Elililly
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INDUSTRY OVERVIEW
The market size of pharmaceutical industry in 1993 totaled $191billion worldwide.
Top 15 competitors accounted for more than one third of the industry sales. US pharmaceutical industry is one of the fastest growing sectors in the US economy. It grew at a CAGR of 18% from 1982 to 1992 but this growth rate was expected to fall down to 8-12%. Eli Lilly was one of the four largest companies in the US. Among the most critical activities for pharmaceutical companies was the discovery and development of novel therapeutic compounds.
The number of uncertainties involved ranged from approval by the FDA to the amount of the new drug that would be required for the market. The pharmaceutical products were sold to hospitals, HMOs, retail pharmacies and physicians. Volumes were declining but still the pharmaceutical companies were able to maintain revenue and earnings growth by raising prices. Average gross margins in products ranged from 70-85% in the US. During the 90s, the industry started facing pressure due to the following factors:
Rising costs: Even though average amounts invested in R&D had increased, from $1.1billion in 1975 to approximately $12.6billion in 1992 the number of novel drugs launched during this period had risen only slightly. Also, the cost to develop a new drug had increased to $359 million in 1992 from $120billion 5 years earlier. The reasons for rising costs were:
FDA regulations concerning product quality.
EPA regulations concerning pollution control and waste treatment facilities.
Increased potency of drugs which required costly containment facilities.
Development of more complex molecules required more advanced production technology.
Under utilization of facilities.
Pricing Inflexibility:
Government intervention in 1993 which led to caps on price increases and caps on reimbursement for Medicare and Medicaid.
Growth of managed care providers like HMOs which bought in bulk and were able to demand price discounts of as much as 60%.
Increased competition from within the sector. Due to the crowding of the market with substitutes, period of exclusivity was shrinking.
Growing availability and use of generic drugs: These were typically priced 30-60% lower than brand name products.
Long Launch Process: It typically took around 8-12 years for a company to develop the compound into a marketable product even after it has shown to be therapeutically potent.
Consequential to the above mentioned market changes, Eli Lilly needs to act quickly and focus on the following:
Reducing cost of manufacturing
Shorten the time to market
Design shorter clinical trials which is the traditional bottle-neck in the drug development process
COMPARISON OF ALTERNATIVES
There are two alternatives provided in the case, one for a specialized facility and the other for a flexible facility. Here we have done the cost and revenue analysis for a duration of ten years from 1996 to 2005 and made a comparison. The basic details provided for the two options are listed below.
Specialized Facility
These plants could only manufacture products for which they were specifically designed.
Total cost of construction: $37.5 millions; this is calculated using number of rigs being built and used for production. In specialized facility it is 1.5 rigs at the rate of $25 millions per rig.
Operating costs: $6.8 million per annum. The cost is considered to be in real money value terms. Hence, although the cost would increase year by year, when we calculate the present value in real terms, it would come out to be the same i.e. $6.8 millions.
Capacity utilization: 80% for each of the rigs.
Average output per year: 16000kgs for each rig every year at 80% capacity utilization.
Advantages
Product specific design translates into high productivity as capacity utilization is high and there is no downtime in terms of switching from one product to another.
Better yields due to experienced and dedicated operators.
Smoother operations of the processes due to the absence of product changeovers.
Low setup and annual operating costs.
Disadvantages
Product failure may lead to retrofitting of the plant which increases the cost equivalent to coming up with a new rig.
Redesigning of facility to accommodate in case of change in manufacturing process is difficult.
Launch of new product may be delayed due to construction delays as construction of specialized plants start only during beginning of phase 3.
Risk of idle plant due to a delay in the regulatory approval.
The excess capacity cannot be utilized for manufacturing some other product.
Flexible facility
These plants could be used to manufacture any of Lillys new products and could also serve as a “launch plant” for future new products.
Total cost of construction: $150 million; this is calculated using number of rigs being built and used for production. In specialized facility it is 3 rigs at the rate of $50 millions per rig.
Operating costs: $9.48 million per annum. The cost is considered to be in real money value terms. Hence, although the cost would increase year by year, when we calculate the present value in real terms, it would come out to be the same i.e. $9.48 millions.
Capacity utilization: 65% for each of the rigs. The capacity is assumed to be 80% if there are no changeovers as has been mentioned in the case. The low capacity utilization of these rigs as compared to the ones used for specialized