Article | November 5, 2018
Standard Costing in Pharmaceutical Manufacturing - Industry Challenges & Solutions
At a Glance
- Current state of cost accounting and profitability in current day mid-market pharmaceutical manufacturing
- What does the C-level really care about?
- Impact of people and incorrect processes on costs and bottom-line
- Improper habits of recording data can be a major culprit in building hidden sunk costs
- 30% of costs go undetected due to poor business practices and the inability to detect them
- Are you following industry best practices?
- A simpler solution & insights into daily cost, cost variance and profitability analysis in a pharmaceutical manufacturing company
- Key takeaways
Where Is the Pharmaceutical Industry Heading?
Mid-market pharmaceutical companies based in the United States will only see a rise in opportunity in the coming years. The projected increase in the industry calls for more streamlined processes within Pharmaceutical Manufacturing and Contract Development and Manufacturing Organizations (CMOs & CDMOs).
The global pharmaceutical market will reach nearly USD 1,430 billion by 2020. The United States share of the global market will increase from 40.3% in 2015 to 41% in 2020, while Europe’s share will fall from 13.5% in 2015 to 13.1% in 2020.
Rising R&D costs have been accompanied by more stringent testing requirements. The number of new chemical or biological entities (NCEs and NBEs) launched on the world market increased to 226 in the 2011-2015 period compared with 146 a decade earlier. (IFPMA facts).
R&D costs are on the rise due to stringent regulatory requirements. Tariffs and changing political climate has a huge impact on the dynamics of the pharmaceutical manufacturing industry.
If the pharmaceutical manufacturing companies need to adopt to these changing market dynamics, it is imperative to build sophistication in their methods of costing, profitability analysis and production variance calculation & reporting. Most companies are constantly watching their bottom line to measure profitability and production variance analysis.
This article lays the foundation for standard costing, best practices and its optimization within a Pharmaceutical Batch Manufacturing company. In the subsequent blogs, we will cover best practices within other aspects of costing - weighted average, ABC costing etc.
The Never-Ending Challenges of C-Level Reporting
So, what is my overall profitability for a Product?
This is a major concern for a C-Level executive when there are fast moving raw materials, labor, overheads and other indirect costs involved in identifying the actual cost of a batch in the pharmaceutical manufacturing industry.
As a pharmaceutical company, one of your prime objectives is to comply with the processes set forth in your Standard Operating Procedures (SOPs) to ensure compliance reporting with FDA. In many cases, the focus has been to stay compliant while losing sight of key indicators that drive profitability and organizational goals.
In continuous production and batch manufacturing processes, the multitude of activities involved brings about a need for costing that ties to each activity. There are always many moving parts in identifying the right cost breakdown structure. When there is a need to provide key analytics for stakeholder reporting, it is imperative to measure true costs.
What matters to the CFO?
A CFO, however, is not just looking at this unilaterally. Instead, a broader view is what matters which includes the details in determining the actual cost and how the variance came about. In reality, the manufacturing process is heavily intertwined with product costing and therefore the need to highlight many different elements that aid in standard cost determination and variance reporting. Production variance reporting is however just a subset of the overall cost breakdown structure in bottom-line reporting.
Depending on the reporting structure, there may be a preference of backflush costing methods to delay costing until an item is manufactured. It could be a reporting nightmare if a proper method is not leveraged in deriving analytics and production performance metrics. Many times, people resort to traditional means to analyze these costs and variances using excel spreadsheets. Analyzing costs can be extremely challenging if your system does not keep a track of perpetual costs until the completion of a production job.
Does an extremely complicated cost excel sheet with COMPLEX macros and v-lookups ring a bell?
Data Capture Discipline & Lost Visibility
Certain processes in longer production campaigns, specifically in continuous processing, can span across days, weeks or sometimes even months. Recording actual numbers based on material and resource consumption to report standards vs actuals can get very tedious. Enforcing process discipline can alleviate some of these pains.
In real life, this can take hours of data crunching to gain clarity. Now, add to it a statistic of rework batches or lots which adds significant complexity to the overall calculation. What is not easily visible is the additional cost of starting material, line clearance, labor and machine hours that get compounded to the original batch cost.
This statistic makes you wonder where your company ranks in performance. Human capital, machine or work center hours need to be planned across multiple production jobs to better understand how to source and schedule labor as well as allocate machines to each production run. As material is being processed, it becomes essential to understand the cost of each operation in process that would further feed numbers into each production job.
People & Processes in Pharmaceutical Production – Impact on Costs & Bottom-Line
A large amount of time and resources are spent in an attempt to recover from inefficiencies caused due to improper procedures followed in day-to-day operations. This could be due to lack of proper KPIs, processes or even methods to track efficiencies.
- The Production planner cares less about cost and more about possible capacity roadblocks with additional material and resource requirements that could in-turn lead to unplanned variances.
- Warehouse operators need to record consumption based on feedback from Quality Control (QC) on when to proceed with the job, how much to consume on the batch and how many hours were already recorded. But do the operators have systems and processes in place to capture critical data real-time?
- For the sake of convenience, operators tend not to record data during operations and instead wait till the end of the production run. It would be ideal to capture this data in real-time, directly in the ERP system. If not, recording on paper would do.
- Based on a proper set of batch instructions and results of WIP testing performed by Quality Control (QC) personnel, the production manager is always looking for ways to substitute materials to meet timelines, quality standards, batch potency and capture relevant batch information accurately.
- Understanding how expensive the total batch record is going to be helps proactively plan for all the operational costs involved in producing a batch mainly for your ‘A’ items.
Improper habits of recording data is a major culprit in the accumulation of hidden sunk costs
Batch Manufacturing - An Example from Real Life
In long running batch manufacturing processes, there may sometimes be a need to test the PH value of the mixture / API every hour. Depending on the PH values and WIP tests, operators add additional compounds to achieve the desired PH. These additions are often not captured in the system nor on paper. These compounds / chemicals are consumed from Inventory without even tracking their use. Considering that Inventory is now out of sync and inaccurate, the controller may have to categorize these as overheads thereby losing sight of costs when they occur. Most of us have experienced such processes in real-life.
Now, what are a few practical solutions to minimize such practices?
- Having an industrial grade tablet or mobile device on the shopfloor to aid in data capture real-time is one possibility,
- IoT is very relevant for today’s markets to track start, stop and inputs within each operation
- Mobile supply chain gun or a handheld scanner is another input method that can aid in capturing data on the shopfloor
- Putting systems in place that are easy to follow and not over complicated is another one
- An ERP system that will flag the deviation when it occurs and not after the fact
- Checks & balances involving electronic signatures that can help stop incorrect practices and the list goes on
High-Level Production Process
Standard Cost Calculation
In a sophisticated mixed mode manufacturing ERP system, where both process manufacturing and discrete processes occur within the same operation facility, the standard cost is derived from standards set on the Formula or BOM depending on a combination of the following:
- Batch being manufactured
- What is packaged into containers
- Hours spent on each operation
- Standard resource costs per unit price
Calculated cost on a Formula or a BOM is derived from ‘individual raw material / intermediate costs’ just as the cost of operations are derived from ‘resources and machines’ assigned to the Route.
It is important to set the standards correctly based on past history to proactively manage production runs and keep a close tab on production costing.
For any C-level who is tracking profitability or for a Plant Manager whose bonus depends on higher margins, a better gauge of where they are headed from a numbers standpoint helps them proactively fix redundant spend resulting from operational and resource inefficiencies.
Estimation of Production - What Should Happen?
- First step is to plan the size of the batch that needs to be produced. Your ERP system should automatically scale from the standard batch size and identify standard cost.
- This information already provides an insight on subsequent decisions to be made about the batch such as ‘identifying the right margin’ and ‘set an appropriate selling price’ on customer quotes / sales orders.
- As production jobs are released to the production floor, operators allocate all appropriate raw materials for consumption marking those specific raw material lots as unavailable for other batches.
- Allocating raw material lots / resources correctly and recording data in a modern Pharmaceutical ERP software can control unnecessary mistakes and coverups providing a true picture of product costs.
The standard cost rollup for a manufactured product comprises of Direct Material, Direct Labor, Overheads and Indirect costs.
Following actual raw material consumption, there is a tendency of not wanting to record point-in-time information due to a fear of making mistakes or to better state it - wanting a flexibility of making mistakes and not keeping a track of what was altered from standards, making variances a bit of an enigma.
- During raw material consumption, physical inventory is relieved by directly booking material costs to Work-In-Process (WIP). If we were to assume that the only changes on a production run is to the overall labor and machine time on operations, then all standards relieved from WIP would book production and quantity variances based on standard cost when the lot is closed out.
Multi-Tier Formula / BOM
- A much complicated scenario occurs when there is a multi-tier formula where intermediates are produced and consumed into the next tier with additional flavor of substituting raw materials and continuing until the final finished product is produced. There may be times where yields are properly known before they move on to the next step and in some cases the shop floor goes by standards and records adjustments to material and operation after the final finished lot is yielded and finally closing out all tiers in the multi-tiered BOM/ Formula.
- It could easily become a complicated cost calculation with all tiers involved – their costs, variances and the costs being fed into the final finished product along with the final set of variances.
Key Takeaways – Move Forward Plan
- With proper methods and good industry standards it is possible to streamline operations to control these variances from being unpredictable.
- The first step would be to stop and understand what your current manufacturing practices are and what the downstream impact is on costing.
- It is imperative to identify what competitors with an outlook of outperforming the market are doing to create operational efficiencies.
- Once that is established, it would be important to properly identify the correct methodology to implement changes in business practices which bring about a noticeable change in productivity and worker efficiency.
- Sophisticated ERP systems made for the process industry offer deep functionality that provides different types of production cost buckets including quantity, substitution and lot variances.
- You will benefit from a sophisticated analytics and business intelligence tool embedded within your Finance, Operations and Sales productivity systems with necessary insights to grow and stay ahead of the market.
XcelPros is a Chicago based company and delivers transformation through technology. We offer business and technology solutions with deep industry experience in Chemical, Pharma, Life Sciences (including Medical Devices, Bio-Medical & Biotech), Insurance, Discrete Manufacturing, Process Manufacturing, Distribution and Food & Beverage.
XcelPros is a Microsoft Gold Partner, Direct Cloud Solutions Provider (CSP) and a Systems Integrator (SI) offering software licensing, implementation and consulting services for Microsoft Dynamics 365, CRM, Microsoft Dynamics AX, Business Intelligence & Analytics (Power BI), SharePoint, Office 365 and Azure (Cloud, IOT, Microsoft Flow amongst many others).
Our mission is to provide integrated technology solutions that amplify impact and empower our customer's businesses. We believe technology is the key enabler of exponential growth for us and our customers.
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