Product Recalls: Associated Costs and How Procurement Can Help Reduce One-Time Expenses

Spend Matters welcomes another guest post from Ashwin Kumar of GEP.

In August this year, New Zealand company Fonterra – the world's largest dairy company – faced a serious food safety scare when bacteria was discovered in some of its milk products. These products had been exported to several countries across the world, thereby prompting a massive product recall operation that was closely monitored by many government agencies and regulatory bodies.

Increased supply chain complexities, global supply network, high degree of customization, faster time to market, stringent regulatory norms, and high consumer awareness levels are key factors that have led to an increase in product recalls over the last three to four years. While such recalls are commonplace in industries such as automotive, pharmaceutical, and consumer goods, it nevertheless hits the company when it is least prepared. In order to salvage reputation and stem the ebbing of consumer confidence, companies splurge millions of dollars in a short period of time to scour the market and restore normalcy. Though it is difficult to implement a premeditated strategy for such events, there is definitely some value in allowing for these occurrences in supply chain strategy planning.

 Imagine this: How does a US firm track and recall an alleged violative product that was sold three weeks ago to a retail consumer in a remote corner of Asia?

The whole recall operation is highly intricate. Each aspect (which is probably handled by different departments) involves certain costs. Consider the following:

Reverse logistics and distribution costs: Though the onus of managing the distribution operation rests on the logistics team, procurement can play a critical role in ensuring that these costs are negotiated at the time of awarding carrier contracts. Since the carrier may charge exorbitant rates to service small volumes for a relatively atypical route, factoring in a part of sales volumes for recalls while awarding contracts will help avoid one-time costs.

Penalties and costs reimbursements: If the cause for the violation is from the external supply network, procurement should ensure that the damages (often times, an educated guess), penalties, and product costs are partly or fully recovered. Having a strongly worded and clearly stated chain of responsibility and product quality standard clauses  in the supply contracts is an effective measure to reclaim costs.

Inventory and disposal costs: Identifying the root cause quickly and tracing the dependencies are critical aspects of any recall operation. If it is an external supply problem, procurement should be able to trace the raw material batch swiftly to enable Production and Distribution to map the probable location of various finished products. In order to re-service the impacted customers quickly and prepare for the subsequent regular operations, procurement has to make available adequate amount of raw materials in the inventory. Procurement can also play an influential role in maximizing revenue from product disposals by finding suitable buyers and negotiating for competitive disposal rates.

Communication costs: These are typically handled by marketing teams as they set up new communication channels or use existing ones to interact with public and help correct any false rumors.

Legal costs: These are handled by legal and corporate teams and involve settlement claims towards consumers, supply chain partners, and other agencies concerned.

Since a typical product recall operation more often than not creates a huge marketing/PR frenzy, the contribution of supply chain teams and the associated costs of such events are largely unnoticed. However, to contain unplanned spikes in operating expenses, procurement and supply chain must be adequately prepared to restore normalcy quickly and, to the extent possible, avoid incurring additional costs.

For more interesting thinking on procurement, visit the GEP Knowledge Portal.

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