Lorex Pharmaceuticals

**This analysis by batch – not by case**

Introduction:

Lorex Pharmaceuticals is seeking the most ideal target fill rate for the production line of a recently FDA approved blood pressure medication, Linatol. Lorex has chosen to market the product in 10 ounce bottles with 12 bottles in a case. Internal testing has revealed the target fill setting is fairly reliable with some variation. During the testing phase, an arbitrary target fill figure was chosen; however, no economic consideration was given to this number. The company is concerned of two issues; one, too many under filled bottles per batch resulting in extra costs to prepare them for secondary market as well as lost revenue due to discounting selling price per case.  And two, too many bottles over filled, causing increased cost in product as well as reduced revenue due to less bottles sold.  Lorex Pharmaceutical’s goal is to identify if the 10.2 ounce target rate allows for the fewest under filled bottles resulting in the largest profit margin, or if a different target fill would allow the company more success in reaching this goal.

Analysis – Revenue:

The analysis began by identifying the potential amount of cases containing under filled bottles in a batch by calculating the probability that a bottle would be filled to less than 10 ounces determined by the target fill selected. The minimum amount desired in a bottle is 10 ounces, therefore, that is the minimum target fill observed. As shown in Exhibit 1, it is revealed that a target fill of 10.2 ounces (the arbitrary figure used in testing) results is a likelihood that, out of a batch of product, 10.6% could result in under filled bottles. This was determined to be too high to successfully reach the company’s goal of reducing the amount of under filled bottles. However, target fill figures 10.3, 10.4, 10.5, and 10.6 ounces appear to reduce the possibility of this occurring significantly as indicated by 3.04%, 0.6%, 0.09%, and 0.01% respective probabilities. If each batch produced is 169,088 ounces and there is always 12 bottles per case, the target fill chosen will affect the final number of cases produced. The greater the target fill, the fewer the output of cases. However, of these cases a larger target fill can reduce the number of cases produced with under filled bottles (Exhibit 2). Assuming all cases are sold either in the primary or secondary market, the potential revenue, based on target fill figures is presented in Exhibit 3. Cases of product sold in the primary market are sold at the normal price of $186.00 per case while the secondary market selling price is $148.80 per case.

Analysis - Cost

The company has provided a Projected Operating Profit statement. Costs associated with the filling production line will change based on target fill rate chosen; however, the costs associated with blending a batch containing 169,088 ounces are not dependent on the target fill decision. Therefore, it is assumed the blending expenditures for every batch blended is projected to be $69,962. This includes the purchase of the active ingredient as well as the labor and manufacturing overhead expenses. The cost of materials required to bottle the medication is estimated to be $1.10 per bottle and is dependent on how many bottles are produced and, in turn, how many cases are produced. As the target fill increases, the amount of cases produced decreases resulting in lower costs. The cost of manufacturing overhead is assigned to the project per hour at a rate of $89.50. As with the case of materials, the fewer cases produced, the fewer hours required to fill and package a batch of product.

The cost of labor is dependent not only the amount of cases produced but also on the amount of cases that are under filled. In the initial filling line, two employees are paid $12.80 each per hour to manage the line to fill the bottles. If the electronic eye does not identify the bottle as under filled it is moved on to the automatic packaging process and no additional costs are incurred. However, if an under filled bottle is identified, it is rejected and follows a separate process to prepare it for the secondary market. This is an additional cost in labor as the attendants who manage this manual process are paid $8.50 per hour each. Therefore, fewer under filled bottles produced results in fewer labor hours and costs assigned to a batch of product. Please see Exhibit 4 for labor costs per target fill and Exhibit 5 for total cost per target fill.

Additional Details:

Calculations for this analysis include several details not mentioned prior. Per information provided by the company, the production line has the capabilities of producing 1,000 cases, however, due to unavoidable delays and set up processes, an average of 500 cases can be produced in an 8 hour period. This is not expected to change. Also, each batch will produce 169,088 ounces and the cost of the active ingredient as well as the cost to blend the product will remain the same.

Assumptions:

A few assumptions were also made and are as follows. Filling line performance is normally distributed meaning the amounts of the product in each bottle are all fairly close to the chosen target fill amount with only a little variation. This is based off the company’s results of the fill test. Results of the company’s test were used to develop the calculations used in this analysis and will remain constant so long as the target fill is in the general range of 10.2 ounces since this is the figure the company based data from.  It is also assumed that calculations in this analysis can be applied to any production output since they are based off of the details per batch. These calculations also assume the target rate chosen will not be changed from batch to batch.

Recommendation:

The final recommendation is to not use 10.2 ounces for the target fill amount. While the 10.2 ounce target fill will result in more cases produced (1381 cases), it will also result in more of those cases containing under filled bottles (145 cases). This will reduce the potential revenue, increase the costs associated with filling and packaging the bottles, thereby reducing the gross margin. A better alternative would be to use a target fill amount of 10.3 ounces. In doing this, the amount of cases produced is reduced to 1368 cases per batch, however, the amount of cases containing under filled bottles is reduced to 42 cases per batch. Since more cases can be sold into the primary market, revenue is increased to $252,906 per batch. Since less labor goes towards packaging fewer cases of under filled bottles, costs are reduced to $90,569 per batch. Overall gross profit becomes $162,337 per batch. This is an increase of $1,663 in gross profit compared to the resulting gross profit if the 10.2 ounce target fill were used (Exhibit 6). A target fill of 10.4 ounces is not ideal because the amount of cases produced becomes too few and potential revenue begins to decline. Please be in contact with any questions.

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