99-Big Cost Differences in an Industry – Part 2
McKinsey and Company has undertaken a detailed examination of Productivity in the pharmaceutical industry. This extensive study offers us an opportunity to see common patterns in cost management and productivity improvement. We described these patterns in Part 1 of this blog. These common patterns of Productivity improvement include four major concepts.
- Reduce the rate of cost for the Input
- Reduce the Inputs not producing Output
- Reduce unique Intermediate Cost Drivers(ICDs) in products and processes
- Spread fixed cost ICDs over new Output
McKinsey undertook a detailed analysis of 1900 pharmaceutical production lines at 150 plants located all around the world. The Firm measured the Productivity levels among the plants and companies in their study and found dramatic differences in Productivity among these 150 plants. (See the Perspective, “What Makes Returns High?” on StrategyStreet.com.) The top quartile of the companies involved in this study had manufacturing utilization rates that were more than twice those of the bottom quartile companies. McKinsey estimated that, if the average drug-maker would match the total labor productivity of the top players in the industry, it would realize an improvement of 5 to 6 percentage points in operating earnings, quite an improvement
Here are some of the cost management reasons for the superior performance of the best performing companies and how these cost management efforts fall into the four categories of cost reduction above:
- Measure of I/ICD and Concept #2: McKinsey found that the top performers used non-production labor extraordinarily efficiently. For example, the quality control employees for the top performers reviewed an average of 110 batches a year, while those in the bottom quartile did less than 5. This finding is a good example of both an Input, the quality control employee, and an Intermediate Cost Driver, a quality control batch. A company using this measure would reduce Inputs not producing Output through reporting to the employees of this measure of their efficiency. (Concept 2)
- Concepts #2 and #3: The high performers use standardized ways of measuring and controlling equipment, reducing line stoppages and waste. This is an example of two of the patterns. (Concept 2) This approach reduces Inputs not producing Output by eliminating unplanned downtime. It also reduces the unique ICDs in processes by standardizing processes. (Concept 3)
- Concepts #2 and #3: The top performers were more likely to use lean management tools to plan and schedule activities, so they released a higher percentage of their products to market without reworking. This approach reduced Inputs not producing Output by improving the accuracy of production forecasts. (Concept 2) It also reduced unique ICDs in the process by reducing the rework activities through a reduction in errors. (Concept 3)
- Concept #2: The top quartile players reached final delivery in half as much time as the average manufacturer, and more than five times faster than those in the bottom quartile. The top performers reduced Inputs not producing Output by speeding the process.
- Concept #3: The best performers eliminated unnecessary complexity from their production planning activities by using fixed, repeatable, short duration production schedules in order to avoid forced changes in production plans. These companies reduced unique ICDs in their processes by reducing the movements of Inputs.
- Concept #4: McKinsey found that small plants were substantially less productive than larger plants. However, the very largest plants were not the most productive. This illustrates the spreading of fixed cost ICDs over additional product Output. It also warns us of the limit of that concept when there are multiple products emerging from the plant.
Every drug maker that McKinsey studied had launched a lean, or Six Sigma, project in the recent past. Yet relatively few of these companies were effective in reducing their comparative costs.
For further explanation of these cost reduction patterns, and for over 600 cost reduction concepts, illustrated by 2400 examples of these concepts in action, please visit www.strategystreet.com/improve/costs. These concepts will help you improve your company’s productivity.
The pharmaceutical industry seems to be lagging in the productivity of its R&D spending. In relation to total revenue, the pharmaceutical industry is among the biggest investors in research and development (R&D). Based on data from the Pharmaceutical Research and Manufacturers of America (PhRMA), the industry in the United States spent around 21 percent of global revenues on R&D in 2020. In 2008, the pharmaceutical industry spent 16.6% of revenues on R&D. By 2020 that rate had increased to 21.4% of revenues. The average R&D cost to develop a pharmaceutical compound from discovery to launch was $1.19 billion in 2010 and $2.51 billion in 2020. The percentage return on investments in R&D among large cap biopharmaceutical companies fell from 10% in 2010 to less than 2% in 2020.
THE SOURCES FOR STRATEGYSTREET.COM: For over 30 years we observed the evolution of more than 100 industries, many hostile. We put their facts into frameworks applicable to all industries and found patterns. Strategystreet.com describes the inductive results of these thousands of observations and their patterns.