Pricing Anderson & Co Healthcare Case prompt: Our client, Anderson & Co, is a medical devices company based in Chicago, US. They produce diagnostic devices and focus mostly on the US and Western Europe. Next year, they plan to enter the Chinese market with their new magnetic resonance imaging (MRI) device, Avengenia. Since their prices depend on various factors, they asked for our help to define a pricing methodology and find the most optimal price point for this new product. Question #1: How would you solve this problem? Possible clarification questions: To clarify, I would like to check a couple of things before diving into the solution. • Do the client’s current products have comparable features with this new product? • Are there any financial or strategic objectives I need to beware of? Interviewer responds to the clarification questions: • Their existing portfolio contains products similar to this new device, and has some advantages and disadvantages in different aspects. • A significant proportion of the executive committee members’ compensation package is set based on this product, and they aim to reach breakeven in a maximum of 5 years. Interviewee builds the framework: I understand, then we can frame our solution as follows: 1. Context a. Product i. What exactly is the product used for? ii. What is the lifespan of the product? iii. Are there any complementary products and services sold along with our product? b. Client i. Does it have a patent for the product? β If so, how long does it last? c. Customers i. Who are our clients’ customers? ii. How can we segment the customers? iii. What is the size of each segment? iv. Who pays for the product? Is it subsidized? d. Competition i. What are the available substitutes in the market? ii. How different is our client’s product from its peers in the market? iii. How do our client’s and competitors’ products align with customer needs (i.e., the differences in the purchasing criteria)? Licenced to Lucrezia Contegiacomo (lucrezia.contegiacomo@ Pricing Anderson & Co Healthcare 2. Price level determination a. Minimum price i. Cost-based pricing: To calculate breakeven point (per device), what are the costs associated with the product (e.g., fixed cost items such as R&D, marketing, or variable cost items such as manufacturing, etc.)? b. Maximum price i. Competition-based pricing: What is the price level for the comparable products of the competitors? ii. Value-based pricing: How much are customers willing to pay for the new device? c. Supporting factors i. Client objectives: Does our client have any other objectives, such as ROI, or profit margin? ii. Analogs: Do we have any examples of price levels for similar devices in other markets? 3. Potential risks a. Affordability: The customers may not be able to afford the product if we price it too high. b. Demand: Demand for diagnostic devices may decrease, or it may shift toward products that are different from MRI. c. Regulations: There may be some regulatory restrictions on MRI pricing, as healthcare is a sensitive industry. Interviewer validates the framework: That sounds good. Please go ahead. Interviewee deep-dives into context: I would like to start with the context and understand the product better. I wonder what the customers will use this product for. Interviewer provides information: Anderson’s new device, Avengenia, like the other MRI devices, is planned to be used to create anatomical images of the patients in the disorder diagnostic phase. It produces easy-to-interpret visuals for doctors to conclude whether their patients have any medical problems related to their complaints. This is quite a crucial device that hospitals rely on in their radiology processes. Interviewee continues: As we mentioned the processes, do we know how long Avengenia’s lifecycle is? I would like to understand how often hospitals would buy a new one. Licenced to Lucrezia Contegiacomo (lucrezia.contegiacomo@ Pricing Anderson & Co Healthcare Interviewer answers the question: Once installed, it is expected to be used for 12 years. Interviewee finishes the context understanding: I understand. As the last point in the product section, I would like to know about the complementary products or services used together with this device. Related to that, I wonder if there are direct substitutes in the market. Interviewer provides information about the other products: As a complementary offering, there is software used to analyze and interpret the data generated by MRI devices. With higher computational capabilities, these devices have penetrated the market quite aggressively in recent decades. Regarding substitutes, hospitals usually use computed tomography (CT) devices for radiology. However, CT is not a direct replacement for MRI because of its lower image quality and higher radiation levels. In addition, MRI devices, including Avengenia, provide different services to the hospitals, as compared to CT devices. Hence, any benefit brought about by Avenenia would be incremental to the hospitals. Interviewee summarizes the points discussed and continues to the next section: It looks like this product is a core element of the hospitals' diagnostic process, and is a long-term investment. It is interesting to see that technology has changed the market dynamics in favor of MRI device producers. That is worth diving deeper into when setting the price. As the second step in understanding the context, I would like to check if the client has a patent for its product, so that its competitors cannot easily replicate its technology. Interviewer responds: Yes, they do. However, these patents are related to the specific techniques they use in manufacturing, and their competitors also have other patents that protect their intellectual property. Since all players have differentiated their manufacturing processes, then even if their patent is lost, it would not be feasible for competitors to replicate each other's production technologies. These patents are designed more to protect players against potential new entrants. Interviewee continues with the product section: That is interesting, but also makes sense, as this is quite sophisticated technology. As the next step, I would like to analyze Anderson’s potential customer base. Have they identified their target customers to sell Avengenia? Licenced to Lucrezia Contegiacomo (lucrezia.contegiacomo@ Pricing Anderson & Co Healthcare Interviewer elaborates on target customers: Yes, they plan to initially target high-end private hospitals in tier-1 Chinese cities. After gaining a track record, they aim to focus on the tier-2 cities again through the for-profit hospitals. Interviewee further investigates customers: I understand. Do we know how big these segments are? It would also be useful to know the revenues and spending of these companies in diagnostic functions. Interviewer responds and provides exhibit #1: We do have a piece of information about the customers. Please find below the hospital revenues by geography and service type in China. Note that service type indicates whether their services involve radiology diagnostic processes. Exhibit #1: Hospital revenues by geography and service type in China in 2020 Interviewee interprets the chart: I see that the proportion of revenues generated from radiology-related services is much higher in tier-1 cities (14%) than in the other cities (10%). Tier-1 city hospitals seem to be a good start for Anderson, as planned. To analyze what price point it should aim for, I would like to go ahead with the quantitative assessment. Based on the available information, we can test the following pricing methods: i. Cost-based pricing by adding a markup to the estimated cost. ii. Competition-based pricing by benchmarking against comparable offerings in the market. iii. Value-based pricing by measuring customers’ willingness to pay. Licenced to Lucrezia Contegiacomo (lucrezia.contegiacomo@ Pricing Anderson & Co Healthcare To start with the cost-based pricing, as the first step, we can layout a cost breakdown as follows and calculate the total breakeven cost. As we know, the breakeven target is 5 years; we can estimate quantity based on the market size and share that Anderson can capture to find a breakeven price. Do we have information about the items in the following tree? Interviewer provides additional information: We do not have the information reported as detailed as you specified, but we know the following: • CAPEX: $20M • Fixed cost: $7M • Variable cost per device: $80K Interviewee comments on the data provided: That information suffices to proceed. So, at this point, do we have any insight that helps us estimate Anderson’s market share? Interviewer provides additional information: Based on the market and planned sales force deployment, Anderson aims to gain a 5% market share in hospitals in tier-1 cities for the first 2 years, and then increase it to 10% in the following three years. Please note that only 1/3 of the hospitals have MRI units, and each hospital would purchase 2 devices on average. They do not plan to target tier-2 cities, which are the ones in tier-2 and tier-3, until year 6. Interviewee proceeds with the calculation: Then this information is enough to calculate the expected quantity sales in the following years: π ππ£πππ’π πππ π¦πππ = # ππ βππ πππ‘πππ ∗ % ππ βππ πππ‘πππ ∗ ππππππ‘ π βπππ ∗ # ππ πππ£ππππ π πππ β ππππ 1 = 10.5πΎ ∗ 33% ∗ 5% ∗ 2 = ~350 Licenced to Lucrezia Contegiacomo (lucrezia.contegiacomo@ Anderson & Co Pricing β β β β ππππ 2 = 10.5πΎ ∗ 33% ∗ 5% ∗ 2 = ~350 ππππ 3 = 10.5πΎ ∗ 33% ∗ 10% ∗ 2 = ~700 ππππ 4 = 10.5πΎ ∗ 33% ∗ 10% ∗ 2 = ~700 ππππ 5 = 10.5πΎ ∗ 33% ∗ 10% ∗ 2 = ~700 β πΌπ π π‘ππ‘ππ ππ 5 π¦ππππ = 350 + 350 + 700 + 700 + 700 = 2,800 Healthcare We can expect to sell 2.8K devices in a total of 5 years. At this point, we can estimate the cost-based pricing by following these steps: i. Calculate the total cost. ii. Calculate the breakeven price based on the total cost and expected quantity sold. iii. Calculate the price by adding a markup to the breakeven price. πππ‘ππ πππ π‘ = πΆπ΄ππΈπ + πΉππ₯ππ πππ π‘ ∗ #ππ π¦ππππ + ππππππππ πππ π‘ ∗ # ππ π‘ππ‘ππ πππ£ππππ π πππ = $20π + $7π ∗ 5 + $80πΎ ∗ 2.8πΎ = $20π + $35π + $224π = $279π π΅ππππππ£ππ πππππ = πππ‘ππ πππ π‘ $279π = = ~$100πΎ ππ’πππ‘ππ‘π¦ π πππ 2.8πΎ At this point, I would like to see if we have any markup figures. Do we have any target markup figures in mind? Interviewer provides markup figures: No, we do not. How would you like to proceed? Interviewee continues: Alright then, in this case, we can take this breakeven price as the minimum price. To find the ideal price point, we need to investigate the other two methods. To start with the competition-based pricing, I would like to know the following: β How is our product qualified compared to the competitors? β How much are the competitors pricing their products? Interviewer interrupts: The executive team believes that there is no direct substitute for Avengenia in the market. With its unique technology, Avengenia provides high-quality image analyses on a much wider set of screening services than other products in the market do. On top of that, we already explained how it differentiates from CT products that are currently in use. So, I would not suggest that you go with competition-based pricing. Licenced to Lucrezia Contegiacomo (lucrezia.contegiacomo@ Anderson & Co Pricing Healthcare Interviewee responds: Alright then, we can eliminate this option and proceed with the last alternative, which is value-based pricing. We can do the following: • Estimate how much revenues customers can generate using this device. o price of an MRI screening operation, and o total MRI screenings during the lifetime of the device • Deduct all non-device-related costs from the revenue to calculate its profits. • Claim a proportion of that value. We already know that the lifecycle is 12 years. Do we know how much the average customer charges its patients and how many MRI screenings occur every year? Interviewer answers and ask for quantity estimation: The price of an MRI screening is $150 on average. How would you estimate quantity? Interviewee continues with the estimation: Okay so we can assume that a screening lasts an hour, and the working days are from Monday to Friday, and the operating hours are between 8 am and 6 pm. So, then, given that each hospital buys 2 devices, the number of total screenings will be the following. We should assume that the client does not work at full capacity - but let’s say 75%. πππ‘ππ # ππ π πππππππππ = # πππ£ππππ ∗ π’π‘ππππ§ππ‘πππ πππ‘π ∗ # π€ππππππ πππ¦π πππ π€πππ ∗ # βππ’ππ πππ π€ππππππ πππ¦ ∗ # π€ππππ ππ π π¦πππ ∗ # π¦ππππ πππ‘ππ # ππ π πππππππππ = 2 ∗ 75% ∗ 5 ∗ 10 ∗ 52 ∗ 12 = ~47πΎ πππ‘ππ πππ£πππ’ππ = $150 ∗ 47πΎ = ~$7π On the other hand, do we know how much their cost associated with these operations is? Interviewer responds: You can assume that the client has an $80 cost per operation. This includes both fixed and variable costs, excluding the MRI device cost. Interviewee estimates value creation: Then we can estimate that total cost and profit, excluding the MRI device cost, is as follows: πππ‘ππ πππ π‘ = $80 ∗ 47πΎ = ~$3.8π ππππππ‘ (ππ₯π. πππ π‘ ππ π‘βπ πππ£πππ) = $7π − $3.8π = $3.2π Licenced to Lucrezia Contegiacomo (lucrezia.contegiacomo@ Anderson & Co Pricing Healthcare Since this is the profit for a total of 2 devices in the MRI units, we need to take half of it. So, we can estimate that each device would generate a $1.6M lifetime value for hospitals. Do we know what a fair share of that value that we can claim is? Interviewer answers: You can assume that we can take 20% of the value created. Interviewee finishes the analysis: If we claim 20% of this created value, this would price the product at $320K and still leave hospitals with almost $1.3M per device. This seems like a better pricing option for us, while also being easy to rationalize. Interviewer responds and asks about potential risks: Alright, that is fair enough. Given that we proceed with the value-based pricing and price the device at $320K, what risks do you see associated with this strategy? Interviewee lays out the risks: There may be three risks related to this pricing decision that Anderson should consider. β Customer income: We apply a high margin and offer a product that would pay off in the long run. This would require a high initial investment from hospitals, and creates concerns regarding the affordability of the product. β Demand: Although we assumed demand for MRI services, we need to ensure that this trend keeps its pace. β Regulations: Since healthcare is a highly regulated industry, then before introducing a price, Anderson should make sure there would be no regulatory road-blocks. Interviewer responds: The team has made a detailed analysis and projected the healthcare sector. Regarding customer demand and the hospitals' liquidity, they do not expect to see a significant downturn shortly. On the other hand, Anderson’s Chinese government ensured that there would be no price caps on med-devices, as long as their value is rationalized. Therefore, I would not be so concerned about regulations either. How would you like to conclude? Interviewee makes the conclusion: If neither of these risks is substantial, we can go ahead and suggest Anderson price its new device at $320K for the following reasons: β Hospitals are estimated to make a $1.6M profit with this product in its lifetime. This is five times as much as the proposed price level. Licenced to Lucrezia Contegiacomo (lucrezia.contegiacomo@ Anderson & Co Pricing β β Healthcare There is no direct competitor in the market that our customers can benchmark. So, a price war is not likely. Demand for MRI services is expected to continue, and our customers can afford this price. Going forward, Anderson should finalize its go-to-market strategy and start its sales efforts to launch its product in the market. Licenced to Lucrezia Contegiacomo (lucrezia.contegiacomo@ To share Pricing Anderson & Co Exhibit #1 Healthcare Exhibit #1: Hospital revenues by geography and service type in China in 2020 Licenced to Lucrezia Contegiacomo (lucrezia.contegiacomo@
