Ask Not Who is Responsible for Supply Chain Quality, It Rests With You

This morning, I'd like to welcome back a regular guest columnist to Spend Matters, who is sharing a two-part piece that will be continued Monday. Brian Sommer is author of the blog Services Safari.

Recent news stories detailing problems with Heparin, an anti-clotting drug sold by Baxter International and other firms, indicate that a potential allergen was introduced into the product via a Chinese component supplier. This contaminant has apparently been responsible for numerous allergic reactions and possibly some fatalities. This story has particular importance to me as a family member suffered a devastating allergic reaction to an anti-clotting drug years ago.

(Note: The cause of the contamination is still under investigation and the role, if any, in a Chinese supplier is still unclear.)

In the United States, if you sell a product and hold it out to be power generator, it must generate power. If you sell someone a box of rocks while claiming it to be a power generator, you just violated state law for implied warranty for merchantability or warranty of fitness for a particular purpose. This government web site does a great job of clearly stating this concept. It says:

"The implied warranty of merchantability is a merchant's basic promise that the goods sold will do what they are supposed to do and that there is nothing significantly wrong with them. In other words, it is an implied promise that the goods are fit to be sold. The law says that merchants make this promise automatically every time they sell a product they are in business to sell. For example, if you, as an appliance retailer, sell an oven, you are promising that the oven is in proper condition for sale because it will do what ovens are supposed to do—bake food at controlled temperatures selected by the buyer. If the oven does not heat, or if it heats without proper temperature control, then the oven is not fit for sale as an oven, and your implied warranty of merchantability would be breached. In such a case, the law requires you to provide a remedy so that the buyer gets a working oven."

It continues, "The implied warranty of fitness for a particular purpose is a promise that the law says you, as a seller, make when your customer relies on your advice that a product can be used for some specific purpose. For example, suppose you are an appliance retailer and a customer asks for a clothes washer that can handle 15 pounds of laundry at a time. If you recommend a particular model, and the customer buys that model on the strength of your recommendation, the law says that you have made a warranty of fitness for a particular purpose. If the model you recommended proves unable to handle 15-pound loads, even though it may effectively wash 10-pound loads, your warranty of fitness for a particular purpose is breached."

The purpose of these laws is to prevent hucksters from passing off bogus/sham items as the real deal.

This is critical in the Heparin case as products that were supposed to be of a specific standard and free of contaminants were apparently not so. Worse, it says that all buyers of Chinese products are on notice that suppliers may get away with producing sub-par, possibly deadly products at any time with no recourse. Sure, you can move your business to another supplier once you detect this and hope the new suppliers are more compliant but don’t expect any help from the government when your firm is sued into oblivion because of your reliance on sub-par Chinese products with hidden or well-hidden surprises built in.

In an Associated Press article of 2/28/2008 (see below), the following paragraph caught my eye: "We attach high importance to this," the agency (China's drug safety agency) said in its first comment on the heparin recall. But it said that based on international practice, "safeguarding the legality, safety and quality of raw materials imported for use in pharmaceuticals is the responsibility of the importing country."

Is the Chinese government's reaction understandable? In some ways it is as this is a country without a rich, long-lived system of tort law, capitalism, etc. This is a country that doesn't want to penalize its emerging businesses. Unfortunately, protecting them against litigation due to the manufacture of sub-standard and deadly products only protects today's miscreants for a time. Longer-term, unless Chinese suppliers accept responsibility for the products they produce, buyers will go elsewhere. The unwillingness to stand behind one's products is a crippling limiter of country's business base.

The implications of this decision on buyers of Chinese goods should be stark and well discussed. If a major reason your firm buys goods from China is due to lower pricing, ask yourself if the prices are still competitive when you fully load the increased cost of more product inspection and the cost of future litigation when product failures appear?

An example may help bring the problem into light. Suppose your firm makes big, expensive construction equipment. Suppose you buy a low cost, cast metal flange cover that fits over a hydraulic pump assembly that happens to be near where an equipment operator sits. A Chinese supplier is chosen to make this part and all of their early specimens meet your design standards. But, for some reason, the Chinese supplier changes their manufacturing process or raw materials source and ends up producing substandard parts some of the time. Unless your firm tests all these imported parts, you may not detect the defects for some time. But, eventually, the defects injure or kill customers and lawsuits occur. The damages plaintiffs are seeking may total in the billions of dollars for a part that cost your firm less than $100 per part. Your firm may have to undergo an expensive and humiliating recall that costs your brand long-term and short-term earnings. Will the Chinese supplier step up and accept responsibility? That's doubtful. Will the Chinese government help you enforce a judgment against this supplier? That, too, may be doubtful. Will your business seek bankruptcy protection? That's a real possibility. Is the potential failure of your business worth this? No.

Buyers need suppliers they can trust. This may be an old-fashioned axiom but low-cost suppliers who are risky sometimes aren't worth the risk. Procurement executives should:
- make a savings to potential risk assessment on every product sourced from offshore sources
- monitor the quality and financial stability of each and every supplier
- determine the firm's ability to tie suppliers to defect mediation costs whether by litigation or supplier contracts
- determine which countries are better sources of quality suppliers across several factors beyond just cost
- put all Chinese suppliers on notice that your firm will diversify its supply risk to other suppliers in other countries

- Brian Sommer

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