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Ciron Pharmaceuticals

In the summer of 96, three brothers with entrepreneurial spirit – Manu Shah, Ratan Shah and

Kirti Shah eventually decided to give shape to their dreams – Ciron Pharmaceuticals. Located in

the spacious Laxmi Industrial Estate, adjacent to the Jogeshwari railway station, Ciron

Pharmaceuticals was the culmination of the untiring and dedicated efforts of the three brothers to

make a mark of their own in the big bad world of the Pharmaceutical industry. While Manu and

Kirti were commerce graduates, Ratan had a B.Pharm degree. As a result they complemented

each other’s skill sets. Ratan took care of manufacturing; Manu looked over accounting and

general administration while Kirti handled sales. The firm specialized in production of three

brands of tablets – Paramol, Ibupara and Acelofen Plus. Each tablet comprises of active (main

ingredient) and a host of excipients (binders, fillers, coatings and sorbents to name a few).

Examples of excipients include talcum powder, pharma grade sugar, carnuba wax, guar gum,

colours, etc. The active ingredient for Paramol was Paracetamol, while Ibupara and Acelofen

Plus contained Ibuprofen and Aceclofenac respectively over and above Paracetamol. Each of

these drugs had different combinations of excipients. Paramol and Ibupara contained just 3

excipients while Acelofen Plus contained 8 excipients.

The year 2008-09 saw their turnover increase from 15 million to 18 million. For the next year

they had set an ambitious target of 20 million. The firm continued to maintain an overall 8% net

profit over the last five years. Paramol contributed about 12% of overall sales, while Ibupara and

Acelofenac Plus contributed about 42% and 46% respectively. However in terms of profitability,

the situation was not as rosy as it appeared. The first two gave a net profit of 15% and 18%;

while Acelofenac Plus suffered a loss of 3%. April 2009 passed by and the results were more or

less identical. Manu Shah decided to hire the services of Nitesh Malde, a reasonably well known

consultant and who incidentally happened to be his childhood friend. Nitesh had pursued his

MBA from a reputed B-School in Mumbai after having practiced as a Chartered Accountant for

three years.

Manu had come prepared for the first meeting with Nitesh. He handed over a sheet containing

necessary information (Exhibit 1) for analysis.

Manu Shah: Our costing process is very simple. We know exactly how much active and

excipient goes into production of each batch of tablets. Run time labor hour per batch is also

known and hence labor cost can also be determined. The overheads are assigned to production on

the basis of run labor cost.

This case was prepared by Professor Vishwanthan Iyer of IMT Hyderabad based on his past engagements with the company as

statutory auditor. Data and details have been appropriately modified to mask sensitive information about the operations of the

company. This case is intended to be used for class discussion and is in no way designed to present illustrations of either correct

or incorrect handling of a business situation.

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Nitesh Malde: Fine. So based on this approach you have concluded that Aclofenac Plus is

posting a loss of 3%.

Manu Shah: Yes. Bulk of our gross revenue comes from Aclofen Plus. Given the competition,

we cannot increase the price any more. Ideally we expect a net margin of 8% from all three

products. As of now, Ibupara is subsidizing Aclofen Plus. Its delivering a supernormal profit of

18% plus.

Nitesh agreed to look into the matter over the next couple of days and promised to get back. In

the meanwhile, he discussed this case with his assistant Sandip Tripathy and asked him to give

his analysis.

After going through the details (Exhibit 1), Sandip felt there was a problem with the existing

method of assignment of overheads to the products. He decided to assign setup cost directly,

storekeeper’s salary on the basis on material cost, supervisor’s salary on the basis of run labor

cost and the remaining overheads on machine hour. His logic was simple. Setup cost can be

directly identified, storekeeper’s job is to handle material and record inventory movement and

supervisor’s job is to oversee the production. As drug manufacturing is more technology

intensive than labor intensive, he decided to use machine hour as the basis for allocating the

remaining overheads.

Based on these revised assumptions Sandip recomputed the profitability only to find some

startling results. First, Paramol’s net margin was almost 25% higher than Ibupara and that

Acelofen plus was actually delivering a 5% profit instead of a loss of 3%. Is this really possible,

he pondered. If at half the price Paramol can give such impressive returns, then Manu Shah

should focus more on this product rather than Ibupara, he thought. He presented these ‘extra-

ordinary’ results to Nitesh Malde.

Impressed by his subordinate’s effort, he encouraged Sandip to dig further. Nitin explained about

Activity Based Costing (ABC), a modern approach to Cost Accounting. Such an approach, he

opined, would depict cost more accurately through a deeper understanding both of the activities

involved and the resources consumed by each of those activities. Enthusiastic as always, Sandip

wasted no time in gathering information about ABC from the internet and gave a thorough

reading. He soon realized that to implement ABC, he needs a profound understanding about the

nature of activities associated with each of the overhead costs. Accordingly he decided to visit

the factory for gaining firsthand information about the nature of activities involved in the

process.

At the factory, he first interacted with the storekeeper. He found that on a typical day, about 80%

of the storekeeper’s time was spent on recording the receipt of raw materials and/or its issue for

the production process. The remaining time was spent on recording the batch-wise inflow and

outflow of finished products. Next he visited the Quality control Department. Their task was to

enforce GMP (Good Manufacturing Practice) regulations and ensuring that the tablets produced

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match the required standards. Essentially, they take out some sample from every batch of tablets

produced and certify its quality. Thereafter he met the Supervisor of the plant. On his

interactions, he realized it makes more sense to distribute his salary on the basis of total labor

hours rather than run labor cost. He went on to observe their packaging and transporting process.

Although the number of boxes dispatched was different for each of the product, there was only

one packaging per dispatch. It occurred to him that using number of dispatches could be a more

logical method for allocating the packaging and transporting cost rather than labor or machine

hours.

On his way out, he met Manu Shah and confirmed his observations. To this, Mr. Shah added that

machine maintenance expenses, depreciation and electricity charges were directly proportional to

the usage of the machinery and hence could be apportioned using machine hours.

Armed with this new set of information, he decided to re-estimate the costs and arrive at product

wise profitability. He had no clue of what surprises were awaiting him at the end of this

process…

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Exhibit 1 Basic Details about the company

Paramol Ibupara Acelofen plus

Tablets per strip 10 10 10

Strips per box (SKU) 20 20 10

Tablets per batch 15000 12000 8000

No of batches manufactured / sold 20 45 60

No of boxes despatched at a time 300 150 240

Selling price per box (Rs) 120 240 150

Raw Material

Active Paracetamol (100%) Ibuprofin (40%) Aceclofenac (33%)

Paracetamol (60%) Paracetamol (67%)

Total Excipients required 3 3 8

Cost of Active (per batch) 3240 5472 4320

Cost of Excipients (per batch) 360 288 480

Material Cost (per batch) 3600 5760 4800

Labor

Setup time in hrs (per batch) 5 7 4

Run time in hrs (per batch) 8 12 15

Total time in hrs (per batch) 13 19 19

Wage rate - Setup time (per hour) 100 100 100

Wage rate - run time (per hour) 150 150 150

Machine hours (per batch) 8 15 12

Overhead Expenses for April

Storekeeper's salary 22,625

Supervisor's salary 45,100

Quality Control 45,000

Electricity charges 77,750

Maintenance Expenses 65,310

Depreciation 1,78,825

Packing & Transporting 64,500

4,99,110