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MRTS Analytics can bring valuable Cost/Capacity valuation


Imagine an early stage Biotechnology firm develops a disruptive technology. Expansion from R&D prototype to pilot production to full production often experiences lopsided unpredictable costs during the first year of ramping up and ultimately full expansion utilizing full input capacities. MRTS (Marginal Rates of Technical Substitution) can be a significant analytic tool to identify cash consumption when considering capital expansion. Sometimes firms develop a technology which has great marketability but they possess no internal resources to be a “First Mover” marketing organization. Their skill sets are geared towards manufacturing and have neither the capital to invest in or a no sales organization to engage in a market conversion. In these situations, often a Biotech firm seeks a partner who has distribution with a marketing strength, brand identity and significant sales organization.

Recently, an early stage Biotech firm which shall remain unnamed and we will refer to as “Company A” developed a significant new disruptive technology with a SAM (Servable Available Market) in the US of more than 50 million chronic care consumers. A mega Health care firm (shall be referred to as “Company B”) paid more than $150+ million plus for an option for exclusive distribution rights. Company “B” had a limited time period to execute distribution rights but has decided they would “not act” and forgo the $150+ million as they’ve decided to put their muscle behind a internally developed organic technology which might be construed as a half step towards the “true disruptive” technology developed company A. We might consider Company “B’s” organic technology as a mildly disruptive technology (intermediate) which still uses a similar platform but an easier dispensing system to the gold standard treatment. This organically developed product had already consumed huge capital and marketing resources and simply company “B” decided to “leave the dance” and relinquish their rights to company “A’s” real disruptive technology. Company “A” who developed the technology decided to use that $150+ million to triple their manufacturing capacity and believed (rightfully so) there would be another partner found as their technology was truly disruptive and had already been put on the second largest US National Pharmacy chain formulary.

So the question arises how to best efficiently utilize this $150+ million (least cost method). Allocation is a fundamental economic crucible! Looking at throughput, costs, available automated technology, acceleration rates and regulatory review times, using MRTS calculations can be a “measurable Analytic tool” to make an assessment on expenditures and rates of growth verses risk/costs with new manufacturing techniques. Fixed and variable proportions for substitutes can be accurately assessed using such Analytic tools such as MRTS. An elementary mathematical explanation for this blog to move along an expansion path on a cost curve is expressed by (“MRTS”=-∆K⁄(∆L=〖”MP” 〗_L⁄〖”MP” 〗_K )). Choosing an output level by current combinations of Capital (K) and Labor (L) into a linear equation by using an isoquant we can simply find the point of tangency with an isocost line. From there the chosen isocost line determines the minimum cost of producing the output level that has been selected.

While this rendition above seems complicated, it represents nothing more than the use of Economic Quantitative Analytics. Private Equity Banks considering raising capital could use this tool as a “leash” to make determinations on use of capital. What Analytics does your firm use?

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