IIM TIRUCHIRAPPALLI

American Connector
Company (A)
Case Submission - 3

Submitted to
Prof.D. Krishna Sundar

Group 1
Varun Prabhat Soreng 1401052
Karunagaran S 1401080
Kunal Nagpal - 1401084

Eli Lilly and Company Choosing the best option

This case submission is in a Q&A format, with questions covering the gamut of options that
Eli Lilly is contemplating as well as their implications for future growth. Excel sheets with
supporting calculations have also been attached for necessary clarity.

I.

How has the competitive environment in pharmaceuticals changed over

the past few years? Why focus on reducing time-to-market and
manufacturing cost is essential for Eli Lilly?
For a firm competing in an industry such as the Pharmaceutical Industry, the critical success
factor is R&D. Eli Lilly, being one of the top 4 players in the worlds largest pharmaceutical
market, has to ensure that it comes out with new products to beat the competition from other
patented medicine manufacturers as well as genetic manufacturers.
The industry landscape had considerably changed since the power was shifting from pharma
companies to other stakeholders such as Government, buyers, generic manufacturers etc.
The following factors forced the industry leaders to rework their strategies in order to align
them with the realities of the times:
1.
2.
3.
4.

Restrictions imposed by Government on pricing decisions

Shrinking period of exclusivity for patented products
Pricing pressure from generic manufacturers
Increasing complexity of new products leading to increased manufacturing and R&D
costs

The twin goals that Eli Lilly has set for itself are Reducing time-to-market by 50% and
reduce cost of manufacturing by 25%. Both the objectives are aimed at strengthening the
competitive position in the changing industry landscape. The decision on the kind of facility
to set up, not just for the existing products but for future products also, will have a huge
impact on both time-to-market and manufacturing cost.

II.

How does each facilities option affect Lilly's cost structure, capacity
management and product development capabilities? For what type of
products does the proposed flexible facility provide an efficient (i.e. low
cost) manufacturing capability?
Eli Lilly is expected to come up with 37 new active ingredients by the year 2004. These
products will be much more complex and potent thereby requiring much lower production
volumes. However the manufacturing process will be more complex and hence it can be
assumed that a specialised facility will be able to produce maximum 2 types of products in a
single facility. Thus for 37 products, nearly 18-20 specialised facilities will be required in the
future. Compared to this, assuming that a flexible plant will be able to produce 6-7 such
types of complex products in a single facility, nearly 5-6 flexible plants will be required. A
simple calculation of construction cost and annual operating cost for such a scenario is
shown below:
Assumptions:

1. Plant life is taken as 15 years

2. Discount factor r = 15% considering that risk is moderate to high for an established
pharma company
Specialised facility:
Construction cost per facility = $ 37.50 million
Annual operating cost per facility = $ 6.8 million
For 18 specialised facilities, total cost = 18 * (37.50 + NPV of $ 6.8 million) = $ 789.8 million
Flexible facility:
Construction cost per facility = $ 150 million
Annual operating cost per facility = $ 9.48 million
For 5 flexible facilities, total cost = 5 * (150 + NPV of $ 9.48 million) = $ 794.4 million
The preliminary calculation shown above indicates that if the flexible plant is expected to be
technologically advanced enough in the future to handle production of 6-7 products then it is
worth investing in flexible facilities as the higher construction and operating costs will be
spread over a larger number of products. Over a period of 15 years, the cost of building and
operating 5 flexible plants is almost equal to that of 18 specialised facilities. A qualitative
comparison of specialised and flexible plants is shown in the table below:
Specialised Facility
Flexible Facility
Better utilisation rate and yield
Time to market for a new product is
reduces per unit cost
reduced since facility construction time
is saved
Labour learning will lead to better
As molecules become more potent an
quality products
volume of production reduces, a flexible
plant will be suitable as it will be able to
Pros
produce low volumes of more types of
products
Inventory management is easier
Less risk in case the product fails to get
since demand fluctuations can be
FDA approval or the demand does not
met with relative ease
meet projection
Not enough utilisation in the initial
Utilisation is less due to time wasted in
years of product launch
changeovers
Retrofitting is time consuming and
Inventory management becomes
costs the same as a new plant
difficult since sudden change in demand
cannot be accommodated
Labour learning is not enhanced and
Delays the product launch since
hence there is little scope for yield
facility construction can start only
Cons
improvements
after Phase II trials
Risky in case product fails to get
FDA approval or demand fails to
meet projections

More costly to build

III.

How does the utilisation of two types of plants compare for a life of 10
years of a product?
From Exhibit 4, it is observed that a specialised plant always has some excess capacity
whereas a flexible plant has excess capacity only in the first 4 years. This is shown
graphically in the chart below:

1.20

1.00

0.80

% of available capacity utilised 0.60

Specialised
Flexible

0.40

0.20

0.00

The utilisation of a specialised plant is less than that of flexible plant throughout a products
life of 10 years. This is because the expected sales volume of three products is not enough
to utilise the available capacity of a specialised plant. In the future when molecules will
become more potent and hence their volumes will be less, the utilisation of specialised plant
will drop further. On the other hand, a flexible plant producing more number of products will
always have a higher utilisation rate. It will also be more suitable for the more potent, lowvolume products which will be manufactured in the future.

IV.

What type of flexibility does the "flexible facility" provide?

As of 1993, all of Eli Lillys plants were specialised, for building only one particular kind of
product. The flexible concept, however, was not new, as the company had tried building
generic facilities in the past capable of manufacturing a variety of products. But once
volumes began to increase, the equipment would be retrofitted to improve yields, cycle times
and throughput. Hence, a flexible plant would soon be converted to a specialised plant. For a
new plant to be flexible facility in the truest sense, it would:
Be able to commence manufacturing even before the manufacturing process for the
drug had been locked down
Be able to start constructing facilities even before drug approval had been obtained
Be able to incorporate any new product without delay ( other than a 2 week
changeover/setup time)

V.

Not require require retrofitting the plant, in case there was a change in the production
process.

Given Lilly's strategic goals in the 1990's, which option should Steve
Mueller recommend? Are there other options that Lilly should be
contemplating? If so, what are they?
Steve Mueller is picking between the Specialised and Flexible, with the pros and cons as
mentioned in the earlier question. Another option that is possible here is the hybrid one
both specialised and flexible, where the high volume product Alfatine is produced on a
specialised line, while the lower volume products such as Betazine and Clorazine are
produced on a flexible facility. However, this option is feasible only if certain parameters such
as the production process are locked down, and the necessary approvals have been
obtained for the drugs in the specialised plant.
Considering the two major options available and the costs given in Exhibits 3 & 4, let us try
to calculate the

Construction Cost
No. of Rigs
Per Rig cost
Operating Cost / yr
Capacity of Rig (kg)
Utilization (%)
Actual Output of Rig
Cost for First year (mil/kg)
Cost for Second year (mil/kg)

Specialized

Flexible

37.5 million
1.5
25 million
6.8 million
20000
80%
16000
0.001846
0.001065

150 million
3
50 million
9.48 million
7500
65%
4875
0.010905
0.005776

Continuing this process, we can obtain the following graph, considering a life of 15 years for
the plant.

Costs Per Kg of Bulk active Ingredients

0.01
0.01
0.01
0.01
Costs - Million/ kg

Specialised
Flexible

0
0
0

Years of Operation

We observe that costs for both the processes stabilise after the 10 year mark. Hence, we
can safely assume that this cost structure will continue, provided there are no upsets such
as drugs being rejected at clinical trials. Since competitive pressure in increasing and there
is emphasis on improving manufacturing costs and shortening the time to market, the
flexible option would be preferred.
The flexible plant can impact the second goal which is to reduce the manufacturing cost by
25%. This is because a flexible plant will be much more suitable to produce low volume but
complex products. Since a flexible plant will be able to produce more number of products,
the costs will be spread over across products thereby reducing unit cost of production.
However, the downside of producing more products in a plant is that the utilisation will
reduce due to increase in number of changeovers.
Eli Lilly has set the target of reducing time-to-market by 50% which means reducing 8 to 12
years which it currently takes to 4 to 6 years, which is a huge task considering that the threephase clinical trials take 7 years. The facility construction becomes critical only when Phase
III clinical trials begin. Considering this, facility decision does not have much impact unless
the time for clinical trials is reduced which is not possible since the Phase III trial is for
checking the long-term side-effects of the product and hence it will take 4 years. The only
positive impact that a flexible plant will have on time-to-market is that the time lost due to
delays in constructing specialised facility will be saved.

References
P.Pisano, G., 1997. The Development Factory: Unlocking the potential of process innovation.
Boston, Massachussets: Harvard Business School Press.

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