Augustine Medical Must Determine How

Augustine Medical must determine how to price their new Bear Hugger thermal system, used to treat hypothermic post-op patients. Several factors will play into the decision. In preliminary surveys, response to the system was positive but it was indicated that price will be a factor in purchase decisions. The most direct competitive product is marketed at $4,000 in England, but is not available in the U.S. market. Water-based competitors are priced between $2,999 and $4,735. The Bear Hugger represents superior technology to the water-based competitors. Competitors offering disposable blankets price them between $20 and $24.

Another factor of importance is the limit for independent purchasing decisions. Any capital purchases over an average of $1,500 are subject to approval from budget committees. Thus, if Augustine prices below $1,500, they are liable to see an increase in sales as a result. Another factor to consider is discounting. Discounting is a common practice in the industry, so the list prices quotes for competing products are unlikely to represent the average sale price. Some in the survey indicated that they would be willing to accept a free machine and then pay for the blankets. Blankets, however, are often discounted at 50% of list price. Some units, such as the $2,999 manual units, are discounted as much as 40%.

The size of the market can be calculated by first determining the market size for each segment. Each Bear Hugger unit is expected to serve 8 beds. Thus, we take the average size of the hospital in each segment and divide be eight to determine the number of units for each segment. The results are as follows:

7-11 beds

1281 hospitals

1409 units

12-17 beds

18-22 beds

23-28 beds

29-33 beds

33 (avg used 35)

Therefore the total potential demand in the United States is 2742 units.

The blankets are disposable. This means that one blanket will be required for every surgery. We have estimated our sales based on the two largest segments of the market, hospitals with 7-11 beds and those with 12-17 beds. This will give us the most efficient use of our sales dollars. These two segments represent, in total, 60% of all surgeries. The total number of surgeries is 12,600,000 per year at these hospitals. Of these surgeries, 60-80% result in hypothermic patients. We will use the conservative estimate, which gives us a total potential market for blankets of 7,560,000 per year. Of these, we must remember that the Bear Hugger will not be used for infants, on whom heat lamps are typically used to combat post-op hypothermia. We do not know the exact percentage of surgeries that are performed on infants, but we should understand that this fact reduces the potential target market somewhat.

In order to set the price, we must consider the cost of competing products. Warmed hospital blankets cost $0.13 per pound to launder. Even at two applications per surgery, this is the least expensive option because the blankets are reusable. However, this is also the least effective option. Thermal drapes are another inexpensive, but inefficient option. The Bear Hugger technology is vastly superior and should not be considered competitive with these two options. Those options may reduce our total market potential, but that will not affect our contribution calculation unless our market potential drops so low that we do not cover the $500,000.

Doctors have indicated that making the patient feel more comfortable is important, meaning that demand is relatively price inelastic when compared with these low-end solutions. Evidence shows, however, that demand is highly price elastic when compared to similarly-effective solutions.

There are four pricing alternatives from which to choose. The first is $995 for the unit and $12 for the blankets. The second is $1,499 for the unit and $20 for the blankets. The third is $3,995 for the unit and $22 for the blankets. The fourth is $5,000 for the unit and $25 for the blankets. Fixed costs are $500,000. The contribution margin is expected to be 70% on the units and 60% on the blankets on the delivered price.

Our demand estimates are derived based on the price relative to the main competitors, and take into consideration the impact of having to gain formal approval beyond the $1,500 price point. We have also assumed that wherever we set our price point, we will need to offer a discount. Buyers expect to receive a discount, so we believe that even if we offer a low price point there will be a psychological need on the part of the buyer to receive a discount; not offering one could compromise sales.

The $995 machine and $1,499 machine will be able to capture significant market share, because they are price below existing inferior technologies. These rates also come with lower blanket costs. The $995 machine offers blanket costs of $14, lower than our competitors. This will help lower operating costs for hospitals by 30-41% over existing disposable blanket costs. At 10 million surgeries, this represents a significant savings. For this reason we feel that the $995 machine and $14 blankets will be able to capture a 60% market share. The $1,499 machine with the $20 blankets will capture a smaller, but still significant market share, perhaps 40%.

The $3,995 machine with the $22 blankets is comparably priced against competitors. We believe the Bear Hugger represents superior technology. This will allow us to capture some of the market, maybe 15%. We feel that the highest price point, $5,000 for the machine and $25 for the blankets, best represents the value of our technology. However, at these levels, the price elasticity between us and our major competitors would limit our sales. We expect that we would only be able to capture a 5% market share if we priced ourselves above our competitors. Our estimated market is 7,560,000 surgeries for the number of blankets and 2117 machines. The blankets at the $14 range would contribute the following, based on 50% discount and 40% commission on delivered price.

The contribution at the $995/$14 price point is therefore: $14 * 50% = $7 delivered price