Eli Lilly and Company

The Flexible Facility Decision (1993)

The case is of 1993, Steve Mueller, manager of strategic Facilities planning of Eli Lilly and Company,
is in a dilemma about the type of manufacturing facilities to construct for the three new
pharmaceutical products (Alfatine, Betazine and Clorazine) that the company expected to launch in
1996. He has two options first to build flexible manufacturing facilities which could accommodate all
the new products or to go with the specialized plant.

Eli Lilly and Company, developed, manufactured and marketed pharmaceuticals, medical devices,
diagnostic products, and health products. Company sales were $6.2 billion in 1992 and Lilly ranked
ninth in the world among the drug companies with a 2.5% market share. In the United States, Lilly
ranked among the top six pharmaceutical companies. Ceclor, an antibiotic and Prozac, an anti-
depressant were the two best seller products of Lilly and accounted for a large part of sales: Ceclor
sold $950 million and Prozac sold $1.1 billion in 1992 and both the products were 15 biggest-selling
drugs in the world.

The critical activities for pharmaceutical companies were the discovery and development of the novel
therapeutic drugs. Companies research thousands of chemical compounds to find one that can be used
for treating or curing diseases. Once the protentional compound is found, it takes eight to twelve years
to develop a marketable product. The process includes first testing where the compound is tested for
safety and efficacy in three phases of human clinical trials, and then process is developed for
commercially manufacturing the product and designing an appropriate dosage strength and
formulation (i.e., tablet, capsule, liquid, etc.), the last step involves submitting the product for the
approval by federal regulatory agencies. The fall-out rate of new drugs in development was extremely
high. Once the product is in the market it was sold to hospitals, health maintenance organizations
(HMOs), retail pharmacies, and physicians, each of which prescribed the drugs to patients. Three-
fourth of the sales volume of ethical pharmaceuticals were sold to wholesale distributors and the
remaining one-fourth of the volume was sold hospitals, HMOs, retail pharmacies, and physicians
directly. The pharmaceutical industry was changing as average annual growth was at 18% during
1982 through 1992 but was expected to slip to 8% to 12% range in 1993 and beyond. Although the
sales volume was declining, many companies were able to maintain revenue and earnings growth by
raising prices. New factors like diminishing price flexibility, slow rate of innovation, growing
competition within the drug classes and generic substitutes, more stringent FDA’s regulations and
pollution control laws have put pressure on drug margins. Also, the cost of developing a new drug
was increasing every year.
The competition was increasing as many firms were developing similar compounds and the period of
exclusivity was shrinking. To face this fierce competition Lilly set new goals for reducing lead time
by 50% and reducing manufacturing cost by 25%.

Lilly’s Existing Operations strategy: Eli Lilly Operated 23 plants worldwide including four plants
in Indiana. Out of the 23 plants eight plants were for bulk drug manufacturing and 15 were for
formulation, filling and finishing. Since filling and finishing of products were dependent on market
hence these plants were situated in geographically disperse locations. The active ingredient for a
product did not vary by market hence it was produced in bulk usually in one or two plants to achieve
economies of scale. Tanks where ingredients were combined based on chemical recipe came in
different sizes typically 500 to 4000 gallons with different control, different temperature ranges and
different piping configurations.

In Bulk drug production the unit of capacity was called RIG. A RIG was the set of tanks and
equipment required from start to finish 2000-gallon batches. The challenges of capacity planning were
that the output of a RIG varied by both the product and technology required. In a very complex
product the amount of bulk drug produced from 1 RIG might be only a few hundred kilograms. While
another simpler product might require only one RIG to produce several thousand kilograms of bulk
drug. Thus, in predicting future capacity needs in RIGS, facilities planning needed to take account
both the expected demand for a product in Kilograms and the expected volumetric efficiency of the
process in Kilograms per RIG. The smallest increment of capacity that could be built or added to an
existing facility was one quarter of a RIG.

All Facilities include Single product and Multi product plants which were specialized for a specific set
of products. Because of the time and disruption to existing operations involved in adding physical
capacity, new capacity was built to accommodate estimated peak demand for the product which
typically occurred for the first five years after market launch. As a result, most of the plants were
underutilized for the first few years. In a multiproduct plant capacity could not be swapped among
products excess capacity from one product could not be used to produce any other product. As
demand for a product declined towards the 12 th year of a product the plant would again have excess
capacity. At the end of the products life when Lily would no longer manufacture the drug, the facility
could be converted to produce another product. This change called retrofit involved replacing tanks
equipment and took about one year and the cost of retrofit was almost equal to the cost of building a
new facility.

Most of the plants were specialized however attempts were made to make the plant more flexible. One
of the major concerns of specialized plants were the time involved for design and construction.
Because facilities were designed around specific products and processes facilities engineer couldn’t
their work until process development activities were completed and process technology was finalized.
The company preferred not to start construction until there was a high probability that the product
would make it to market. This created severe time pressure in trying to launch new products.

Bulk Drug Process Development: The challenges of process development had increased in recent
years as molecules became more complex (requiring more sophisticated technology) and as the
company sought to achieve large reductions in overall product development lead times.

Lilly divided process in three phases

1. To develop crude process as quickly as possible in order to make several kilograms of bulk
required to start clinical trials
2. Chemist to determine the sequence of chemical reactions which would be used in the
manufacturing process
3. Completing clinical trials and transfer of the process to the commercial manufacturing site

Sourcing: Bulk chemicals requirements were met both through in-house production and through
outsourcing. Complex and proprietary steps were done in-house. They considered manufacturing
capabilities to be an important competitive strength. Lilly believed that manufacturing in-house was
critical for maximizing speed to market, assuring product quality, and guarding proprietary
technology. Lilly was considering to outsource more of the steps for the older products.

Production Planning: Lilly’s manufacturing while scheduling, took account of product demand,
inventory levels, and production start-ups and shut-down costs. The object of production scheduling
was to optimize these above-mentioned factors. Production scheduling was expected to get more
challenging in the future. High potency molecules consumed more manufacturing capacity per unit of
output because they were typically more difficult to manufacture than older products.

The Manufacturing Facilities Decision: Alfatine, Betazine, and Clorazine were three products in
development at Eli Lilly in 1993, anticipating clearance from FDA. Alfatine was in phase I clinical
trials and thus because of Loracarbef project, they didn’t had time for Alfatine. So, they had decision
to make whether to have specialized facility or flexible to induct new products with current product
manufacturing

There were three products in development at Eli Lilly in 1993, Alfatine, Betazine and Clorazine.
Though there was still some uncertainty regarding the FDA approvals, the company anticipated
launching the three products in 1996. By the end of 1993, a final decision needed to be made
regarding the kind of capacity to be added for the three products. The decision had to be made
considering the importance of meeting the goals of 50% shorter development cycle and a 25%
reduction in costs. There were two options in front of Steve Mueller:

1) Build one specialized facility

According to this, Lilly would continue to design and build one specialized facility which will
be used for the three products. In this plant, Alfatine, the largest-volume product, would have
one full rig of capacity. Betazine and Clorazine would each have one-fourth rig of capacity,
the minimum feasible scale for a facility. These products would remain in the facility for their
entire 15-year lives. The total cost of building the facility was estimated to be $37.5 million.
Operating costs for the facility were expected to be $6.8 million per year.
In this facility, productivity would be very high, averaging 16000 kilograms of output per rig
at 80% utilization. This is because the plant was specially designed and optimized for the set
of products, resulting in better yields.

2) Build one flexible facility

Under this option, Lilly would build flexible facility. While this, would be able to produce the
three new products like the specialized facility, but it also had had the capability to produce
virtually any new bulk chemical product. It could be used as a launch plant for future new
products. The cost of building this facility would be $150 million and annual operating costs
were estimated to be $9.48 million.
The reasons for the cost to be so high for this kind of facility was because of the relatively
lower productivity of flexible capacity and thus the need to install more capacity in order to
meet the volume requirements of the products.
While a rig of specialized capacity could produce 20,000 kilograms of product in a year, a
similar capacity of flexible plant could produce 7,500 kilograms of product in a year. This
difference in productivity was further exaggerated by significant differences in utilization
rates.
The expected utilization of the flexible plant would be 65% compared to 80% for a
specialized plant. Thus taking into account the utilization rates, a rig of flexible capacity
could actually only produce 4875 kilograms of product per year, whereas a specialized rig
would yield 16,000 kilograms.

Calculation:

With the rigs used being flexible for usage to produce any type of chemical, i.e. Alfatine, Betazine or
Clorazine, we have to decide a metric that shall decide which type of facility between Specialized and
Flexible facility would be profitable for the company to invest in and under what circumstances.
The following assumptions are being made to arrive at a metric for comparison:

i. The life of either type of facility is decided to be 15 years

ii. Straight line of depreciation of the facility over 15 years of its life

Figures:

Annual Operating Cost= 6.8M for a Specialized Facility, 9.48M for a Flexible Facility
Annual Output= 24,000 kg for a Specialized Facility, 14,625 kgs for a Flexible Facility

Specialized
  Facility Flexible Facility
Annual Depreciation Cost (A) 2.5 10
Annual Operating Cost (B) 6.8 9.48
Total Annual Operating Cost
C=(A+B) 9.3 19.48
Maximum Output (D) 24000 14625
Operating Cost/Kg
E=(C*10^6/D) 387.5 1332

Now, to match the products Alfatine, Betazine or Clorazine based on the type of plant to be
constructed, we look at the following logic:

Considering a Flexible facility, the smallest unit of a rig that is used=0.25 rig

0.83333
Annual Depreciation Cost/0.25 Rig 3
Annual Operating Cost/Rig 3.16
Annual Operating Cost/0.25 Rig 0.79
1.62333
Total Annual Operating Cost/0.25Rig 3
Annual Output (Kg) threshold 1218.75
Thus, we arrive at the output that if the
threshold output is lesser than or equal to 1218.75 Kgs annually, then Flexible capacity plant is to be
built, else a Specialized capacity plant is to be built. Therefore, we can qualify the below conditions
with the type of facility to be chosen:

Specialized Facility Flexible Facility

Approval Uncertainty of the drug Low High
Demand Uncertainty of the drug Low High
Expected Sales of the drug high low
Price Sensitivity of the drug high low