PREDICTIVE MODELING FOR THE HIGHLY UNLIKELY Estimating the Effect of the Fiscal Cliff Deal on Total Orders of Medical Equipment in the US

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By Anton GerunovSenior Business Consultant, GemSeek Consulting

THE “BLACK SWAN” MODEL: MODELING THE HIGHLY UNLIKELY

In times of benign economic conditions common forecasting tools such as time series models provide extremely good approximations. The real challenge comes as your company needs a model for a “black swan” – a highly unlikely yet extremely influential event with significant bottom line impact. The GemSeek team has built upon our vast statistical expertise to provide customized solutions for challenging problems in our domains of expertise – healthcare, pharmaceuticals, and consumer goods. Recently we had a particularly interesting question at hand: one of our customers – a leading medical equipment company with large presence in the US market – needed scenarios for the impact of the Fiscal Cliff deal on total orders and its own market share. With such unprecedented policy changes traditional tools tend to become unreliable and thus turn into a poor guide for executive decision-making.

GDP VS. HEALTHCARE SPENDING

The Fiscal Cliff can affect the market through two main channels – direct spending cuts and second-order income effects. As budgets are sequestered and possibly hospitals made to take up some reimbursement costs, this will affect total available financing for equipment purchases, thus contracting orders. A more subtle effect is that an overall government spending contraction leads to decreased GDP growth and a dropdown in related indicators such as personal disposable income. Less income means less spending on consumption, including health. The effect of depressed demand for healthcare service will spill over into less demand for equipment.

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Naturally there is also the additional caveat of timing – these effects do not happen simultaneously, often the lag is substantial, and their quantitative effect might not be large. To properly evaluate impact, we resorted to a combination of modeling, benchmarking and expert evaluation. While GDP decreases have large quantitative impact on healthcare equipment orders in smaller economies (we estimated that a 1% decrease in GDP leads to 2-3% decrease in total market in Spain, Greece and Italy), this result was unlikely to carry over to a large and sophisticated economy such as the US, especially given the structure of its tender procedures. Modeling the US alone made a case in point – the total market effect is less than 1% decrease in orders, corrected for direct spending cuts.

Market positioning also has to be taken into account as some companies’ orders may not be perfectly synchronized with the overall market. In fact, that is exactly what we observed as we took a deeper dive. Taking into account possible complications, and cross-checking with a bottom-up model, we reached a 95% confidence interval for parameters under interest, allowing us to produce a robust quantitative estimate of the effect of the Fiscal Cliff.

APPROACHES TO MODELING POLICY SHIFTS

This analytic approach allows the production of a number of scenarios, in this case the market size impact as different combinations of spending cuts are introduced. Following the hard deals reached in January and March respectively, it seems that the final net effect will be relatively small – we estimate a total market impact of approx. USD 120 million, spread over a period of two years. Such a deep modeling approach also allows for rich scenario-building capabilities that can be readily employed for unexpected policy shifts beyond the initially envisioned ones.

PREDICTIVE MODELING FOR THE HIGHLY UNLIKELY Estimating the Effect of the Fiscal Cliff Deal on Total Orders of Medical Equipment in the US

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GEMSEEK LIKES CHALLENGES NEVER SEEN BEFORE

While the Fiscal Cliff might well be an exceptional occurrence, businesses operate in a constantly changing fluid environment that presents many challenges never seen before. A sophisticated analytic model can provide great value in supporting the design of alternative strategic actions. If you are interested how this can be applied to your organization or your specific problem, we would be more than happy to discuss in person or via a conference call.

Can we help you? Contact GemSeek’s Senior Business Consultant Anton Gerunov at: office@gem-seek.com.

We will offer a free consultation and an inventory of the data sources available for your industry and markets.

PREDICTIVE MODELING FOR THE HIGHLY UNLIKELY Estimating the Effect of the Fiscal Cliff Deal on Total Orders of Medical Equipment in the US