Supply

Sumbul
ChainImran,
and Operations
Abul Qasim,
Management
EILLY LILLY
Waseem, Tayyab bhatti

Case analysis
Question No.1
How has the competitive environment in pharmaceuticals been changing
over the past few year? What are the implications for the role of
manufacturing within Eli Lilly?
A number of factors are affecting the competitive environment of pharmaceuticals in a negative
way. These factors have put a pressure on the margins from multiple directions. Price flexibility
was decreasing, the rate of innovation was slowing, competition within drug classes and from
pharmaceutical generic substitutes was growing putting a pressure on margins upon companies
in pharmaceutical industry.
Specifically the cost of developing new products was increasing. This increment in cost was due
to increase regulatory requirements and complexity of new compound. According to one study
the cost of developing a new product was 359 million dollars, as compare to 120 million dollars
5 years earlier. Moreover, due to intense competition in the industry, companies started to invest
highly in R&D but the increase in novel products was slight.
Increasing Manufacturing Cost: The other major change in the industry was increasing
manufacturing cost. The cost of goods sold was 20% of sales as compare to 10% in 1980s. The
reasons behind these increasing costs of manufacturing are numerous. These are discussed
below:
1. FDA and EPA Regulations: FDA requires companies to use more sophisticated
equipment to maintain product quality, while EPA regulations were forcing them to invest
heavily in costly pollution control equipment and waste treatment facilities. These
regulations increase the cost of manufacturing.
2. Potent compounds: many new drugs were based on highly potent compound that
required costly containment facilities to produce.
3. Advanced production technology: As the drug discovery and design technology
advanced, drug researchers were able to synthesize more complex molecules in
laboratory requiring more advanced production technology for large scale manufacturing.
4. Under-Utilization of facilities: Under Utilization of manufacturing facilities throughout
the industry was also a cause of increasing manufacturing cost.

Not only the R&D expenditure and manufacturing costs were changing the competitive
environment of the industry but there were also some forces changing the competitive
environment. Lets discuss them all in detail:
Limited or No Price Flexibility: the industry was also facing diminishing pricing flexibility.
The reasons for this thing are Government interventions, and rapid growth of managed care
providers. Lets discuss these two in details:
1. Government Intervention: In response to increasing cost of health care, the Clinton
administration in an attempt to curb proposed caps on price increases and caps on
reimbursement for Medicare and Medicaid. These measure are translated by many people
 as federal price control. That was uncertain that how this federal policy will work but it
was prominent that price flexibility will be diminished.
2. Rapid growth of managed care providers: The increasing number of managed care
providers like HMOs and there buying in bulk quantity was also putting pressure on
manufacturers to limit prices. The HMOs and other types of managed care providers
networks represented an increasing share of health care providers, accounting for 64% of
pharmaceuticals purchases in 1992.

Increased Competition: More firms in Pharmaceutical industry was working on similar

compounds, that increases substitute in the market. There was a war that says the winner is the
one who get early approval. This increased competition also put pressures on margins.

Generic Products: Generic products was the main reason for price limitation and increasing
pressure on gross margins. The generic products do not need to bear R&D costs, nor did the
marketing and sales expenses so they could price less. In 1990s these generic products priced
less than 30% to 60% than branded products. This price war also limits the price increases option
for branded products.

This changing competitive environment has some implications on the companies like EILY
LILLY. These implications are discussed below:
Investment in high cost equipment and facilities: In order to compliance with the FDA
and EPA regulations Eily Lilly needs to invest in high cost equipment for quality
concerns as well as pollution control equipment and waste treatment facilities. These
changes require huge investment and also huge sales in order to capitalize on these
investments. If the company remains conservative and do not invest in these equipment
and facilities, it will soon be out if the market as the products will not be considered of
quality by the customers.
Flexible facilities: In order to bring the products early in the market in an era of intense
competition flexible facilities are mandatory. Most of the Lillys facilities were
specialized that let it manufacture a single product specifically. Also these facilities were
built after clinical testing of the new product in development test that increases the lead
time (8 to 12 years). If the flexible facilities will be there the company will be able to
bring the product early in lesser time to the market and can win the market share as
flexible facilities allow manufacturer to manufacture different products by utilizing one
facility. This action will also mitigate the problem face by the industry of under-
utilization of the facilities. If the company carry forward its strategy of specialized plant,
it can never ever beat the competition.
QUESTION NO 2
How does each facility affects Lillys cost structure, capacity management and product
development capabilities? For what type of product does the proposed flexibility facility provide
and efficient (low cost) manufacturing capabilities?
Answer:
Before going into depth analysis, let us clarify that from given two options that are specialized
and flexible facilities. For short term specialized is good one as it is less costly as compare to
flexible but in long-term flexible facility is good option to pursue. Because, it will enable us to
launch product quickly and hence will enable us to service in this dynamic market environment.
The comparison of each facility based on cost structure, capacity management and product
development are explained below in paragraphs separately.
In terms of cost structure, operating as well as installment cost of flexible facility is more as
compare to specialized facility which is dollar 150 million and dollar 9.48 million. Whereas
specialized facility is only costing $ 37.5 million for installment and $ 6.8 million for operations
per year. But in flexible plant installment cost is one time where as in specialized plant we have
to invest money almost by every 12 years for retrofitting as sales of that product will be tapered
significantly. And this cost is almost equal to installing new specialized plant. Hence it will
increase overall cost more as compare to flexible plant in long-term.
Like cost in long-term capacity management will be well managed if we will plant flexible plant
as compare to specialized one. As it is mentioned is case, specialized plant has drawback that in
start and at the end of product life it will have idle capacity and in between 7 to 10 years we will
be able to utilize or operate on 100% level. But this issue will be resolved by specialized plant
because we can use it by 100% capacity in all times by producing different products
simultaneously.
In managing product development capabilities again flexible facility is going to help the cause.
As it was mentioned in case that illy lily going to install plant usually 2 to 3 years before product
launch and when they are sure that they will be able to make product through market
successfully after getting approvals. This is resulting in delays in product launch. Which is very
threatening to company to lose market share. But on other hand, flexible plant will enable us to
have change overs quickly which is in 2 weeks this will reduce lead time and we will be able to
launch products in time and will reap sufficient market share.
In addition to it, in my opinion, flexible plant is good for all types of product but especially for
new product launch it is the best option due to several reasons which are given below in bullet
points.
It will reduce product launch time hence this time reduction will reduce the cost of losing
market share and loosing sales to competitors.
As market is going through intense competition, new product launches will be more as
ever. These new and frequent product launches it will be difficult to open specialized
plant every time due to scare resources and managing they will be very difficult.
 Moreover, it will reduce risk if product will not make in to market successfully. If this
sort of uneven thing happens than our cost of capital will go in vain as we have to
dissolve our specialized plant and will have to invest in other one. This will increase our
cost which company may try to recover from its customers by raising retail prices which
may lead to decline in sales as per economics law of demand. But this high risk will be
minimized up to negligible level by installing flexible plant as it allows us to produce
variety of products in same plants. Hence we can say that this type of facility is more
robust and efficient and effective as compare to former.
Even if we see companys objectives that are to reduce product launch time and lower cost.
These two will be best served by installing flexible facility rather than by specialized facility. By
doing this we will be able to survive in market otherwise we will be forced out from market by
competitors.

Question no. 3
What type of flexibility does the flexible facility provide? What is value of
this flexibility to Eli Lilly? How much is Lilly paying for this flexibility?
Answer:
The flexibility that is provided by the flexible facility, its value and cost are discussed below. The
flexibility is defined by the comparison of specialized versus flexible facilities, while cost and
value is defined under the discussion of flexible facilities
Specialized facility:
Three plants operations Alfatine using full ring capacity. Betazine and Clorazine using one-
fourth rig. All three plants have 15 years life and while using one-product line is costly the
multiple product productions. Cost having $37.5 million and operating cost would be expected
6.8 million and would utilize high capacity 80% means them utilizing almost near to full
capacity utilization. While after year by year as employee become experience there will be few
problem regarding quality problem or batch failure. More learning operation will help us
minimize the lead time and wastage and will be able to achieve economy of scale. There is also
risk level involve while doing this if the manufacturing process or market condition has been
changed their will be huge risk include in it. Means there is the no flexibility is available for any
change. While doing that they were able to reduced time and almost half and it is possible if they
doing so before three month. If any miss happen occurs there will be delay in product launches
and cause million dollar loss.
Flexible Facility:
It can produce in bulk while connecting virtually with new and future plants. This is a long term
investment. Cost of going with this facility is higher $150 million and operating cost per year is
about $9.46 million. Reasons behind the cost higher are that it produces lower then specialization
65% of capacity and required 1.5 rigs for each three plants. And using extra rigs costly about the
around $25 to $50 million. But flexibility has wider range of control over other process factors.
Having less capacity but it have significant benefits more adoptable and reduce lead time
effective communication and control over process if it built it will help others plants without any
delay in process not more than 2 weeks. Also plant will help us or give us information about free
space for repair and change in equipment parts. This would more beneficial for them while
introducing new products in future, and were able to develop pre-clinical and clinical trials
approach without wasting any time and process for development of the product can be start
prior. But having less capacity can create threat loss of generic sale of the products which
demand may increase and increase mentality level of the customer.
The value for Eli Lilly is that in first option it can use full capacity while producing more
products can easily address the generic need of customers. Life time is greater than ten years for
products. Including some risk related to market and manufacturing process through that option
they were able to begin their process in 100days prior to the final decision. While taking about
the second options it has more cost then first one and having less production capability then first
one. Flexibility have capacity of 65% so it can produce 14625 kilograms instead of that first have
capacity of 80% but able to produce 24000 kilograms. Although second one have more
adoptability and lower risk but option have more high risk and return is also more than that one.
While seeing the exhibit 4 it total talk about the value adding process which process having
excess producing issue and which have not, option 1 have excess capacity production n issue
whole year because of transfer of goods from second option to first and bear so FDA process it
take few weeks or even a year. Thats why it require to them produce in excess rather than
reactive they to be proactive. Alfatine is the plant increase consciously over the time period,
other have also some increments but not in huge quantity. Operating cost in 15 years (15*6.8 =
102+37.5= 139.5) under first option 139.5 million per year it will be 9.3 million and for second
option 292.2 million again it is for the 15 years and per year cost will be 19.48 million.
(15*9.48= 142.2 +150= 292.2)

Question no. 4
Given Lillys strategic goals in the 1990s, which option should Steve Mueller
recommend? Are there other options that Lilly should be contemplating? If
so, what are they?

RECOMMENDATIONS
Up till now Eli Lilly strategy of specialized facility was working well. But now, as competitive
environment has been changed, it has to decide either it has to change its strategy of facility by
availing option of flexible production plant or has to go with same strategy of specialized plant.
In addition decision has not confined to production of these new three products production
instead it has to take decision by considering long term position of itself. At this turn it has to
evaluate its both available option of plant, flexible facility or specialized facility, with their pros
and cons.

Specialized Production Plant

PROS
With going this option, Eli Lilly has to incur
less cost, construction is $37.5 MN and
operation cost is $6.8 MN.
Specialized plant has high productivity. With
specific product it produces more because no
shifting time goes on for any other product.
It produces rig of 20000 kg/ year that is more
than flexible plant.
It has 80 % utilization of plant capacity.
Flexible Production Plant
PROS
By choosing this option, company would have
capability to produce virtually any new product
under the same roof.
Flexible plant would work as launch plant; it
would be able to accommodate any new idea
of product.
By attempting this option company could
reduce the risk. If any product which is not
profitable than company can eliminate it and
instead of that produce a new one in place of it.
It assists company to introduce products soon
in market. It would reduce the lead time of new
product because company has no more
problem of design and construction until
demand is more in market.
CONS
Capacity in specialized plants keeps idle in
initial years as well as ending product life.
As market has been more dynamic, new
processes introduced very soon, if firm has
begun to design specialized facility for a
particular product and new process has been
introduced company has to start again to
accommodate the change that would lead to
take more time to introduce product in market.
What if a product does not get success in
market than company has to retrofit the plant
to produce new product in which company has
to bear more cost. That clarify this option
contain more risk in itself.
This option does not console if product is
rejected in approval stage by FDA. Company
has to work again to change your constructed
plant for new product.
CONS
This type of plant demands more cost. Firm
has to bear $150 MN construction cost and
$9.48 MN operating cost.
It has lower productivity. Because time is
waste in shifting from one product to other.
It produces rig of 7500 kg/year.
When demand of product increase more in 5th
or sixth year this could not provide sufficient
capacity firm has to shift specialized plant.
No idle capacity even when one product shifts
from the plant any other can be produce.

By considering companies objective of to come in market with new products in less time; which
they want to reduce from 8 years-12years to 4-8 years and reducing the cost by 50%, along
market variables that impact on company.
I would recommend picking the flexible production plant option because it could entertain
first objective of company in well manner. When company has flexible plant, that has great
design, where it can produce any product without hesitation the result would be reduce the time
to launch product in market soon, where competition has been increased. In addition flexible
plant would support in condition when change in technology of process negatively impact on
company when it has specialized plants.
Shorter product exclusivity supports the option of flexible plant. As flexible plant would function
as launch plant as well it assists company to save the time of design and construction for new
products that take 4 years.
With this option company has to incur more cost this problem can be solve by its advantage of
short time to launch new product in market. When company come in market with new product
and there is no competitor in market firm can charge premium price. Another argument regarding
cost involve in options; flexible plant has more cost comparison to specialized plant but per unit
fixed cost could be high in specialized plant because its capacity remain idle in initial 4-5 years
whereas flexible plant would not be idle it could produce different products.
In addition it could not accommodate the high demand product when they are at peak, firm has
to shift it from flexible to specialized plant where it incur $1mn but it could be mitigate when
company come late in market and lost $1.35 each year in result of delay. By this option it has to
bear a onetime cost depend on condition but certain that it save company to lose the market by
losing each year $1.35mn sales.