Private Hospitals in Crisis: When Will They Break Through?

Author: Wei Wu. Published with authorization from VCBeat. Additions and deletions have been made without altering the author’s original intent. The views expressed in this article are solely those of the author.

The healthcare services industry is at an inflection point in its development. Industrial conglomerates have slowed their expansion, while investment firms find themselves in a dilemma over whether to hold or divest their assets. There are only a handful of listed medical institution targets on the A-share market, and the deep-pocketed investors who once vowed to diversify into healthcare now harbor mixed feelings. As one drinks water, one knows best whether it is hot or cold.

Listed Chinese healthcare institutions frequently employ such phrasing in their prospectuses: “According to Frost & Sullivan, our group holds a leading market position in the private healthcare services market within the [specific] segment...” The sense of pride is palpable. This also highlights a somewhat poignant aspect of some private hospitals in China, as they often remain unaware of who their competitors actually are.

According to data from the National Health Commission, from January to November 2018, hospitals recorded 3.23 billion outpatient and emergency visits, with public hospitals accounting for 86% and private hospitals for 14%. The number of hospital discharges reached 178.626 million, with public hospitals accounting for 82% and private hospitals for 18%.

Wuhan University People’s Hospital ranked 50th in the Fudan Edition of the “2017 China Comprehensive Hospital Rankings.” In 2018, it recorded 5.2 million outpatient visits and 205,000 discharges. It is estimated that, to date, no private hospital in China has achieved such a scale of operations. The healthcare landscape, dominated by public hospitals with private hospitals playing a supplementary role, remains unchanged both in aggregate and at the individual institutional level. At their inception, domestic private hospitals should not overlook this overarching structure. Against this backdrop, we attempt to analyze the reasons why the majority of private hospitals in China operate on slim margins or incur losses.

Some have interpreted the income statement as follows: “Profit (or loss) is the effect, while revenue and costs/expenses are the cause.” Following this causal logic, we will conduct a comparative analysis of the predicament facing private hospitals. China’s non-public healthcare sector is at a critical juncture of transformation. This article focuses solely on analyzing phenomena and does not make moral or operational judgments regarding specific enterprises’ business practices. It is our hope that this analysis will serve as a reference and guide for the positive development of the industry.

Based on the nature of patient treatment in hospitals, medical institution revenue is primarily divided into outpatient revenue and inpatient revenue, which can be expressed as follows: Revenue = Outpatient Revenue + Inpatient Revenue = Outpatient Volume × Average Cost per Outpatient Visit + Inpatient Volume × Average Cost per Inpatient Stay = Outpatient Volume × Average Cost per Outpatient Visit + (Outpatient Volume × Outpatient-to-Inpatient Conversion Rate + Referral Volume) × Average Cost per Inpatient Stay.

For public hospitals, their inherent geographical advantages, superior infrastructure, and highly skilled medical teams, coupled with decades of established reputation, ensure that as long as they avoid major errors, demand will basically outstrip supply, resulting in overwhelming patient volumes.

From the patient’s perspective, the typical hierarchy of priorities in medical care is: (1) safety; (2) quality; (3) experience; and (4) cost. Public hospitals have firmly established their advantages in “safety” and “quality,” while “cost” remains relatively affordable due to strict regulatory controls.

Therefore, for public hospitals, patient volume has never been an issue; in fact, the sheer volume has led to prominent public livelihood concerns such as “difficulty in accessing medical care” and “difficulty in securing appointments.” Conversely, there are few reports of similar access difficulties at private hospitals. This is because patient volume is actually a critical vulnerability for private medical institutions and one of the root causes of the widespread malpractices plaguing the private healthcare sector.

How Can Private Hospitals Cope with Their Significant Disadvantage in Organic Patient Acquisition Compared to Public Hospitals?

Ethical private healthcare institutions enhance their patient acquisition capabilities by narrowing the quality gap with public hospitals through recruiting renowned specialists from the public sector, rigorously improving services to optimize patient experience, and steadily conducting free community clinics to expand their influence. Private healthcare institutions operating in legal gray areas focus on referral mechanisms, establishing channels to “buy patients” in the market through exorbitant referral fees. Those crossing ethical and legal boundaries not only adopt the latter strategy but also manipulate outpatient-to-inpatient conversion rates and average costs per visit (including both outpatient and inpatient care) through overtreatment, or even illegally defraud the pooled basic medical insurance funds. Such practices seriously violate medical professional ethics and contravene relevant laws.

Beyond this, there are even more “sophisticated” strategies and tactics. Since private hospitals cannot compete with public hospitals, they “transform” by rebranding themselves as a department within a public hospital (departmental trusteeship). Alternatively, they “go underground,” with private hospital investors operating behind the scenes of public hospitals to become investors in certain capital-intensive medical equipment, thereby earning revenue shares (equipment placement).

Private medical institutions have turned former rivals—public hospitals—into allies, thereby gaining direct access to their patient flow. Setting aside regulatory and ethical considerations, this early strategy employed by the Putian-based medical groups was exceptionally well-designed from a business perspective and demonstrated profound industry insight, far surpassing that of later entrants such as deep-pocketed investors and major market players.

Similar to industrial enterprises, the operating costs of hospitals are primarily composed of “labor,” “overhead,” and “materials,” albeit with differences in their specific proportions.

“Labor” refers to personnel costs. Private healthcare institutions that are committed to genuine operations must bear significantly higher costs in this area compared to public hospitals. The logic is straightforward: Why would physicians leave stable positions at public hospitals, where they enjoy institutional support, professional status, research opportunities, and competitive compensation, to join private hospitals? Without a 50% increase in compensation, it may be impossible to recruit head nurses who are key personnel at Grade III Class A public hospitals; without equity arrangements that go beyond salary, it may be very difficult to attract department directors from these same top-tier public hospitals.

Although retired physicians from public hospitals are not included in this category, they still face fierce competition from their counterparts in the private healthcare sector. It is difficult for them to stand out, and their compensation has risen accordingly. In contrast, public hospitals leverage their overwhelming platform advantages over private medical institutions, thereby maintaining a decisive edge in labor costs.

Senior physicians recognize that professional titles, resumes, research achievements, and clinical experience cannot be “bought” outside the public healthcare platform. Despite dissatisfaction with compensation in public hospitals, they remain within these institutions and are reluctant to leave. Each year, a steady stream of residents-in-training rotates through departments in public hospitals, gaining experience while earning meager salaries. While private medical institutions are still busy poaching department heads from top-tier (Grade A Tertiary) public hospitals, public medical institutions continue to cultivate physicians at the level of department directors. Between gold and the hand that turns stone into gold, which is more precious?

“Fees” refer to cost expenditures associated with medical institutions. Significant amounts include depreciation costs (for property and equipment), amortization (for renovations), and rent (if applicable). Property management has long been a persistent challenge for private capital investing in healthcare. Whether to lease or purchase buildings remains a significant problem.

Those familiar with finance might readily opt for leasing premises, citing the benefits of an asset-light model. Regardless of the merits of this approach, it is an undeniable fact that many healthcare institutions have failed to generate profits from their medical operations but have instead realized gains from property appreciation. Of course, whether one chooses to purchase or lease facilities, the scale remains incomparable to that of public hospitals.

Public hospitals rarely pay rent, as most own their properties; when building new campuses, they even have the leverage to negotiate with the government on site selection using maps. Even if private medical institutions successfully resolve property issues, they must still “overcome numerous obstacles” to achieve normal operations: complying with regional planning, obtaining establishment permits, renovating the property, passing fire safety inspections, passing environmental impact assessments, securing practice licenses, and enabling health insurance reimbursement.

Each regulatory hurdle can be painfully arduous, entailing substantial time commitments and significant opportunity costs. In contrast, the same processes may proceed smoothly and without obstruction in public medical institutions. Regarding equipment, private medical institutions generally do not pursue high-end, prestigious models as public hospitals do; instead, they favor cost-effective configurations, resulting in budget savings from selection to price negotiation compared to their public counterparts. In terms of facility decoration, private medical institutions that prioritize patient experience invest more per unit area than public medical institutions.

“Materials” refer to the supplies used by medical institutions, primarily including pharmaceuticals and consumables. For identical product specifications, the invoiced price should be consistent across both public and private hospitals. However, private medical institutions generally adopt more market-oriented approaches to supplier selection to secure the most favorable pricing terms. Consequently, their material portfolios may exhibit certain distinctions and differentiation from those of public hospitals, without compromising clinical needs. In terms of payment conditions, public medical institutions hold a significant advantage; suppliers are often willing to extend credit sales to public hospitals, confident that payments will eventually be settled. It is common for procurement contracts for pharmaceuticals and consumables to involve payment terms exceeding one year.

Period expenses primarily include selling expenses, administrative expenses, and financial expenses. Although the terminology used in the financial statements of public medical institutions may vary slightly, this classification logic remains applicable.

Regarding sales expenses, there is a significant disparity between private and public medical institutions. Public medical institutions allocate a minimal proportion of their revenue to such expenditures, whereas private medical institutions generally maintain double-digit sales expense ratios (sales expenses/revenue). For some private medical institutions, this ratio even exceeds 25%, with cases where the size of the marketing team approaches that of the clinical staff.

At a deeper level, this tests the strategic choices of managers in private medical institutions: whether to adopt an expense-driven or asset-driven model. The high-sales-expense model yields quick results but relies heavily on marketing investment, whereas the long-term brand value (intangible asset) model is complex to implement and slow to show results, yet it endures and remains relevant over time. In contrast, public hospitals have passively chosen the latter.

Regarding administrative expenses, private hospitals and public medical institutions have different areas of focus. Public medical institutions may include expenditures related to academic research, whereas private hospitals typically establish a non-clinical management team to handle core functions such as brand management, human resources, and supply chain management, thereby incurring corresponding expenses. In addition, start-up costs for private hospitals are recorded under this account (in the first year), and due to potential challenges during the initial preparatory phase, the amount recognized as administrative expenses can be significantly high.

Regarding financial expenses, the primary items are interest expenditures on financing. This account also offers a glimpse into the circumstances of two types of institutions. Public medical institutions in the expansion phase may incur certain amounts of interest expenses (not necessarily at high rates), as financial institutions are willing to provide financing to public hospitals. Moreover, due to their low-risk profile, the credit assets of public medical institutions have become “hard currency” in the asset securitization market.

In the absence of distinct competitive advantages, private hospitals often struggle with financial expenses. Lacking owned properties or guarantees from high-credit entities, they find it extremely difficult to secure credit financing from mainstream financial institutions. This implies that indirect financing (credit) is insufficient to support their investment and expansion efforts, forcing them to rely heavily on direct financing (equity financing), which severely constrains the development of private hospitals.

Private medical institutions, lacking owned properties or guarantees from high-credit entities, find it extremely difficult to secure credit financing from mainstream financial institutions, although their resulting financial expenses may not be substantial. This implies that indirect financing (credit) support is insufficient for private medical institutions seeking investment and expansion, forcing them to rely primarily on direct financing (equity financing), which in turn constrains their development.

Public healthcare institutions may receive non-operating income, such as government subsidies. When handling medical disputes and paying medical compensation, both types of institutions record these payments as non-operating expenses. However, due to the inherent disadvantages of private healthcare brands, they tend to have greater concerns when addressing such matters, which weakens their bargaining power with patients and leads to higher actual compensation amounts.

Meanwhile, any fines imposed by the National Healthcare Security Administration (NHSA) during its audits are also recorded under this account item, although in most cases such penalties fall on private medical institutions. Furthermore, for-profit private medical institutions are required to pay a 25% corporate income tax if they report profits, whereas public medical institutions are exempt from this tax.

Based on experience in the healthcare industry, we may proceed with this assumption for trial calculations:

(1) The average net profit margin of public medical institutions is 10%;

(2) The ratio of labor costs to revenue is calculated at 30%; labor costs in private medical institutions are at least 50% higher than those in public medical institutions;

(3) Drug revenue accounts for 30%, and consumable revenue accounts for 10%. Compared with public medical institutions, private medical institutions receive procurement discounts of 30% on drugs and 50% on consumables;

(4) The sales expense ratio of private medical institutions is more than 10 percentage points higher than that of public medical institutions;

(5) Private medical institutions have lower equipment acquisition costs than public hospitals, while their renovation expenditures are higher.

(6) Private hospitals have higher building depreciation and higher rental costs than public hospitals. Therefore, excluding the scenarios mentioned in items (5) and (6), the net profit margin for private medical institutions is calculated as follows: 10%-15% + 9% + 5% - 10% = 1%. While the above pro forma calculation does not constitute a fully robust or effective argument, it preliminarily illustrates the logic behind the thin margins or losses experienced by most private medical institutions.

Private Healthcare Is Already in Dire Straits: What Lies Ahead? The “4+7” centralized procurement program has already been implemented, with the scope of included drugs continuously expanding, while centralized procurement for medical devices is also in the works. Private healthcare institutions have little room or time left for price negotiations.

The plight of the social security fund needs no further elaboration. Cost containment in medical insurance will continue to intensify, and most companies genuinely engaged in health insurance (excluding critical illness coverage) are operating at a loss. How can incremental capital enter this market? The supply chain and payment endpoints face a “double kill.” As the industry consolidates and institutions diverge, private hospitals committed to delivering quality medical care urgently need greater support. They long for social treatment equal to that of public hospitals. When will the distinction between “primary” and “secondary” status finally disappear?

E-commerce giants are still, year after year, tinkering with internet hospitals, while others continue to showcase to investors the number of institutions they have established across China. Newly emerged healthcare upstarts proudly announce that their group’s hospitals have reached 20,000 open beds, securing a place in the first tier of private healthcare providers. The future direction remains uncertain and will require sustained, multifaceted efforts.

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