I was at a meeting a few months ago with a potential client, a startup with 5-10 employees, discussing their medical device. It was a disposables revenue model with injection molded plastic and electronics in a single-use device. As part of our initial product definition discussion I asked what the end user sell price would be and was told $50, their margin was presumably based on their understanding of what the market would bear including the available reimbursement. In my mind I did a little quick rule-of-thumb math. I assumed a target of 75% gross margin for a disposable which meant $12.50 landed cost. Then I assumed that the landed cost would be roughly double the raw parts cost, which is about right in our experience for complex medium volume medical manufacturing. That left $6.25 for parts.
When I asked about the costs of the components they rhymed off a bunch of expensive chips and connectors totaling over $20, which in the simplified model I sketched out above would put their target sell price at around $160. They would definitely not have been able to build a successful company and attractive acquisition target selling for $50.
This story is in fact an amalgam of a number of similar conversations I’ve had with companies over the years. As part of our initial dialog we ask a bunch of clarifying questions to get under the hood and understand how they have addressed the main influencers on product definition. Often we find an area that could be strengthened and one of the most common is in design for margin.
The cost of distribution in medical devices is very high. Depending on the distribution model it can easily exceed 50% margin for marketing and sales. This holds true whether the model is OEM or Strategic partner distribution. With stocking distributors or independent sales reps the costs may be lower but they don’t typically bear the marketing costs for you, and you still need to manage them. Direct sales and marketing may be cheaper but you typically don’t get the reach.
With 50% of the final sell price eaten up by distribution and 25% for the product that only leaves you with 25% for running your company including rent, insurance, staff, R&D and indirect operations costs. Can you live on less than that?
Maybe the numbers in your case are a little different but I’d urge that they be considered carefully as part of defining what product you plan to bring to market.