Determination and Management of Should Cost

By March 6, 2017 Cost Analysis

“As global competition becomes a hot priority for top management in many companies, there is going to be a scramble to lower prices at any cost.”Supply Chain Quarterly

Global competition is a powerful driving force in the biotech and pharmaceutical industries, as complexities continue to rise and adjustments to the way we do business need to be met.  Remaining competitive in the rapidly changing global landscape requires companies to reconsider inflexible, outdated and inefficient models of pricing.

Prescription drugs often provide effective alternatives to expensive medical procedures and hospital stays. Consequently, spending on prescription drugs as a percentage of the total national health care spending is increasing and is one of the fastest growing components of health care spending.  The cost of bringing a new drug to the marketplace has also been steadily increasing, with manufacturing costs comprising a substantial part of the total cost structure.  

How much should it cost?

A study in the Journal of Pharmaceutical Innovation highlighted a correlation between the reduction of the cost of goods sold (COGS) and the increase in R&D expenditure for brand-name companies.  This suggests that for brand-name companies, a reduction in COGS will positively impact investments in R&D, potentially resulting in much-needed innovations and future health benefits for society[1].

An accurate determination of project cost structure is a critical component in controlling costs and maximizing profit.  If a company expects to remain not only relevant but innovative, then the approach to determining project cost structure should reflect that attitude.  Evolution and innovation shape the climate of the biotech industry and demands novel, adaptable tools in determining cost and pricing structures.

Accurately determining the cost of any project begins with a basic question, regardless of whether you purchase your starting material or synthesize it: what SHOULD it cost to produce?


What exactly is should cost, and why is it important?

Should cost is both deceptively simple and complex; a simple concept with a surprisingly complex set of variables.  The should cost of any compound is an estimation of what a manufacturer, working under a reasonable set of assumptions, can expect a specific product to cost during the manufacturing process. Knowing this range allows companies to bargain effectively for materials, or determine a campaign direction.  Calculation of the should cost allows for consistent, evidence-based decisions regarding the direction of a project, and allows for a determination of the major cost drivers in the process.

A cost of goods analysis is an excellent starting point for determining the value and true cost of a product.  A strong cost model requires several components: gathering and organization of data to complete the analysis, as well as calculations that are aligned with the data.  But what happens when you have multiple projects, potentially at various points in the development timeline?  The projects may be under your control, have adopted, purchased or are in the process of selling.  As any project manager knows, managing multiple projects and scenarios simultaneously is aiming at a moving target.  A rapid, accurate and adjustable tool is necessary in order to determine the cost of goods and manufacture of these products, in order to make well-informed decisions.

Traditionally, determining the cost of goods and developing a cost structure is based on many factors: past experiences, understanding of predictable pricing and spreadsheet calculations.  This traditional approach suffers from multiple flaws:  user bias, lack of consistency, and a general lack of flexibility and utility. Understanding manufacturing costs is not trivial; many important factors are not directly related to the process itself such as plant capacity and other fixed costs but can make cost estimation difficult.

A reliable cost model should provide financial understanding for complex pharmaceutical processes.  In addition, it should allow users to break out data into multiple formats and scenarios, incorporating and allowing for comparison of variables such as different facilities, routes, and sources.  Flexibility is important and should be reflected in the cost model as well.  Software that allows for a sensitivity analysis at the outset of your project will allow planning for the “worst case scenario,” with minimal financial surprises.

Establishing an accurate cost of goods model is the cornerstone of a successful project, and is a critical step in maximizing cost benefit and potential of any pharmaceutical.

 [1]. “Analysis of Manufacturing Costs in Pharmaceutical Companies,” J Pharm Innov (2008) 3:30–40.