Eli Lily Case

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Question #1

A once fast-growing and profitable sector, with growth rates of 18% and gross margins above 60%, the U.S. pharmaceutical industry began to undergo changes in the early 1990s. Less pricing flexibility, slower rates of innovation, growing competition within drug classes, and the entry of generic drugs would make the pharmaceutical environment much more competitive.

Despite increased investments in R&D, the number of new compounds launches in the market would stall and, the rate of innovation began to slow throughout the industry. Development costs had increased threefold due to regulatory requirements and complexity. For the same reasons, the cost of manufacturing increased. Satisfying quality and environmental regulations, and manufacturing more complex drugs required more costly equipment. Lastly, under-utilization of facilities and inefficiencies would contribute to increased manufacturing costs.

Price flexibility had also decreased. To make healthcare more affordable, the Clinton administration proposed price-ceilings. This measure would reduce price flexibility for the industry. In addition, managed care providers such as HMOs were experiencing rapid growth; they were buying in bulk and could ask for huge discounts (up to 60%). Third party payers (public and private insurers) would became major players and were gaining leverage on pharmaceutical companies. The diminishing price flexibility weakened the remarkable 85% gross margins the industry once experienced.

Competition had also increased throughout the industry from two origins. First, companies became more competitive by rapidly developing compounds similar to their competitors. The consequences were a shrinking period of exclusivity, meaning lower sales and less R&D recoupment, and lower prices due to discounts offered by second entrants. Second, additional pressure was coming from generic drugs. By manufacturing knockoff products generic companies could sell substitutes at lower prices . In the 1993-1999 period, expiring patents represented annual sales of $20 billion and these figures were expected to grow.

This competitive environment shifted management’s focus to getting new products to market faster, at lower manufacturing costs.

Question #2

In 1993, Eli Lilly was deliberating a significant operational shift from specialized to flexible manufacturing facilities. This decision would affect the company in cost structure, capacity management, and product development capabilities. Table 1 in the appendix shows the cost structure and demonstrates the financial significance between the two facilities.

Table 2 shows that a specialized facility has a tremendous amount of production capacity compared to the flexible facility. The specialized facility would suffice for the entire lifecycle of Alfatine, Betazine and Clorazine while a flexible plant could only produce Betazine and Clorazine their entire lifecycle; Alfatine could be launched in a flexible plant, but demand would exceed capacity resulting in the need for a specialized plant. Therefore, a specialized facility provides better capacity management compared to a flexible facility.