Figure 1: The Four phases of the definition of a Supply Chain Risk Management Strategy.
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Figure 2: Risks identification in the extended Supply Chain.
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Figure 3: Example of Supply Risks identification with SCOR Geo-mapping.
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Figure 4: Example of Suppliers Risks evaluation (Occurrence probability versus Impact).
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Figure 5: Example of Suppliers Risks Monitoring.
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Recalls of consumer products like foods, cosmetics and pharmaceuticals have dramatically increased in recent years, especially for those produced in China. Toymaker Mattel conducted unprecedented recalls of its toys in August 2007, with 21 million toys recalled twice due to harmful magnets and lead paints. And more recently there was a mass recall of dairy products in China that had been tainted by Melamine.
This leads to key questions embedded into the management of the supply chain:
- How to control a fierce race on cost reduction while guaranteeing the quality of products?
- How to efficiently ensure the execution of outsourced activities in a much more complex environment?
- How to identify, assess and mitigate potential disruptions of the supply chain in a systemic way, to control those risks?
The Colossal Consequences
The consequences of a recall always exceed the significant upfront expense of recalling a product.
A recall attracts media attention and may negatively affect a manufacturer's reputation and brand name, which can result in residual damage over the years. It could also either lead to the collapse of an entire organization or have negative implications on a national scale for an industry. For instance, more than 11 countries banned the importation of diary products from China where milk was found to be contaminated by melamine. The impact of such a recall reshapes not only the companies concerned but also their environment:
- Their suppliers: activity disruption (sudden and significant activity fall)
- Their customers: alteration of buying behavior
- Their industry: impact on reputation and strength
- Their competitors: market destabilization, scandal propagation
- Their country: affecting national image, exportation volume and international relationships
1.) The direct costs:
In 1990, the withdrawal of 160 million bottles of Perrier products worldwide (in 120 countries), after a benzene contamination was discovered, cost $263 million to the Perrier company, including $30 million only for direct costs such as the ones described below:
- Recall campaign (press releases, TV and newspaper ads, mailings)
- Customer support hotline/toll-free information line
- Negative news screening (it reached USD $440,000 for Sanlu, a company involved in China's milk scandal)
Loss of sales:
In October 2007, when toymaker Fisher Price recalled 1.5 million infant toys worldwide, the total bill in lost sales rapidly exceeded $30 million (with a retail unit price varying from $5 to $40). And even earlier in 2007, when Mattel issued a recall of 21 million of units of Chinese-made toys, the resulting cost was simply astronomical. Such important costs could seriously affect the company's profitability and lead to bankruptcy.
Cost to maintain "business interruption":
In some cases, companies are forced to interrupt their business. To be able to recover after the crisis they have to cover their revenue loss and necessary continuing charges and expenses during the business interruption period.
This includes any company inventory that has to be destroyed, in addition to any products removed from market circulation.
Cost of refund/compensation:
In most cases, defective products have to be refunded to the customers and, at least, equivalent-value coupons could be offered in exchange for recalled products.
The cost of recall process is often associated to:
- Physical collection of the products or shelf withdraw
- Shipping and redistribution
- Disposing of the defective product
- In case of replacement, the shipping cost of the replacement product
- Potential cost to isolate and store the defective products
- Extra overheads to conduct investigation, evaluation or analysis.
In the cases mentioned above there were instances of litigation. By October 2006, the Montreal-based Mega Brands, maker of Magnetix, a construction toy made in China, had paid $13.5 million to settle four lawsuits and 10 claims related to Magnetix injuries (because of fatal consequences due to magnets ingested by children). This could have potentially been much higher if the scope of the damage had been extended (reaching billions of U.S. dollars).
2.) The intangible/indirect costs:
- Loss of market share (Sanlu stock value decreased up to 2/3 due to the melamine-tainted milk scandal in China)
- Subsequent loss of sales
- Negative impact on a brand or company's image
- Cost to rehabilitate company reputation
- The collapse of an organization
Supply Chain Management Challenges
Paradoxically, whereas outsourcing decisions are mainly driven by cost reduction considerations, this strategy could lead to often-unconsidered costs if there is a recall of products. Some of the most respected and well-run companies in the world have experienced massive product recalls: General Electric, Dell Computer, Nestle, Kraft, Johnson & Johnson, General Mills, Campbell's and Nike are just a few examples.
These companies issued recalls as a result of a lack of control of key components in their Supply Chains, i.e. suppliers or contract manufacturers, which are often wrongly excluded. Basically, the control of the quality of products is vital but remains a huge challenge in a more complex and composite environment where companies have to deal with several layers of remote suppliers that hardly control their own suppliers.
As a result, the impact of the total recall cost (direct and intangible) on the supply chain, in the long run, could make companies re-consider their make-or-buy strategic decisions, or at least, in the shorter term, force them to review their procurement strategies to combat efficiently such catastrophic issues.
When a company is facing a massive product recall, the challenge lies in its ability to efficiently manage the recall logistics in a real crisis environment. This is often compared to reverse logistics but on a larger scale (with sometimes more than a hundred million units to be handled) with many stringent constraints (such as timeliness, especially when public safety is at stake).
However, this is only the tip of the iceberg, and the hidden part of this huge challenge is the upstream preparation of building a robust mitigation plan to avoid or minimize the impact of such risks before they occur.
The Essential Approach in the Supply Chain Risk Management: SCOR 9.0 Model
The Supply-Chain Operations Reference (SCOR) model is a process reference model that has been developed and endorsed by the Supply-Chain Council (a non-profit consortium) as the cross-industry standard diagnostic tool for supply chain management. This model enables companies to address, improve and communicate supply chain management practices, spanning from the supplier's supplier to the customer's customer.
As an essential approach in the supply chain risk management, SCOR.9 integrates a comprehensive set of processes, tools, best practices and metrics to identify, assess and mitigate any potential disruptions in the supply chain in order to reduce their negative impact on the company.
The model is composed of four phases (See Figure 1: The Four phases of the definition of a Supply Chain Risk Management Strategy):
Phase 1 — Risk Identification:
The objective of this key phase is to identify any potential risks that could affect negatively a company's supply chain.
Based on a description of the entire supply chain (supply chain SCOR mapping), the risks identification is conducted through analysis of historical problems, industry trends, assessment surveys, site audits or other specific methods (Delphi, cause-effect diagrams or critical path method) .
Then, a list of the relevant supply chain risks is established to highlight potential threats, such as raw material shortage, equipment breakdown, suppliers' failures or product liability. (See Figures 2 and 3.)
Phase 2 — Risk Assessment:
From the list of identified risks, a qualitative and quantitative evaluation is conducted to assess and prioritize the probability of occurrence of each risk and its impact on a company's supply chain.
This assessment can be performed with the support of specific tools (Failure Mode Effects Analysis, Fault Tree Analysis or Event Tree Analysis), "what-if" simulations, financial models, SCOR metrics or experts' opinions.
The result of this phase is a categorization and scoring of the risks by occurrence probability versus impact (such as COSO risk categories). (See Figure 4.)
Phase 3 — Implementation of Supply Chain Risks Management Plan:
The supply chain risks management plan is evaluated in terms of solutions-suitability, cost-efficiency and ease of implementation. Implemented measures and options should cover major identified risks, including a response and crisis communication plan, risk transfer and sharing options, sourcing risk mitigation strategies (multiple supply sources, supplier collaboration, sourcing opportunities etc.), enhanced business rules to mitigate risk and supply chain reconfiguration options to limit disruption.
Phase 4 — Risk Mitigation:
Finally, this phase brings an answer to how the major risks can be controlled, mitigated and monitored. The risk mitigation includes drills of the supply chain risks plan to ensure the company's readiness and, also, a series of metrics to monitor the risks levels to anticipate as early as possible the risk occurrence. (See Figure 6.)
The financial consequences of a product recall are colossal, and the persisting damages spread rapidly beyond the company's boundaries, affecting severely its environment, from suppliers and customers to the industry and even the country.
With minimal anticipation, these tragedies can be avoided with a robust risk mitigation plan, which could be built with a proven methodology of supply chain risk management such as SCOR 9.0.
Product recalls are only one of a series of risks that could disrupt a company's supply chain, however, so to be effective the supply chain risk management should integrate any potential risks from supplier's failures to natural disaster or terrorist attacks.
Finally, the real challenge for today's companies consists of integrating risk management into the configuration of their supply chains and, more broadly, in all strategic decisions.
About the Author: Frederic Gomer is a senior supply chain consultant at iCognitive, a consulting and research company that specializes in Supply Chain Management. On the Web at www.icognitive.com.