Continuing from our previous article about food recall causes and prevention, this article will be more focused on the financial impact of food recalls, whether it be direct or indirect.
According to a study by the Food Marketing Institute and the Grocery Manufacturers Association (GMA) in the US, food recalls cost companies an average of approximately RM39 million in direct costs. Yet, these costs are often not as damaging as the intangible costs of a recall.
The aspect that consumers remember most with regards to a recall is often the consequences that follow it. Take this case for example, till today many can still vividly recall the incident in 2008, where Chinese melamine tainted milk powder had affected hundreds of thousands of infants despite the news being a decade old. If more implicating evidence is needed to prove how consumers react negatively to a brand or product post recall, a survey by Harris Interactive also found that 15% of consumers would never buy that product again and 21% of people at a center of a recall would not buy any product from the same manufacturer.
The direct cost of a food recall can be defined as a price that can be completely attributed to the management of a recall. Falls in value that are difficult to attribute to a single process/service (eg. depreciation) is then termed as indirect costs.
The direct costs of a food recall include:
How can we estimate direct costs?
In 2010 researchers Moises Resende-Filho and Brian Burr developed an easy-to-use model to estimate the direct costs of a food recall. This was based on the selling price of a product and rough estimates of transportation and communications costs, including both notifications of recall and Public Relations.
It may be difficult to visualise the direct costs of a recall simply by looking at a formula, so let us illustrate these costs with a hypothetical example. Company A is a producer of rice, and due to contamination they had to do a recall of 300 tonnes (equivalent to 300,000 kg) of their product. Applying the formula above, if their rice was sold at RM5/kg their recall of 300 tonnes would total a staggering RM1.71 million just in direct costs.
On top of that, a food recall would also incur indirect costs which include:
These costs have no finite period and are hence difficult to measure. For example, there is no way to be certain that a reduction in sales or profits is entirely caused by a recall. However, it can be agreed upon that the worst indirect cost comes in the form of reputation damage and brand avoidance by consumers, as it can last for years and result in major declines in revenue.
Additionally, product recall insurers, Lockton estimates that about 80% of the total costs are incurred long after the recall has been dealt with. In view of such damaging consequences, it is paramount that food companies take steps towards lowering the probability of a product recall.
Given all the negative costs associated with food recalls, it puts the positive costs of preventing a food recall in better perspective for every company. In achieving business integrity, these positive costs are productive investments to provide better traceability and transparency to the entire supply chain risk management. By weighing the possible positive and negative costs, it would be more prudent for businesses to prevent food recalls from the get-go, instead of ultimately forking out unnecessary money to settle substantial recall costs down the road.
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To find out more about the causes of food recalls and the breakdown of preventive steps that can be taken, read our article on Getting to The Root of Food Recalls.