Smitheford Pharmaceuticals has been facing a few other issues. The company is behind with modern manufacturing technology. In Pueblo and Colorado Springs the company was in the means of updating the injectable manufacturing facilities. It has become more complicated for Smitheford Pharmaceutical's in the scheduling of numerous manufacturing operations. During the 1990's, based on forecast for the growth of osteoporosis medicine (Ostto54), Smitheford Pharmaceutical's plant in Pueblo tremendously expanded, which caused the facility to double in size, mainly with processing equipment and tanks. However, this medicine, Osto54, caused an increase in the enzyme level of the liver which led to several elderly deaths because of the interactions of the drug, which caused Smitheford Pharmaceutical's to face a loss of several millions of dollars pertaining to liability suits, including Pueblo. Ultamyacin, a new treatment for the immune system, was discovered two years ago by a Smitheford researcher. This drug could be manufactured at the facility in Pueblo for bulk manufacturing, but in Puerto Rico, final manufacturing steps were to be made for final purification and last sent to Fort Collins for final manufacturing, placing it into sterile bottles for injection. There consist of several modernizing scenarios pertaining to this analysis. I will start out by defining the term cost-benefit analysis and next discuss centralized versus decentralized, fixed costs versus variable costs and strategic forecasting. I will be performing a cost-benefit analysis calculation pertaining to two equipment scenarios. The leadership of Smitheford has narrowed decision-making down to two options which is a higher technology option in one location and a lower technology option in several locations. I will consider the lead cost alternative, variable cost per unit and then I will determine other factors to be considered.
Cost-Benefit Analysis (term)
Cost-benefit analysis is an analysis of the cost effectiveness of different alternatives in order to see whether the benefits outweigh the costs. (Dictionary.com, 2013) Creating a cost-benefit analysis will assist in deciding which route would be best when it comes to setting goals or making a decision on the best plan of attack. The benefits of a given situation or business-related action are summed and then the costs associated with taking that action are subtracted. (Investopedia.com, 2013)
What is centralized versus decentralized?
All organizations should determine if its' decision-making policies are considered centralized or decentralized. Companies that are highly centralized tend to have more technical traits, while companies that are highly decentralized appear to be more out of control. Both of these extremes appear to be engulfed with wastefulness. Work systems of high performance decision-making features seem to be more decentralized, but their culture which is formed around philosophy and values tend to be highly centralized. If we create a centralized philosophy and value system this will allow our employees to be more empowered in making their own decisions which leads to decentralized. Centralization versus decentralization is considered an issue of control.
What is fixed costs versus variable costs?
Fixed costs and variable costs are two costs faced by companies. Fixed costs are costs independent of output. These costs remain constant all the way through the relevant range and are more often considered to be sunk for the relevant range. Fixed costs usually include machinery, buildings and rent. Fixed costs are paid week-to-week, month-to-month and year-to-year. Variable costs vary with output. Variable costs generally increase at a constant rate that is relative to capital and labor. Variable costs usually include utilities, wages and materials utilized in production. Variable costs do not change based on the level of activity.
Strategic Forecasting
Most organizations utilize strategic forecasting in order to support decisions about their future business and marketing strategies. Strategic forecasting utilizes historical data pertaining to sales of a product or service making predictions about trends of future sales in order to create an estimate of future demand. The estimate of demand provides the basis for development of strategies for other resources such as product development, marketing budgets, manufacturing capacity and employee levels.
Cost-Benefit Analysis
High technology
Low technology
(centralized)
(decentralized)
Annual fixed cost ($)
Variable cost per product
620,000
110,000
Annual production (units)
16.31
18.89
Year 1
100,000
100,000
Year 5
170,000
170,000
Year 10
225,000
225,000
Cost Computations:
Annual fixed cost
620,000
110,000
Annual variable cost
Year 1
1,631,000
1,889,000
Year 5
2,772,700
3,211,300
Year 10
3,669,750
4,250,250
Total cost
Year 1
2,251,000
1,999,000
Year 5
3,392,700
3,321,300
Year 10
4,289,750
4,360,250
Formulas that were utilized
Annual variable cost = variable cost * annual production
Total cost per year = annual fixed cost + annual variable cost (Keown, 2002)
In terms of annual fixed cost, high technology that is a centralized mode seems to be more expensive at $620,000 than the low technology at $110,000 which is a decentralized mode. In terms of variable cost, the high technology option is considered to be less expensive the the low technology option in all years 1, 5 and 10. In terms of total cost, the high technology alternative is considered to be more expensive that the low technology alternative is considered to be more expensive than the low technology alternative in both years 1 and 5. Therefore, high technology would become less expensive than low technology alternative in year 10.
Variable cost differences
Variable costs savings (benefits) with the use of high technology alternative are listed below as:
Year 1 ($1,889,000 - $1,631,000) = $258,000
Year 5 ($3,211,300 - $2,772,700) = $438,600
Year 10 ($4,250,250 - $3,669,750) = $580,500
Benefit = $1,277,000
Total cost savings (benefit): $1,277,000 with the utilization of high technology option
Additional fixed costs with the utilization of the high technology option:
Year 1 ($620,000 - $110,000) = $510,000
Year 5 ($620,000 - $110,000) = $510,000
Year 10 ($620,000 - $110,000) = $510,000
Costs = $1,530,000
Total additional costs (costs) = $1,530,000 with the utilization of the high technology option
When to centralize manufacturing and opt for high technology option
Based on the cost-benefit analysis, the high technology or centralized mode would be less expensive than the low technology or decentralized option in year 10. However, There consist of a possibility for the company to try this option of starting year 10. With the assumption that this trend would continue thereafter, the centralized mode may be implemented.
Conclusion
The utilization of the two alternatives would result to the same level of production in years 1, 5 and 10. Fixed cost is relatively higher for the high technology (centralized) option than the low technology option. Total cost savings or benefits with the utilization of the high technology option (against the low technology option) is $1,277,000, while the total additional cost is $1,530,000. Costs of the utilization of the high technology option are higher than its' benefits. I recommend that we should make use of the lower technology option based on the cost-benefit analysis.
