8/4/2019 MediDevice_Inc - Exam

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Choosing a Distribution Strategy

MediDevice Inc., a medical device manufacturer, has developed a new blood analyzer for rapid blood testing in doctors offices. Themuch anticipated device will receive final regulatory approval in time for a January 2010 launch. MediDevice has the next 12 months towork out the final details for its commercial plans. This device is revolutionary and has worldwide appeal. Target markets for 2010 arethe United States, Europe, and Japan.

Demand for this product is driven by the fraction of doctors offices adopting the technology. Forecasts indicate 10 percent of doctors

offices in any country will potentially adopt this type of device. The time it takes to achieve this level of technology adoption isexpected to be two to seven years, depending on several factors including the effectiveness of the sales force in each country.

Each office will buy only one analyzer, but once an office buys an analyzer, MediDevice receives recurring revenue from each officefrom royalties on analyzer supplies (sold by a third party). These annual royalty revenues will continue until MediDevice s analyzer isdisplaced by next - generation technology.

MediDevice expects to be first to market, but a major Japanese competitor is working on a next - generation device. When thiscompetitive device hits the market, it will most likely displace the MediDevice analyzer from a portion of MediDevice s installed base of

doctors offices. However, some of the installed base will continue in use until third - generation devices ultimately take over the entiremarket.

Opinions are divided about the commercial strategy MediDevice should use. It can build its own U.S. sales force and sell directly todoctors, but the company does not have time to put together a worldwide sales team. Alternatively, MediDevice can license the deviceto a competitor to take advantage of its worldwide sales force. A licensing arrangement guarantees instant access to doctors and willprobably lead to faster market penetration but limits MediDevice revenues to a negotiated license fee on each device. On the otherhand, building an internal sales force will increase fixed costs, but it will allow MediDevice to keep all the sales revenue for itself. (Ineither plan, MediDevice earns the same recurring royalty revenue from each office once the device is sold.)

MediDevice will be the sole manufacturer and distributor. Its engineers have assessed the capital required to build manufacturingcapacity for either a U.S. - only or a worldwide launch. MediDevice has identified two alternative commercialization plans:

In the Current Plan, MediDevice will build an internal sales force to sell to the U.S. market only. In the Partner Plan, MediDevice will license the device to the competitor and go for a full worldwide launch.The MediDevice board has commissioned you to perform a cash flow analysis to compare the value of the two plans and make arecommendation. The boards assessments of the key parameters are summarized in the table below:

MediDevice Assessment Low Base High

Market Size U.S. (# of Dr. Offices) 600,000

Market Size Europe (# of Dr. Offices) 450,000

Market Size Japan (# of Dr. Offices) 140,000

Peak market penetration of technology (% of Dr. Offices) 5% 10% 15%

Years to peak adoption (including launch year) 3 5 8

Direct sales revenue per unit ( $ 000s) $8 $10 $12

Annual recurring royalty revenue per office ($ 000s) $0.5 $1 $2

Year when competitor launches next generation device 2012 2015 2019

Percent of offices currently using the MediDevice analyzer that will switch to the competitive product when it launches 50% 70% 80%

Estimated year when third - generation devices completely take over the market 2018 2019 2023

Annual cost to run in - house MediDevice U.S. sales force for Current Plan ( $ M) $ 10 $ 15 $ 20

License fee for Partner Plan (% of sales revenues paid to MediDevice) 40% 50% 60%

Improved time-to-peak adoption in Partner Plan (years) 0 1 2

Total capital cost for U.S. manufacturing ($ M, all spent in 2009) $ 20 $ 25 $ 35

Additional capital cost for international manufacturing ($ M, all spent in 2009) $ 15 $ 20 $ 35

Variable manufacturing cost per unit ($ 000s) $ 3 $ 4 $ 5

Differences in the timing of the cash flows could be critical, so you need to take the time value of money into account. The usual way todo this is to compute the net present value (NPV). So choose the net present value of cash flows as your outcome measure.