Case 2 Anagene

Fluctuating and unpredictable costs and margins of Anagene

Market Analysis
Genome Market

2000 completion of the sequencing of the human genome

Next phase involves identifying genetic variation (SNPs) within the genome
from person to person
Doing so could significantly help in combating diseases among individuals;
more effective drugs, with regards to each individual, could be produced
DNA microarrays were best tools for the process; allows researchers to
monitor large numbers of genes in a single experiment
Increases information that could be obtained; saves time and money

DNA microarrays market

Fast growing industry; $600 million in 2000; projected to be at around $4.5

billion by 2004
2 sources of revenue (other than research and development grants); 1)
equipment sales, and 2) follow-on sales of chips and cartridges (which are
necessary for experiments)
Potential payoff was enormous; many companies entered the market; market
became crowded
Anagene aggressively leverage microelectronics in their microarrays
Their products were considered to be highly accurate
Industry was segmented into two:
1. Industrial genomics dealt with large amounts of data; speed is of utmost
importance; accuracy only second
2. Patient-focused genomics and clinical research involves carefully
examining each patient; accuracy is more important than speed

Anagene

Founded by Mark Hansen and Harold Bergman in 1993

Mission: to facilitate breakthrough genetic analysis
Planned to combine microelectronics and molecular biology to develop
products which will have broad applications in genomics and other fields
Gerald Kelly joined in 1998; got promoted to CFO, and subsequently, to
President
First major product Anagene Molecular Biology Workstation ($160,000 each);
used primarily in SNP and STR analysis
Also sold disposable cartridges ($150 each); used in workstations
Anagene targeted the clinical research market

Highlighted the accuracy of their products

Workstation placement and chip sales

Workstations were either sold outright or leased/rented (no title transfer); the
use of the latter was accelerated since it would mean the companys
workstations would be adopted faster; could lead to a strong base for
cartridge sales
Projected cartridge sales for 2001 was 50,000
However, forecast was revised to 26,000 in the January 2001 board meeting
Lead times and time required for analysis of difficult assays took longer than
expected
Customers were also reusing cartridges rather than buying new ones
Total cartridge volume projected for 2002 -95,000

Manufacturing

Parts of the workstation (loader and reader) required expertise and vast
resources; Anagene decided to outsource the production of these parts;
contract with Hitachi; Anagene performed final product testing but
management expects Hitachi to take over this step in the long-run
Anagene built own manufacturing facility for production of cartridges
Management expected a large market for cartridges; based in Kellys
experience in the diagnostics market, consumables (in this case, the
cartridges) usually had a larger share of the market compared to instruments;
gross margins were also comparably higher; however, he noted that being a
new technology in a new market, margins still cannot be accurately
forecasted
Monthly production volume experienced significant variations

Standard Cost System

Anna Puleski controller and director of finance; hired Daniel Yeltin (CPA) to be
manager of financial analysis
Yeltin developed Anagenes cost system when they started producing
cartridges for sale
Standard costs calculated once a year
1. Budgeted VC per unit was estimated
2. For OH, each machine and equipment was assigned to one of the
manufacturing steps so depreciation may be calculated for each step
3. For support departments (shipping, purchasing) depreciation was
estimated rather than calculated
Plant level OH were allocated to cartridge manufacturing, instrument
manufacturing, and R&D based on budgeted production volumes; OH cost per
unit is obtained

Standard cost per cartridge calculated by adding per unit material, scrap, and
labor costs
Other costs associated with sale of cartridges unit cost of royalties,
estimated return expenses
Standard costs used for financial reporting and assessing product cost and
profitability
Aggregate and infrequently updated standard costs were not so useful for
production cost control

Anagene 2001

See budget for 2001 (approved Oct. 2000)

Per cartridge costs significantly reduced from 2000 to 2001; GP% increased
from 17% to 65%
Kelly presented revised budget at Jan. 2001 board meeting
Costs increase by 40%; GP% reduced from 65% to 45%
Lower projected production volume of 26,000 units increased OH per unit
Board was concerned with the drop in gross margin and the fluctuating
monthly production volume
Kelly also concerned about market analyst who might question him about the
change in estimates
According to Kelly, market analysts want stability with values
Kelly, together with Puleski and Yeltin, discuss the issue; one of the members
of the Board, a business professor at Harvard, sent them a chapter to read
Chapter was about using practical capacity of resources (rather than
budgeted manufacturing volumes) in calculating standard costs
Using budgeted manufacturing volumes is risky; a significant decline in
production volume would increase cost driver rate (or cost per unit?)

Meeting

Decreasing cartridge margins raised questions regarding the companys longterm profitability
Fluctuating monthly production volume made it difficult for board members
and analysts to understand short-term profitability
Yeltin was tasked by Kelly to investigate the practical capacity concept