwide. All invoicing and shipping from HQ.

- Local area manager

- Distributors are managed by an area manager based at HQ or in the region. All invoicing and shipping from HQ.

- Distributors are managed by a local manager with no other staff. May report to a regional office elsewhere in Asia-Pacific. Invoicing and shipping from HQ.

- Country Manager overseas sales and distribution from a local office with support staff. Some invoicing from local office. Shipping from HQ.

- Direct sales force work with local dealers reporting to a local Country Manager. Often requires direct technical service and support. Invoicing from local office. Shipping from HQ.

- Local manufacturing

***Although common, this is not always the most effective way to enter the Chinese market.***

## Distribution Transformation: Evolution of a typical medical sales organization in China

**1. National distributor.**** **

**Sales $**

**Complexity**

- US$ <1M

- US$ 1-5M

- US$ 5-15M

- US$ 15M+

**2. Country Manager organization. Limited technical/ clinical support. 3-10 local dealers.**

**3. Country Manager, full technical service and clinical support teams.**
**10+ local dealers.**

**4. Large organization including Admin/HR and multiple branch offices.  30+ local dealers. **

## Creating an “Appropriate Products” Market Entry Plan More than just take my existing product and de-featuring it, need full value chain

- Define and evaluate entry options

-   Understand
- Market size
- Growth
- Competition

- Features
- Cost
- Prices
- Expected sales

- Assess gaps across value chain to deliver the “appropriate products”

- Quantify the goals and requirements for each option (Greenfield, JV, Contract)

- Evaluate financial & non-financial criteria

- Creating an “Appropriate Products” Market Entry Plan *More than just take my existing product and de-featuring it, need full value chain*

**Notes:**
This is our basic analysis approach.

## “How to Compete” - Define Appropriate Products:Products are NOT de-featured... but performance is reduced

- Key features remain  the same.... But performance is reduced (via alternative, lower-cost designs and sourcing)
- Country-specific features need to be added

- “How to Compete” - Define Appropriate Products:*Products are NOT de-featured... but performance is reduced*

**Notes:**
Based on the price/ cost information I just presented you would like that features would be significantly reduced but in practice they are not.  In practice Chinese hospitals are asking tables with the same features as developed country hospitals just at different specification levels. 
While this is fairly detailed, I think it would be helpful to look at the specifics so we can understand this dynamic. As you can see it is necessary to actually add quite a few features like: minimum height for local market, split legs/ sliding top due to the prevalence European style procedures, Dual Operating modes for brown outs.   In the reduce features performance reduction does take place like with the weight capacity and cushions, but the basic point is that the required tables are not significantly defeatured.

## Must Understand China product pricing and Costing:  Products require significantly lower costs and average selling prices in China

- Overall 70% manufacturing cost difference
- Labor and burden rates are significantly lower
- 30% material cost reduction through simplifying design and re-sourcing components in China (e.g. replace European controls, valves)

- Manufacturing
- Cost

**Notes:**
So let’s look briefly at tables.  One notices immediately that from both an user price and cost structure base local products require significantly lower target pricing and COGS compared to our current NA champion the 3085 table.  This is because the table market is already dominated by a number of strong local players like SMEF and SMEW.  The C100-300 series tables that our potential JV partner is developing will achieve dramatically lower costs by redesigning basic table functions and localizing all components.  Specifically they have designed out the European hydraulics that are key to most international tables. 

Step change in price/ cost what would we expect about the features, in practice it isn’t

## Robust Options Analysis to Determine Execution:Options are often financially equal, choice depends on execution risk

**Criteria **

**2**

**Greenfield Factory**

**1**

**Acquire/ JVs**

**3**

**Status Quo**

**0**

- XX-XX

- XX-XXX

- XX-XX

- Robust Options Analysis to Determine Execution:*Options are often financially equal, choice depends on execution risk*

**Contract Manufacture**

- 5-yr NPV

**Financial (ranges)**

- Revenue (FY10)

- EBITDA (FY10)

- Positive Potential

- Negative Potential

- X-X

- XX

- X-X

- X

- Investment

- Total

**Qualitative Factors**

- STERIS Capability Building

- Ability to protect IP

- Ability to exercise mgmt control

- Time to Market

- STERIS Ability to execute

- XX-XXX

- XX-XX

- XX-XXX

- XX-XX

- XX-XXX

- XX-XX

- XX-XXX

- XX-XX

- XX-XXX

**Notes:**
 Although the different options have significant time to market and competency building implications, in practice, when you do the financial analysis they are not so far apart from a an NPV perspective because of the relative high cost of investment in JVs or Acquisitions counteract initial time to market advantages.  From a qualitative perspective as well the different options also come out fairly evenly with risks associated with working with partners and exercising management control counteracting time to market advantages.   Net-net the steering committee felt that it did not make sense to simply decide on one option but rather evaluate each option by product group to determine what is the best way to assemble our value chain.   The important point from this slide is that all the options have large NPVs and that we need to move to execution to capture them!

In evaluating the financials lets start with the NPVs.  As you know the terminal values are driven by FY10 revenue and overall margin and thus the terminal value approach has a pretty dramatic multiplier effect.   As you will see, the JV option has higher revenue (163 compared to  126 for Gfld and 154 for CM).  Additionally, while JV and Gfld have similar margins (~31%), the CM option has a margin of 21%.  The result of these revenue and margin assumptions is a fairly significant difference in  EBITDA (51 for JV... compared to 38 Gfld and 33 CM).  Ana..lysis of this is presented in the appendix on slide 54.

(Given the 6x multiplier STERIS uses for terminal value... this EBITDA difference of 12, for example, translates into a TV difference of 60 million.  This 60 million, of course, has to get discounted back 5 years (e.g. the 60 million TV in FY10 becomes something like $40 million in FY05 - - which would mean the NPVs would be different by $40 million).  )

3. That said for me the real takeaway, is that the options are fairly close from a financial perspective and the opportunity is basically big no matter which options we ultimately end up choosing.  In fact although one would naturally think that greenfield would be expensive from an investment perspective it actually doesn’t stack up to badly compared to JVs because the investment in phased over time vs. the JVs which require cash upfront.  Go through each one.!!

Thus with things relatively close on the financials, we should consider the qualitative factors.  We hae already discussed some of the key ones here in our value chain analysis like time to market and STERIS capability building.  When we add ability to protect IP, exercise management control, and execute the options really come out more or less equal.  We might give more weight to time to market and thus tip the hat to JVs but actually we are already favoring this time factor in the financials through our application of the ramp ups so probably it is best to not over weight this factor any more. 

All this leads us to the basic conclusion, mentioned earlier, no decision is possible or necessary now on which option to pursue. In fact the basic concept of having to pick an option today is probably misleading.   

## Market Size & Target Revenues for All Products: actual work just beginning but direction is set

**Notes:**
We will talk in a moment about the key appropriate product initiatives that  are required to address these product segments in these two key markets but first lets look at the basic market numbers, share projections we feel we can achieve via initiatives and resulting revenues.  

First of all the key P&R available markets in APAC will be growing dramatically from 120 to 209. Japan will grow about 30% to over 100M but the growth is very different across project segments we have show water business actually shrinking by 4% will VHP grows in spirts of 100% then 10% then 30%.  The key growth segment is consumables, specifically detergents.  Tsuji-san feels that due to adoption of western manufacturing practices consumables should grow to at least 25% of what is done in the US (90M) or 23M.  This is an important assumption and depends a lot on education and upgrading of local practices.  

In China all the markets are growing.  The water numbers for FY11 are a bit deceiving as that year turns out to be at the bottom of the recertification curve, while for steam sterilizers is happens to be at the top.  Any regardless of segment growth is present. 

Key share assumptions we have made for the two countries are, we need to play in steam sterilizers in Japan (grow from a negligible 3% to 11%, maintain share in VHP, recover in water and participate in the consumables growth.  This way we hope to triple our revenue out of Japan.  

In China we even more aggressive targets growing 8 times from a very small 1M base.  Water will be key where we want to increase our share via local manufacturing to 30%.  We also need a strategy for steam sterilizers, something we don’t have today and have thus planned for the out years 09-11.  

## Questions to Answer

- What does STERIS do?
- Why did STERIS and why do most other US Healthcare companies need an Asia (and specifically China) Strategy?
- How did we set STERIS’s China strategy?
- How is implementation going and what have we learned?

## STERIS-SHINVA Joint Venture

**China Joint Venture and Opening of Offices in India and China Expand Regional Base**
- Mentor, Ohio (September 22, 2005) - STERIS Corporation (NYSE: STE) today announced the signing of an agreement with SHINVA Medical Instrument Company of the People’s Republic of China to form a new joint venture company, STERIS-SHINVA Healthcare Systems Co., Ltd.  The joint venture will manufacture and market STERIS’s HAMO® brand washers to the healthcare market in China.  STERIS will own 51% of the joint venture.  The transaction is pending Chinese government approvals and is expected to close in four to six months.
- The Company noted that the joint venture will also allow STERIS the future alternative to establish a manufacturing base for other products to be sold in the Asia-Pacific region, and is just one in a series of recent actions designed to establish a stronger presence there.  In May of this year the Company opened a direct sales and international purchasing office in Shanghai, China and in July, the Company opened a direct sales office in Calcutta, India.  Previously, STERIS’s presence in the region was through dealer and distributor arrangements.  This more direct presence signals the importance of the region in the Company’s growth strategy.

## STERIS-SHINVA Marketing Launch China Medical Equipment Fair Shenzhen April 26-28, 2006

## Lessons Learned/ To be Learned

- Avoid national distributors, give out territory progressively, get your own local distribution manager
- Once you decided to setup some sort of local presence skip the Rep. Office stage and sent up a FICE (Foreign Invested Commercial Enterprise)
- As far as manufacturing, going wholly owned is best if you can do it, but the domestic Chinese healthcare market is particularly difficult to navigate alone
- US and Chinese corporate culture are tough to meld
- Do, correct, do vs. Planning and following the process
- General Manager as King vs. Matrix
- Time to Market vs. Quality Reputation Don’t assume you can’t contribute on sales, service, local logistics, etc.
- Build trust with Chinese partners but have an exit strategy and continually work on it
- Your China strategy should be about creating options.  Don’t put all your eggs in one basket until you know the approach is really working