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About Eli Lilly & its Company Environment in 1993

Eli Lilly & Company ranks among the top six pharmaceutical companies in the
United States. Currently in 2007, Lilly produces products that treat
depression, schizophrenia, attention-deficit hyperactivity disorder, diabetes,
osteoporosis and many other conditions. In 2006 it was a $15.7 billion dollar
company with a large part of those sales coming from its top products
Zyprexa (treatment for schizophrenia and bipolar disorder), Prozac (an antidepressant), & Cialis (erectile dysfunction).
Drug discovery and development is the life-blood pharmaceutical industry,
and it typically takes 8-12 years for each company to identify and develop a
product that can be sold in the marketplace. This process includes three
phases of clinical trials, process development for commercially manufacturing
the product, designing appropriate dosing strengths and delivery methods,
and a required FDA approval process. Based, in large part based on two
blockbuster products Prozac (anti-depressant) and Ceclor (antibiotic), Lillys
portfolio of products was strong by industry standards in the early 1990s and
in terms of company sales Lilly was ranked in the top nine drug companies in
the world. However, those two key products were moving into the later years
of their product life-cycle, and the company needed to start looking to
develop new product to replace their current blockbuster products and stay
competitive in the industry amongst a variety of competing factors.

Situational Analysis
Eli Lilly needs to improve the profit margin to sustain their business in
competitive pharmaceutical industry.
During the 1980s, pharmaceutical companies enjoyed an annual growth rate
of 18% and average gross profit margins on products of 70% - 85%.
However, in 1991 new industry issues began to change the industry
environment. Those factors included a slowing rate of innovation,
diminishing price flexibility, increased competitor competition, and an
increase in manufacturing cost.
The slowing rate of drug innovation was trend that actually began throughout
the industry in the late 1980s. Tightened regulatory requirements from the
FDA also posed a challenge to drug development, and many companies
including Eli Lilly were struggling to develop new product that could match
the success of current blockbuster drugs. Exclusivity in the market was also
diminishing rapidly, as many "me too" drugs and generic products crowded

the marketplace. This increased competition in the industry for blockbuster


drugs within therapeutic areas and rapid introduction of generics in the
market reduced period of market exclusivity resulting in reduced sales and
less time for each company to recoup its substantial R&D investment and
thus forcing Pharmaceutical companies to raise the prices of their drugs in
order to maintain profits. The cost to develop new drugs is also increasing
rapidly, as R&D investments and overall expenditures increase, COGS is
expected to jump to 60% of sales by the year 2000.
Manufacturing costs have already doubled, and there are no new drugs being
made to offset this increase. In addition, new FDA regulations required
different production equipment and the EPA was requiring heavy investments
on pollution control equipment. All of these changes compounded with the
new production technology necessary to produce complex molecule raised
the costs of manufacturing dramatically.
In addition, because of government regulation to curb the increasing costs of
consumer healthcare, the price flexibility that most of the top pharmaceutical
companies had long enjoyed, was diminishing rapidly. The squeeze was
continued by HMOs and managed care providers who, because of their
increased presence in the market, could buy pharmaceutical products in bulk,
and thus demand a significant discount amounting to almost 60% of prices.
This combined with the need of top companies like Eli Lilly to maintain strong
relationships with the HMOs in order to maintain strong formulary positions
was another new challenge to face.
Finally, the cost of manufacturing pharmaceutical products was also
increasing due to several reasons. More stringent FDA regulations on product
quality, combined with new EPA requirements on the type of production and
environmental control equipment used caused the overall industry costs of
manufacturing to increase from 10% of sales in the 1980s to 20% of sales in
the early 1990s. Also the new drugs that were in the development pipeline
were more complex and made from highly potent compounds that required
more advanced and costly production technology.

Specialization vs. Flexible plant analysis SWOT


Analysis

Strength

Specialized Facility
Cost/Kg is less
Effective utilization is

Flexible Facility
Same facility can be
used to produce

80%
Output per Rig is higher
Weakness

Total capacity is either


under or over utilized
Launching new products
could be delayed by
weeks or months
costing millions of USD
lost in sales

Opportunity

Total cost per year is


less

Threat

Inflexible operation,
therefore a facility
cannot be modified to
produce another type of
product

different type of
products flexibility of
operation
Total cost per year is
high (3 times)
Effective utilization is
65%
Output per Rig is higher

No capacity waste, since


it can handle all types of
products
Reduced lead time for
manufacturing new
products
Less capacity than
specialized capacity
Can lead to sales loss
for generic products,
which have
incrementally increasing
demand

Alternatives
1. Build Specialized manufacturing facility
1.1. Reduction in Development Lead-time and Manufacturing Costs
If the company decides in the favor of specialized facility for
manufacturing, there will be no reduction in the development lead time
as a new facility will have to be created for each new product. Also,
since the facility is built only for a specific type of product, there is no
flexibility in operations of a specialized facility. However, they have an
advantage in terms of the total costs involved. The total cost for the
three new products per year is 9.3 million USD over the life of the
products (15 years).

Construction Cost
Annual Operating Cost

37.5 Million USD


6.8 Million USD

Total Cost

Capacity in Rigs
Max output (KGs)
Output per Rig
-

In 15 years = 102 Million USD


In 15 Yrs = 37.5 + 102 = 139.5 million
USD
In 1 year = 139.5/15 = 9.3 million USD
1.5
24,000
24,000 / 1.5 = 16,000 KGs

Cost will be $930 in the first year and then reduces to $433 in the later
years.
Total capacity of the specialized facility is 24,000 kilograms and the
expected demand never goes beyond 21,000 kilograms. Therefore,
there is no loss in sales because of insufficient capacity of the facility.
These types of dedicated facilities have a fixed available capacity for a
product. During the earlier years the utilized capacity is not high which
will result in wastage of resources as well.

1.2. Effect on Revenue


A specialized facility plant would have higher output per rig as
compared to a flexible facility. Also the utilization rate is higher for a
specialized facility (80%). There is no direct impact on the revenue if
specialized facility is chosen.

2. Build flexible manufacturing facility


2.1. Reduction in Development Lead-time and Manufacturing Costs
-

For the three products on the pipeline, there will be no reduction in the
development lead-time but the development lead time would reduce
for the future products. Average total cost per year as 19.48 Million
USD.

Construction Cost
Annual Operating Cost
Total Cost

Capacity in Rigs
Max output (KGs)
Output per Rig
-

150 Million USD


9.48 Million USD
In 15 years = 142.2 Million USD
In 15 Yrs = 150 + 142.2 = 292.2
million USD
In 1 year = 292.2/15 = 19.48 million
USD
3
14,625
14,625 / 3 = 4,875 KGs

Even though the total cost/kg reduced over time, it is still higher in the
case of flexible facility as compared to specialized facility
In this case the facility suffers from under capacity from year 2000
onwards; the facility reaches the maximum capacity and can't handle

more production. This leads to lost sales as the company is not able to
fulfill the market demand for the product because of insufficient
production capabilities.
On the other hand, we should also note that there is no loss related to
wastage of available resources unlike that of specialized facilities.
2.2.

Effect on Revenue For the three products

There will be no advantage in terms of the lead time but the


subsequent new products will come to the market 1 year earlier. So
there will be a revenue improvement because of the advantage
associated with getting a new product to the market earlier. Getting a
new drug to market one year sooner meant one year's sales gained.
Capacity utilization of the facility in the year by year basis. We can
safely assume that bringing the product one year earlier will give an
additional advantage of the 16th year revenue, which should be
around the revenue recognized for 50% (assumption) capacity
utilization of the facility.

3. Make a hybrid of flexible & Specialized manufacturing facility


3.1. Reduction in Development Lead-time and Manufacturing Costs
-

It is highly recommended to have a hybrid system wherein, we will


have Flexible system during the earlier life of the product but after few
years (in our case 5' year) a dedicated specialized facility will be used
for the same product. In this case we make a dedicated facility for
Alfatine only.
This will help in reducing the manufacturing costs during the earlier
part of the product, since only the market demand will be catered and
hence, there will be no wastage of available capacity.
3.2.

Effect on Revenue

During the earlier years of the product, it will be manufactured in the


flexible facility; we will have the 1 year advantage.
During later part of products life, having the specialized facility will
boost up the available capacity so that market demand can be fulfilled
and hence will add to the revenue generated.
However, it should be carefully understood that the hybrid system
should only apply to the product which are expected to have
consistently high demand in the future. For other products which don't
match the criteria should be manufactured in a flexible manufacturing
facility only.

Recommendation
Eli Lilly and Company is recommended to have a hybrid facility system where
the product is manufactured in the flexible facility until the 4 th year and then
have a dedicated specialized facility after that.
In case of unsuccessful products, the flexible plant can still be used to
manufacture generic drugs.