Why Starting with Small Markets Provides Superior Financial ReturnsApr 13, 2022
Consider a medical device startup, facing a critical market decision:
Should the company go big, aiming for the $1B market out of the gate? Or should the company go small, proving value with an initial population having poor medical outcomes?
At face value, you may suggest the large market. After all, that’s consistent with conventional wisdom about healthcare investing. You need the huge market to provide the returns expected by venture capitalists.
Here’s a financial analysis that illustrates why the opposite is the better path to providing strong financial returns.
The image below is a decision tree that starts with the question listed above.
The upper branch is the large market, showing three sub-branches that define various outcomes. These three outcomes are supplemented with probabilities, which sum to 100%.
Each sub-branch value is the product of its financial outcome and corresponding probability. When these sub-branches are summed together, an Estimated Monetary Value (EMV) is calculated, which is shown as $16M.
Using the same process, the EMV is calculated for the small market. This lower branch shows that the large market is pursued if and only if a highly successful outcome is first achieved with the small market. This small market, with conditional expansion to the larger market, results in an EMV of $31M – nearly 2x the EMV for the branch solely pursuing the large market.
So, the smaller market first approach yields superior financial results.
Of course, any financial model is only as good as its assumptions. Below are some of the primary ones used in this model:
1. Success Probabilities of the small market are superior to those of the large market. The medical device company is more likely to achieve its primary clinical outcome by focusing on a small market with a poor baseline outcome than a large market with a moderate baseline outcome. Achieving this primary clinical endpoint will contribute to higher likelihood of achieving market uptake and a successful financial outcome.
2. Success Probabilities for the large market improve after the small market has been validated. In the lower branch, the large market is pursued only if the small market has first been validated. This early data will improve the likelihood of success with the larger market. If the small market is not highly successful, then the larger market is abandoned, and the corresponding investment is saved. Hence, the success probabilities for the larger market that follow the small market validation are superior to the those in pursuing the large market alone.
3. Capital outlay for the small market is lower than that for large markets. Assuming point #1 is true, the sample size of pre- and post-market clinical studies will be lower for the small market than the large market. This translates into a lower capital outlay for the small market than the large one.
This decision tree model is far from perfect. Focusing on small markets does come with some other challenges, namely:
Recruitment & Enrollment – Focusing on a small market will most likely require that patients be recruited beyond a single geographic region. This may require a multi-site study, which could increase clinical study complexity, management, and cost.
Timeline – The lower branch, starting with a small market then transitioning to the large market, will likely require two separate products. Hence, the time for design, manufacturing, verification, validation, and regulatory approval may be elongated in comparison to pursuing the large market alone.
Even with these challenges in-mind, the small market approach is likely to be a faster route to market (in)validation. Most investors operate with a “kiss” or “kill” mindset. The early market insight will provide investors with information needed to either halt or re-up on further investment.
Another consideration is the EMV for the small market if the larger market is not pursued. Is there any value in the small market alone?
Sure, it does not have the significant financial upside that the larger market does, but the probabilities of success are higher, and the capital outlay required is significantly lower. Considering these points, the EMV for the small market (without pursuing the large one) is $14M. In comparison to the EMV for the larger market ($16M), it is not far off. And the timeline to market validation for the smaller market will be much shorter than the larger one, which will result in a superior internal rate of return (IRR) – the primary metric for evaluating investment performance.
When should the large-small market decision be made?
Ideally, the decision of initial market occurs at the very beginning of product development. Step 1 in designing a medical device is defining who it’s for. A small population is likely to have unique user requirements that define the design inputs of the medical device. If this decision is deferred too long, then the design, the human factors studies, the manufacturing, and other elements of the design process may need to be repeated.
Too often, medical device companies aim to create a single product that addresses a massive market. This can be a significant mistake since the usability requirements, clinical requirements, unit level economics, data tracking requirements, and other details often vary between customer segments. As the saying goes, “designing for everyone is designing for no one.”
If you need help defining your market strategy and designing your medical device, reach out to us at Archimedic. Feel free to reply to this email to get the conversation going, and one of our team leaders will be in touch with you.
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