How should pharma startups calculate unit economics?
In the rapidly evolving landscape of healthtech and pharma, calculating unit economics is a complex and nuanced task. Unlike other industries, pharma startups face unique challenges that distort traditional CAC (Customer Acquisition Cost) and LTV (Lifetime Value) metrics. Regulatory delays, patient churn, and clinical success rates all contribute to the difficulty of accurately modeling unit economics. Yet, understanding these variables is crucial for maintaining investor confidence and ensuring long-term viability.
In this blog post, we’ll delve into the intricacies of pharma startup unit economics, exploring the variables that affect CAC and LTV, and providing practical guidance on how to calculate and interpret these metrics.
Understanding fixed vs variable costs
Pharma startups often underestimate the importance of distinguishing between fixed and variable costs. Fixed costs, such as salaries, rent, and equipment expenses, remain constant regardless of production volume. In contrast, variable costs, like raw materials and manufacturing expenses, increase proportionally with output.
When calculating unit economics, it’s essential to allocate costs correctly. For instance, if a pharma startup has a fixed cost of $100,000 per month for salaries and rent, this expense should be spread across all units produced, not just those sold. Conversely, variable costs, such as $5 per unit for raw materials, should be directly tied to the number of units sold.
R&D amortization: the hidden cost
Pharma startups typically invest heavily in research and development (R&D) to bring new treatments to market. However, R&D expenses are often amortized over a set period, which can mask the true cost of developing a product. To accurately calculate unit economics, startup founders must consider the full R&D cost and not just the ongoing expenses.
For instance, if a pharma startup invests $1 million in R&D to develop a new drug, the total R&D cost would be $1 million. If the company expects to sell 100,000 units of the drug, the R&D cost per unit would be $10 ($1 million ÷ 100,000 units). This figure should be factored into the overall unit economics calculation.
Scale economics: the importance of economies of scale
Pharma startups often benefit from economies of scale as they grow and produce more units. By leveraging these economies, companies can reduce variable costs per unit, increasing profitability. However, scale economics can be distorted by regulatory delays, patient churn, and clinical success rates.
For example, if a pharma startup produces a new drug, but regulatory approvals are delayed, the company may not be able to produce and sell the maximum number of units it had anticipated. This can lead to higher costs per unit, reducing the overall profitability.
Calculating unit economics: a step-by-step guide
To calculate unit economics for a pharma startup, follow these steps:
- Determine the total revenue generated by the company.
- Calculate the total cost of goods sold (COGS), including raw materials, manufacturing, and R&D expenses.
- Allocate fixed costs, such as salaries, rent, and equipment expenses, across all units produced.
- Calculate the variable cost per unit, including costs directly tied to production, such as raw materials and manufacturing expenses.
- Consider R&D amortization and factor it into the overall unit economics calculation.
- Identify scale economics and adjust costs accordingly.
- Calculate the customer acquisition cost (CAC) by dividing the total marketing and sales expenses by the number of new customers acquired.
- Calculate the lifetime value (LTV) by multiplying the average revenue per user (ARPU) by the average customer lifetime.
Conclusion
Calculating unit economics for pharma startups is a complex task, requiring a deep understanding of the unique challenges and variables that affect CAC and LTV. By distinguishing between fixed and variable costs, considering R&D amortization, and identifying scale economics, pharma startup founders can create a more accurate narrative around their business. Accurate modeling is critical for maintaining investor confidence and ensuring long-term viability. By following the step-by-step guide outlined in this post, pharma startups can gain a better understanding of their unit economics and make data-driven decisions to drive growth and profitability.
Source:
https://www.growthjockey.com/blogs/health-pharma-unit-economics-calculation
