CPO’s Guide to Product Recalls

This is the 2nd in our series of posts on Practical Procurement where we look at real world events and their impact on procurement and business. You can find the 1st post about Apple’s Chipgate problem, working with multiple suppliers and what the procurement teams can learn from it here.

With massive product recalls dominating the news, we wanted to provide a procurement perspective of the same and with this post we have tried to complete an incomplete picture.

You will find many experts have written about how the recalling companies CPO can help with cost reduction in the recall phase, we thought it would be useful to write about what do when the products you have bought get recalled.

Disclaimer

• We don’t have any insight in any of the below-mentioned companies or news events that have been alluded to
• Neither do we take sides in any of the below scenarios
• We will be only using major and memorable news events and examples to help readers and procurement professionals take precautions when faced with a product recall situation

So the large fleet of cars or computers or batteries or toys or even instant noodles your company bought has been recalled by the manufacturer. The manufacturer has promised to bear the entire cost including door-to-door logistics. Phew!! Right?

Not so fast. Below are 7 hidden costs a procurement / category / supply chain leader needs to be wary of in recall scenarios and their overall impact which we will call “recall loss”.

1. Resale and Asset Value –You are a fleet rental company / logistics provider and a manufacturer just recalled a large portion of your fleet. Other than the costs of logistics the 1st major impact is obviously asset value. Recalled models almost always suffer a loss in asset value. This may be evident in a resale scenario or may directly impact the balance sheet as one-time depreciation event. That is a direct impact to the bottom line. In such scenario, leasing is often considered a more risk averse alternative.
2. Opportunity Cost –During a recall you may suffer a temporary reduction capacity. E.g. a retailer may not have stock of a popular toy or food product for some time and demand for the entire category may decline. This leads to lost sales or lost opportunities to sell. A cost often hard to compute and best to avoid. There are ways around this problem example temporary capacity augmentation or stocking an alternate supplier’s product but when executed within a time-crunch, these quick fixes may not be cost effective.
3. Taxes and Penalties –Think back to the recent recall by a major auto manufacturer as an example. Such a large recall will impact many fleet owners and operators. While most governments have allowed the recalled vehicles to operate without legal fees till the recall is complete, their patience will wear thin if vehicle owners miss recall deadlines. One errant vehicle might result in increased fines and taxes and can lead to increased regulatory scrutiny for the entire fleet.
4. Increased Risk of Legal Liability –While an offending auto manufacturer may meet its regulatory requirements, completing the product recall and replacement in a set time. It exposes itself and large fleet customers to the increased legal risk. If cars that pollute more they should, or don’t stop when they are supposed to continue to operate they are magnets for environmental and consumer lead legal action.
5. Insurance Cost –With the chance of great legal liability comes greatly increased insurance cost. As the risk of legal liability increases, the insurance companies raises premiums for assets and business risk. While these may be minuscule in the wider perspective it is another avenue where cost saving becomes a challenge.
6. The Risk of Increased Maintenance and Running Cost –Recalled and replaced products may not always function as smoothly as they once did. They may suffer from higher maintenance and/or running costs or may simply require more care. When trying to protect the asset cost, companies often do not guard against seemingly minor inconveniences and minor cost spikes. Procurement teams need to be aware of these costs in the long run.
7. Marketing, PR, and Competitive Risk –If you are direct to Consumer Company and have in the past openly stocked or continue to use/sell a recalled product; you leave yourself open to public scrutiny by the media and aggressive competition. This cost of guarding against these is often not measurable in monetary or numbered terms.

So how can procurement guard against these risks?

1. By being aware of the risks — If you or your competitors have experienced a recall event once, it can happen again and you have probably identified products with a high risk of recall. You may also involve operations, manufacturing supply chain teams to further identify such products and expand the list.

2. Involve legal, finance, supply chain and set up a framework — Protecting yourself against “recall loss” involves setting up a framework of legal, finance and operational action plans when you know a product involved in critical business aspect is at the risk of getting recalled

• First involve legal teams to define recall clauses that cover as much of the loss as possible as defined in 7 points above. While total indemnity might not be practical in some cases, supplier’s sales teams are often focused on trying to sell their products by focusing its positives. They may often provide you in terms of indemnity more than you might think.
• Consider Recall Insurance to insure yourself against recall might prove to be “business critical”. The additional insurance cost might prove valuable when guarding against critical losses.
• Ensure regulatory guidelines are complied with in a post recall scenario by establishing a special compliance task force. Ensure you avoid unnecessary regulatory fines and taxes and remember regulatory noncompliance or negligence might also void the supplier provided indemnity as well.
• Prepare a proactive legal strategy — Talk to your lawyers some more to understand potential legal costs and risks in case a recall. In 2007 when a large manufacturer of toys decided to recall toys coated in leaded paint, the retailers carrying the toys were also threatened with a lawsuit. You can avoid the same by defining safety and security standard for your company and your supply chain and ensuring compliance and a legal strategy for scenarios when not everything goes smoothly. Publicize them for goodwill.
• Supply Chain Action — The faster you mobilize your supply chain to fill in the gap left by the recall, the lesser your loss will be. This may even provide a competitive advantage if the recall leads a shortage or a temporary gap in the supply of alternatives.
• Minimize public scrutiny by being proactive — Work with marketing and PR teams to proactively prepare a strategy for marketing and PR backlash, if any. Many in court battles are also won or lost the court of public opinion.

3. Don’t let the recall be a surprise — As we have seen time and again, the problem often occurs due to the quality of the parts shipped by your suppliers being not of the highest quality or meeting the specification standards. However, it is always your brand and revenues that take a direct hit. So, it is very critical that you monitor your suppliers’ performance very closely. This can be regular audits, to detailed quality reports — all of which gets analyzed and bench-marked.

Also, looking at the trend of these parameters is also very important as it often provides those very early warning signals. And in today’s world, often it’s not enough to just look at your suppliers but also your suppliers’ suppliers.

An Opportunity

However, we feel a recall scenario does provide a silver lining. If the recall is in a non-monopolistic or non-oligopolistic industry, it usually increases competition among competing suppliers to capture the recalling supplier’s market share. This gives procurement professionals leverage to renegotiate contracts and lock in long-term cost advantages. This is doubly relevant if payment is pending on recalled the product and the existing supplier may provide better terms.

Zycus’ Source-to-Pay suite helps you make smarter procurement decisions by, among other things, streamlining contract and supplier management across the organization. It can also help you minimize recall loss by deploying an organization-wide framework to protect against the same in future procurement events.