Tuesday, October 23, 2018

Motivating medical device salespeople

Heart valves are sold by putting inventory at hospitals.  When a surgeon opens up a patient, she chooses a valve size based on the patients heart, and replaces the real valve with an artificial one.  When this happens, the sale takes place, and the heart valve company gets paid.

The problem with a particular heart valve company was that its inventory was too big, i.e., it had inventory in hospitals with small expected sales.  Lets run this through our problem solving framework:

1. Who was putting inventory in unprofitable hospitals? 
Medical device salespeople were placing inventory at hospitals with low expected sales. 
2. Did they have enough information to make profitable decisions? 
Yes, they knew the patient volume and the preferences of the surgeons.  
3. Did they have the incentive to do so? 
No, they were evaluated based on sales and paid a 6% commission on revenue. 

OK, now that we understand the problem, lets look at some solutions: 

1. Split the decision rights, so that salespeople would initiate the decisions, but a marketing team would have to ratify the decision, .e.g, based on expected demand. 
This solution ignores the specific information of salespeople, who may know more than the marketing team.   
2. Change the information flow 
It appears that information is not the problem, so not sure this would do anything.   
3. Evaluate sales people based on net revenue, revenue minus the opportunity cost of capital times the amount of inventory necessary to generate sales, e.g., 12% * $1M=$120,000 if the firm's cost of capital is 12% and it takes $1M worth of inventory (the valve company needs to carry a complete set of sizes) to make sales at a hospital.  
This looks like the best solution.   

If we view the hospital as a unit that this can be viewed as an extent decision (at how many hospitals should we place inventory?) for which marginal analysis is used.  The marginal benefit of placing inventory at a hospital is the contribution margin times the expected sales, (P-MC)*Q and the fixed costs of making the sales are F=$120,000.  If the contribution margin is $30,000, then if expected sales are bigger than the break-even quantity, Q=F/(P-MC)=4, then it is worthwhile to place inventory at the hospital.  

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