This section gives an initial example of the extrapolation of statistical results
to business values and decisions, based on simple averages.
Say you are doing an analysis for a potential new drug. The following is information
you currently hold:
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You calculate a mean lifetime net present value of customer spend, if prescribed,
of $1,800 and also get a 95% bootstrapped confidence interval for this mean of $1,000
to $2,550.
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There is an estimated potential for 15,000 customers. Although R&D has been completed,
the drug production will have an initial development cost of $8 million and production
costs per customer of $500.
As a business person, perhaps you would like to answer the following with regard to
this scenario:
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What is my mean estimated profit from this scenario?
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What is the highest and lowest profit in this scenario?
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What is the breakeven lifetime customer value?
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Should we launch the drug?
The statistical analysis works on the principle discussed in this chapter that the
profitability will equal:
Profitability = Value * number of customers – fixed cost – variable cost
Based on the fact that the value has a low, medium and high value (mean and confidence
interval), this leads to three profitability values:
High profitability: $2,550*15,000 – $8million – $500*15,000 = $22,750,000
Mean profitability: $1,800*15,000 – $8million – $500*15,000 = $11,500,000
Low profitability: $1,000*15,000 – $8million – $500*15,000 = -$500,000 (loss)
This does mean that the confidence interval of values includes the possibility of
a loss. The breakeven value can tell us how far along the spectrum of CLVs a positive
profit starts to occur. Breakeven occurs at profit = 0, i.e.
(Lifetime value * Number of customers) – Fixed cost – (Cost * Number of customers)
= 0
Breakeven CLV = (Fixed cost + Variable cost) / Number of customers
= ($8million+$500*15,000) / 15,000
= $1,033
This breakeven CLV is quite close to the lowest end of the confidence interval. In
fact, if we were to loosen our confidence to 90%, the lowest end of the confidence
would probably be in positive profit territory (because less confidence makes for
a narrower confidence interval). This suggests that the risk of loss is relatively
low, and the vast bulk of the statistically likely range of profits is positive.
Of course, as discussed earlier, many organizations aim for a positive profit breakeven
to achieve a minimum cost of capital. The above equations could easily be adjusted
to reflect a minimum cost of capital.