Costing and Pricing of Drug Formulation

In this article, we try to explain and hopefully demystify the cost and pricing of drug formulations. Most formulations sold worldwide are in the form of tablets and capsules, so we focus on these. However, the procedure is the same for all other presentations of a medicine. We do not discuss the cost of a bulk drug, vaccine, or injectables here.

Components of Cost

• Components of the cost of medicines (that is in this case tablets, capsules, liquids) are:

1. Raw material costs, 
2. Manufacturing/conversion costs, 
3. Packing costs, 
4. Quality control/testing costs,
5. Yield/losses, 
6. Marketing costs include trade margins, 
7. Promotional costs, etc.,.

1. Raw Material Costs

• Raw Material Costs include the actual cost of the raw material and other additives added to make the final product. The cost of the active ingredient depends on the actual cost of the raw material and its content in the tablet.

1. For example tablets of paracetamol/acetaminophen (brand names: Crocin, Metacin) are usually of 500 mg strength. Therefore 1 kg has enough raw material for a maximum of 2000 tablets: that is a maximum of 2000 paracetamol tablets of 500 mg each can be manufactured. Let us say the price of paracetamol bulk drug (that is the white powder) is Rs 180 per kg including all taxes. This means the cost of paracetamol raw material per tablet is Rs 0.09, which is 9 paise. We cannot price it for less than 9 paise unless one wants to make a loss.
2. Similarly, the cost of prednisolone (a steroid) is Rs 35,000 per kg. For a 5 mg tablet, the cost of prednisolone raw material is Rs 0.175, i.e., 17.5 paise.

• There are fluctuations in the price of raw materials - sometimes small and sometimes huge. When the fluctuation is large it becomes necessary to vary the price of the medicines. For example, some years back, isoniazid (an important drug in controlling TB) was available at around Rs 375 per kg. As of writing, the price is around Rs 700 per kg. Paracetamol similarly has seen an increase of around Rs 30 per kg in its price. Which in turn means an increase in the price to the end consumer - if you want to make the same level of profit.
• The component cost of additives is small in the case of tablets and capsules. In the case of syrups, the component of the actual raw material (active ingredient) is low. The cost of additives, the packing, the bottle, the carton, and the sugar, are much more than the cost of the actual active ingredient in the case of syrups. This is one good reason to discourage the use of syrups beyond very small children.
• Once we know the actual cost of the active ingredient in the medicine we get a fairly good idea of the actual cost of manufacturing the medicine.

2. Manufacturing/Conversion Costs

• These costs include the cost of labor, electricity, water, etc., needed to manufacture the medicines. We consider these to be fixed costs to a very large extent. (The operative word here is very large extent). These costs do not vary much on the production quantities for a given manufacturing setup.
• So higher production or better capacity utilization means that the component of this cost per unit tablet or capsule comes down because the same costs are allocated to a larger number of products.

3. Packing Costs

• This component of cost is manufacturer-dependent. Fancy packing versus utilitarian packing determines this component of the cost. Packing should be determined if you want to keep the costs low, by the need to maintain the medicine unaffected by the environment and not so much for being attractive.
• Strip packing or blister packing is costlier than bulk packing. The additional cost of a blister pack like aluminum foils, PVC, etc., -- over bulk packing is around Rs 50-100 per 1000 tablets, that is, a strip-packed tablet should cost a maximum of 10 paise over the bulk packed one. That is if the bulk pack of paracetamol costs Rs 150 per 1000 tablets the strip pack should not cost more than Rs 2.50 per 10 tablets, i.e., Rs 250 per 1000 tablets.

ALSO READ: A Beginner's Guide for Pharmaceutical Trading

4. Laboratory/Quality Control Costs

• Like manufacturing costs, these costs too are fixed costs to a very large extent. Increased efficiency and capacity utilization bring down the unit cost per tablet or capsule.

There is a wrongly held belief that price is related to quality. This is true only to a certain extent. 

• As we mentioned earlier, these costs for quality control are fixed and do not vary much and therefore do not contribute very much to the cost of the medicines.

5. Yield/Loss

• There are manufacturing losses incurred during the process. There are also samples to be drawn for testing, and statutory samples to be maintained with the manufacturer during the life of the product.
• Considering all these, the average yield in the case of tablets or capsules is around 98 %. In the case of syrups, the losses are slightly higher - around 5 %, i.e., the yield is 95 %. These losses will also have to be factored in while calculating costs.

6. Marketing/Distribution Costs

• These costs add up to a substantial portion of the costs. These include margins given to wholesalers and retailers. The costs of the medical representatives, the gifts, and free samples given to the doctors, all add up to the cost of the medicine.
• The usual margins for top-selling brands are supposed to be: 2 to 5 % for the wholesalers and 8 to 16% for the retailers. In many cases as in generics, especially branded generics, the margins are much higher. The pricing of many top-selling brands reveals that the bare ex-factory costs and the retail price is of the order of even 2000 to 5000 percent. This means actually a lot more margins are made and shared down the trading chain. 
• Similarly, in the case of OTC products, which involve a push by the chemist, the margins are much higher. Please note that manufacturing costs (that is converting the powder to the tablet form) for costly material like prednisolone, and for one that is much less costly like paracetamol, is about the same.

7. Taxes And Excise Duties

• After the manufacturer decides on his/her ex-factory price of the medicine, excise duty is levied (some essential drugs are exempt however) when the goods leave the factory premises. This rate varies depending upon the manufacturer. 
• Small-scale units are allowed to pay 9.6 % up to a limit (up to a sale of one crore rupees), and after that, it is 16 % whereas other manufacturers are required to pay uniformly 16%. The Excise Duty component of the cost gets included in the MRP of the medicine along with other costs and margins of profit.
• State sales tax is levied at the point of first sale in a state – and hence usually recovered by the manufacturer or his/her agent from a wholesaler or a forwarding agent. 
• Other local taxes are collected as applicable. Tax is not applicable on the MRP although it is collected by all retail pharmacists as a percentage of the printed MRP (Maximum Retail Price). The sales tax varies from state to state. Not only does the rate vary but also the list of items taxable and items exempt from tax also varies from state to state.
• This component of the cost of the medicine is not included in the MRP. However the sales tax paid by the first purchaser in the state is collected from the end user –that is the buyer at the retail pharmacy.

Cost Reduction

• Considering the various components, lowering Raw Material costs through efficient purchasing mechanisms like competitive bidding, etc., could reduce costs. As this constitutes the major single component of the cost any reduction in this will reduce the cost and hence the prices of the medicine.
• We must remember that the cost of the raw material includes the excise duty and taxes paid on it.
• A reduction in rates of excise duty and sales tax of the raw materials and/or finished goods could therefore reduce the cost and hence the price of the medicine – that is hoping the manufacturers and the traders pass on the benefits to the customer.
• Reduction in production losses, efficiency improvement, and better capacity utilization would also reduce costs. However, the scope of reducing costs on this front is limited considering that their component in the total costs is not very large.
• Marketing costs, costs of fancy packing, etc., could however reduce the prices to a large extent.

ALSO READ: Costing of Paracetamol 500mg Tablets