Recently, when walking out of hotel room, I noted the posting of the standard price for that room inside the door. Then I wondered who set that price, since I only paid less than 50% of the posting. I also thought of whoever established that high price and how far off was that pricing. Since I find myself establishing startup business strategies, pricing is my primary concern for fear of not hitting my sales target. Indeed, a recent McKinsey & Co. report stated that 80% of these startups fail because of pricing.
When I begin to develop a financial model, I find that the most time consuming aspect to be the pricing of product or products, especially when the so-called product is unique. Yet, I have developed some kind of methodology, partly based on business school training and the other part from previous experience. I know that there are financial constraints – level of profitability, and economics – the level of inelasticity. Since I deal with a lot of technology, I am shocked how few technology marketing officers concern themselves with establishing a decent pricing model, believing that the technology is unique enough to be inelastic. That is not true.
In the classic first year marketing course, one cannot forget the 4 Ps of marketing – pricing, product, placement, and promotion. However, I have noted from my own direct experience that each “P” impacts the other. For example, the type of product does impact its price (to be explained later), high costs of promotion can mean that the price has to sustain the marketing. And so forth.
Now let’s look at medical device technologies. I recently had coffee with a medical device CEO, whose product is a diagnostic Apnea machine. She wanted to maintain a high pricing model and be treated as a prescribed medical product. The overwhelming assumption is that the price can be high – by implication, inelastic — since many medical device entrepreneurs believe that their product pricing will be sustained since medical reimbursements cover the acquisition costs – and that assumption only applies when the FDA requires that these same products can only be prescribed. And that business model seems to work well for many medical products.
Since AllRest (www.allresttech.com), my current company, deals with a therapeutic product for sleep disorders, I noted that the existence of 2 companies, Resmed and Phillips, each having over $1 billion of sales for their CPAP machines. These 2 companies have gained enough traction to control 70% of that market. Their products are priced anywhere from $500 to $5,000 for a simple breathing device. Resmed’s Gross Profit Margins are over 22%. Besides these 2 companies, I counted approximately 100 other manufacturers of CPAP machines, with variations on face masks, etc. I also found at least that many diagnostic machines.
A CPAP could be considered inelastic products – it is assumed that the product is necessary for the patient’s health. However, many patients, about 40%, abandon the product as they are cumbersome, noisy, and sizeable.
What is interesting is that all other players beyond the two leaders have not had the same financial success. True, they can price their product assuming that the costs will be covered by medical insurance. But the other marketing Ps of promotion and product and placement take precedence over price and inelasticity. The marketing strength of the two players leave little room for market growth in the same market.
There was a sleeping product, founded by three Brown University grads, using smartphones and a medical device that priced itself too highly at $300. User comments in TechCrunch also remarked that, besides the high price, it did require too much human intervention. Sales did not meet expectations. It closed a couple of years later. So ease of use, not just pricing, has a substantial impact on product demand.
Hence I questioned the pricing model for the Apnea diagnostic machine that simply relied on its pricing dependent on medical reimbursements (by implication, inelastic). In fact, I even related to the CEO another factor that should impact the pricing. I added that there is a notable percentage of non-insured patients. And, given the high costs of medical insurance, the deductible has been rising tremendously. So if the pricing depended more on these factors, then it should be lower. With economies of scale, then one can see a much more profitable model.
One new entrant, cognizant of the limitations on medical reimbursments, in the medical device world, a software platform, has priced itself below or same as the co-payments to reflect an elastic pricing model.
Whether the CEO would heed my advice, I don’t know. I certainly felt that she did not consider the competitive environment (market leaders) and elasticity based on the reality of the limited purchasing power of users even with medical insurance. But I find that establishing a pricing model demands considerable research and marketing dynamic analysis. To some degree the baseline pricing model needs to be determined by the cost of capital – the expected minimum return demanded by investors. And that cost of capital is clearly underlined within my financial models. On the upside, my pricing model treats this upper baseline approach as a quadratic equation taking into account competitors, elasticity, early adopter pricing, regulatory (medical reimbursements) and production costs.