Life sciences companies going commercial for the first time have the opportunity to create significant shareholder value – but the path to achieving this milestone will likely be volatile. The words that best sum up my advice to management teams and boards at life sciences companies that embark on the path to commercialization is “BE COURAGEOUS”.
Transitioning from pre-commercial to commercial is an exciting time, filled with risks and rewards. But the odds are that moving along this trajectory is going to cost more, and take longer, than most of your stakeholders think or want. And while, in an ideal world your investors, board members and management team would be patient during the time it takes to go commercial, things may not always play out this way.
In fact, a recent analysis by Lazard of the 98 public biopharma companies commercializing their first key product since 2017 compared their stock price performance to the XBI (S&P Biotech Index). The median stock price performance of these companies was -61% by the end of the second year! And only 5 companies traded up in value over their first three years.
Your goal as a life sciences company commercializing for the first time, is to be one of those five. The following are key lessons I have learned while being part of the leadership teams at several life science public companies – in just this situation.
Here are five ways a life sciences CFO can optimize the potential for success while helping to lead a company on the journey towards commercialization:
1. Remember that Revenue is a Lagging Indicator
An experienced VP of Sales introduced me to the concept that revenue is a lagging indicator. As a life sciences player, it’s easy in the excitement of going to market for the first time with a disruptive product, no competition, pent up demand, and a green field ahead of you, to think that the product will “sell itself.” I hope you get so lucky.
Recently I was talking to a team at a Specialty Pharmacy company who helps drug manufacturers launch their products. Their experience has been that the first 13 weeks of commercial launch typically dictates the ultimate success or failure of a drug product. Therefore, prior to this key period, you must: invest in identifying potential customers; create a value proposition; and enlist key opinion leaders to validate your product, value proposition, and (in the case of life science companies) mechanism of action. You need to: generate leads; establish sales territories; hire sales representatives and train them; and if appropriate invest in demonstration equipment or medical sales liaisons, and much more.
If you want to drive those first 13 weeks of sales and be successful, all this must be in place and fully functioning prior to launch. Alternatively, if you wait for revenue results at the end of 13 weeks to make your decisions about ramping up investment in your commercial platform, you will be too late.
2. Understand the Catch 22 of Capital Allocation
The Catch 22 dilemma is that if you invest too little capital in your company’s commercial platform prior to product launch, you’ll under shoot your revenue expectations and be doomed to failure. Conversely, if the launch doesn’t go as expected and you invest too much capital, you’ll burn through your cash and be doomed to failure. [My recommendation is that you raise as much capital prior to commercialization as you can. Don’t let fear of dilution get in the way.]
To help resolve the Catch 22 of capital allocation in the early quarters of commercialization, I recommend concentrating on the rate of growth versus the size of the investment. If the investment in the commercial platform is driving an attractive rate of revenue growth, your valuation will soar which will allow you to raise additional capital. You’re in the “golden zone” so, rinse and repeat. If the investment doesn’t drive an attractive rate of revenue growth, then storm clouds are brewing.
As one CEO put it in sailing terms, “I’m the skipper taking the boat out to sea. Your job is to keep an eye on the shore to make sure we don’t lose sight of dry land.”
I recommend that companies pursuing commercialization create both a high-level long term proforma financial model that identifies cash flow breakeven and a more detailed sales rep productivity model. These two key tools can act as your compass when keeping an eye to shore.
Note that neither of these models have to be exactly “right”. They need to be representative of key drivers in your business and be realistically achievable at some future point in time. You will refine them as you learn more about your business, and of course, they will vary, business to business.
The following is a simple example of a medical device company selling a piece of capital equipment (one time revenue) that works with a disposable product that is used per surgical procedure (recurring revenue).
Proforma breakeven occurs at $100m in Revenue, with 77 sales reps at an average productivity of $1.3M per rep anticipated to occur in Year 3. By plotting where you are today and where you “think” you will be in 3 years, you can determine the amount of capital necessary to bridge to cash flow positive.
3. Learn at the “Speed of Light” and “Fail Fast”
Learn fast and adjust rapidly. Populate your proforma model with real time data, look at how this is impacting your long-term results and challenge whether you are on track or need to make changes to your strategy.
In the example above, closely track your new account win rate, average revenue per new account, rate of repurchase, average revenue per repurchase, etc. Are these tracking to your Sales Rep Productivity Model? If not, why not?
Some more real-life examples from my experience:
At one company we opened a new sales territory. Year 1 saw revenues grow to $300,000, but in year 2, growth stalled at $350,000. After discussing this with sales leadership, we determined that we were not going to reach our long-term productivity target. As a result, we consolidated the new territory into a neighboring one, increasing that territory’s productivity and reducing our overall investment.
At a different company, we identified that the initial order for our disposable product was significantly larger than the subsequent re-order. This was due, in part, to the sales rep’s compensation plan which rewarded the sales rep significantly for winning large new accounts, including large initial stocking orders. Pay attention to the sales commission plan – make sure it rewards the desired selling behavior.
Looking beyond sales and marketing – the initial gross margin projections will be estimates, and likely include some assumed volume efficiencies. Make sure your product is hitting its cost estimates. Within R&D, cost reduction projects are often seen as “unsexy”, but in fact, they will likely pay for themselves many times over. Examine yield rates and pay particular attention to warranty costs in the early days as these can be areas of gross margin leakage and push out the time to reach cash flow breakeven.
4. Avoid Projecting a Valuation “Priced to Perfection”
Another valuable tip is to set external expectations appropriately and realistically, which generally means erring towards the conservative end of internal expectations.
The worst day of a company’s share price performance should be the day after you announce guidance for the upcoming year. This is your chance to avoid being “priced to perfection”. Your company’s share price will recover as you deliver on expectations and ideally raise your projections throughout the year.
You should remain enthusiastic about the overall long-term market opportunity but also highlight the pragmatic challenges facing the company as it executes its commercial plan. Opening new sales territories and/or backfilling existing territories takes time. New medical device sales reps often take 9 months or more to come up to speed. And scaling the supply chain comes with unknown risks. These are all normal business risks associated with pursuing a path to growth. Clearly communicating them allows investors to understand the challenges of the business and possible speed bumps ahead.
One CEO I worked with was intent on avoiding any discussion of the risks to commercialization when recapping our company’s story for investors. He saw this as projecting weakness and naturally, he wanted to project strength. We came to market with a disruptive surgical device, and expectations were high. Initially sales were very strong, but we ran into a quality issue with the product and had to take it off the market. Although this was only for a matter of weeks, we were not able to make up the lost revenue. In the end, we were unable to meet investor expectations because the company had been priced “to perfection.” Lesson learned!
5. Find the Path Back to Redemption
Finally, one last piece of advice as you and your management team maneuver down the path towards commercialization. If you are unfortunate and have a bad quarter, get the news out right away.
A common strategy is to pre-announce bad news ahead of your scheduled earnings call. You want to be completely transparent with current and prospective investors. They will always see this as a sign of good management.
Avoid the temptation to delay and cushion the disappointing news of a revenue miss with the reasons why.
Get the bad news out early, wait a beat or two, and then provide the context, lessons learned, and how you will move forward in the subsequent earnings call.
The good news is that typically the stock market has a short memory and recognizes that the path to commercialization is rarely smooth. If you can establish realistic expectations and execute, you will be rewarded.
Each of these five recommendations should help arm you with the tools and approaches to making good business decisions as your life sciences company marches towards commercialization. Then, as they say, you just need to “be courageous”!