THE CHINESE UNIVERSITY OF HONGKONG

Sanlus Melamine
Tainted Milk Crisis in China
Jasvin Bhasin 10/21/2011 Student ID: s1155006888 Email ID: [email protected]

The following document analyses the answers to three very important questions regarding the the tainted milk crisis in China.

1. What are the major causes of this crisis?

Answer: The tainted milk crisis in China is perhaps one of the most disastrous scandals to occur in the history of Chinese dairy industry. In September of 2008, the infant formula powders produced by Sanlu group, Chinas biggest milk powder manufacturer and 21 other dairy companies was found to contain melamine- the ingestion of which could cause kidney stones. This sent shock waves across country affecting thousands of infants and young children and leading to casualties. Many factors can be considered as contributory to this crisis: 1. Low Supply High Demand: Chinas dairy and milk production had slowed down due to surging inflation and increased cost of production but the national consumption remained high due to Chinas growing income per capita and increased desire for western diet. To take advantage of this flourishing business industry some infant formula producers made and sold low quality milk products for personal gains. Hence, a high demand low supply situation led to dairy companies becoming dishonest in their activities to save costs make more profits by using cheap alternatives for milk production. 2. Improper Operation Model: Most of Chinas dairy farming was operated on a small scale and less structural basis. Small dairy farm

complexes functioned like a trust company in very scattered set ups with no central control and no unified supervision over the actions of the farm owners or independent milk stations. This led dairy companies to rely on the raw milk provided by multiple and scattered milk sources. There was no central organization that could vouch for quality of this milk. 3. Sellers Market: Initially, the dairy companies had been selective with milk collection stations that were eager to sell. However, after 2005 when more and more dairy industry players appeared in the market it converted the dairy industry to a sellers market with more buyers than sellers. Operating without any formal policy or contract, milk dealers sold their milk to companies that offered them the highest bid. During peak operational period, desperate dairy

companies paid for milk source regardless of quality. However, during off peak season farmers had to accept whatever price the companies offered. Also, individual farmers were exploited via delayed payments since they did not have collective bargaining power. Also, all the cost pressure generated by the dairy companies who reduced prices to compete effectively was transferred on the head of the farmers. Hence, the farmers were no longer making money due to rise of inflation in the country and rising cost of dairy feed. All these situations led to the farmers trying to use cheaper alternatives to increase production and at least break even.

4. Lack of Knowledge and Quality Control: Small scale rural farmers had little knowledge about milk safety awareness. Since payment to the milk farmers was based not just on milk volume but also on the protein content the milk suppliers resorted to artificial means like adding nitrogen rich urea. The traditional approach of measuring milks crude protein level could be tricked by mixing nonprotein nitrogen rich compounds such as melamine but it was still very widely adopted in China. 5. Quality Inspection Exemption: The Chinese government gave Sanlu group a check-exemption since it was considered to have a good product quality record, had a large market share and had standards equivalent to and beyond national and international levels. Hence, Sanlu was allowed to print the national inspection labels on their products signifying a quality assurance to customers despite no tests having been actually performed. This was quite a risky proposition given the fact that there was no way to check if Sanlu had actually performed any real testing at their end. 6. Ignoring Early Complaints: The complaints regarding

contaminated formula first appeared in 2007 but Sanlu ignored the seriousness of the situation and let the problem boil further. If Sanlu had taken more responsible actions when the news first surfaced may be the crisis could have been controlled more effectively. Also, in 2008 there was a big delay by Sanlu in notifying the public and concerned government authorities about the contamination situation.

2. How should the crisis be handled and how product recall strategies influence company in terms of corporate social legitimacy, customer response and companys competitiveness?

Answer: The disaster of the Sanlu tainted milk crisis in China generated an irreversible health hazard, caused casualties and shut down one of the most popular companies in China. Looking back at the crisis one can make a few suggestions about what could have been done to handle the crisis in a better way. 1. Acknowledge Early Complaints: Sanlu ignored the early

complaints when they were made in the year 2007 and did its best to do maximum damage control to its company name at that time. It resorted to acts of bribery to remove any trace of the existence of this This was not right, since an effective realization of the seriousness of the situation at this time could have saved many more lives. 2. Pro-active reporting: Sanlu delayed the reporting of this incident to the government authorities and the public which was not the most ethical way to proceed with such a serious situation. If Sanlu had pro-actively notified everyone of the situation before hand it could have saved a bit of dignity for itself. In this case the news came out to the public when Sanlus foreign partner Fonterra communicated the news to its government.

3. Honesty in Actions: It was noticed that Sanlu tried to gain help from local government to manage the media and to create a good environment for the recall of the companys products and tried to buy out critics by offering money to internet search engines such as Baidu when the situation occurred. If Sanlu showed more responsibility and had honestly shared this news with the central government on high priority the situation could have been controlled a bit better. 4. Better Control on Supply Chain: In relation to the Sanlu case, the state investigators did not recover melamine purchase records at Sanlu and found no evidence to suggest the company had actually added the chemical to its formula during production. Hence, if Sanlu had handled its supply chain better via a centralized quality control over all its suppliers then this crisis could have been prevented.

Product Recalls are major problems to supply chain management in China. A product recall is a request to return to the maker a batch or an entire production run of a product, usually due to the discovery of quality and safety issues. The recall is an effort to limit liability for corporate negligence (which can cause costly legal penalties) and to improve or avoid damage to publicity. A product recall definitely has an impact on corporate social legitimacy, customer response and companys competitiveness as discussed below:

1. Corporate social legitimacy: From an ethical standpoint product recalls if done in a pro-active way are indicative of a good social responsibility on the part of the company. A company has to bear the brunt of loss made on recalled goods, has to suffer negative publicity and possible brand image damage during a product recall. 2. Customer response: Following product recall the customer response to the products of the company is usually negative. The customers become more doubtful of the safety of the company products. This is in sync with normal human psychology where the concept of Once bitten twice shy comes into place. A customer might start looking for alternatives to replace the original company products. 3. Companys competitiveness: Product recalls definitely create challenge for the company. Many a times it is observed that the companys stock price crashes post a product recall and as a result its competitors gain significant competitive edge. Also, when customers are wary of the company post a product recall they look for alternatives in the competitor products and this can cause the company to lose customer base.

3. What advice would you give to companies in this industry in terms of how to design and manage their supply chains to avoid future crisis such as this?

Answer: A close look at the Sanlu Melamine Tainted Milk crisis indicates that the biggest loophole that caused this disaster was the supply chain structure that the company had in place. The supply chain structure in place before the crisis is illustrated below:

It can be observed that Sanlu did not have direct control over the workings and activities of the cattle farmers who provided the raw milk to the scattered independent milk stations/dealers.

These milk dealers transferred the cost pressure of price reduction to the heads of cattle farmers forcing them to resort to dangerous cost saving measures such as adding melamine and other nitrogen rich materials to sell more milk since the volume of milk was not the only criteria to make sales any more and more emphasis was laid on the protein content of the milk. Also, lack of a central supervisory agency to monitor the workings of the different chunks of the supply chain would have resulted in better management of quality aspects. My suggestions to control such crisis are as follows: 1. Iron out the Middle Man: It is observed that the presence of middle man in most supply chains can result in ambiguity of information flow and hence it is important to make sure that the middle man does not become the most powerful deciding authority in the supply chain. In the Sanlu case the independent milk dealers/stations were supplying adulterated milk to Sanlu for years without its knowledge. 2. Central Quality Supervisory Agency: There should be a central quality supervisory agency which manages the testing and quality aspects of products passing at every stage. The central agency should have multiple branches at different points in the supply chain to manage quality at every checkpoint. 3. Balancing out Cost Pressure: The supply chain should be so designed that the cost pressures from the price reductions are not

really borne by one part of the supply chain and are evened out effectively to avoid excess pressure on any one division. 4. Uniform Plan of Action: In a supply chain where multiple parties are involved it is essential to have a common plan of action with defined rules and strict measures in place. In case of Sanlu all constituent parties were following their own course of action without any coherence with a common goal. 5. Better Management: It is very important to coordinate all process flows in a supply chain effectively. Management is responsible for overseeing that the process decisions made at every stage are ethical, legal and risk-free. The management needs to keep a keen eye on the workings of various divisions to yield benefits in the long run and reduce scope of error. The proposed supply chain model design is as follows: