Company Costs of a Product Recall: Incentives to Fix or Ignore Recall Effectiveness Problems (Summary)

October 13, 2008 — By

When I speak with consumers about possible ways to make locating recalled products easier for
manufacturers, many balk at the idea, positing that companies would never have
any incentive to improve recall effectiveness.
For these individuals, the belief is that companies would rather not do everything possible to locate and
retrieve defective products in order to avoid incurring repair and replacement
costs or stirring up media attention.

What these individuals correctly
assume is that product recalls are expensive to conduct. What they are missing, however, is that there
are many indirect expenses that may outweigh any incentives to hide or slow a recall. In my article, Company Recall Costs: Incentives to Fix or Ignore Recall Effectiveness Problems, I identify many of
the direct and indirect costs of recalls and discuss whether the influence is
likely to be positive or negative with respect to a company’s propensity to act
responsibly – that is, to do everything possible to retrieve defective products,
even if that means doing more than what the law requires.

You can read the full article by
clicking the link above. A summary of
my main points, and excerpts from my conclusion are presented here.

  • Direct costs include the cost of implementing the recall, lost inventory and reversed sales.
  • Direct costs tend to increase as recall
    effectiveness increases.
  • Indirect costs include government
    fines, product liability claims and lost future sales; the last of which is driven by brand-image and Corporate Social Responsibility (CSR) effects.
  • Indirect costs tend to decrease as recall
    effectiveness increases.

Company Recall Costs and Incentives

The chart above summarizes recall
costs and whether each carries a positive or negative incentive for companies
to ensure the recall is effective. Although
quantifying these cost incentives is difficult and goes beyond the scope of the
paper, I do offer this small bit of analysis:

Mattel cost pie PNGMattel Stock PricesIn the fall of 2007 Mattel faced
several recalls in a short period of time due to loose magnets and lead paint
violations. Even though the fraction of
Mattel’s products that were affected was very small, the company suffered
significant impact on its stock price.
Given that Mattel had $5.5 billion in annual sales at the time, and
that the then-current direct recall costs were only $69 million, something else
must have been driving the bulk of the impact.[1] Shareholders and analysts were building in
expectations regarding the recalls’ impact on Mattel’s future sales, which are captured
in direct costs.

Therefore, while it may seem
counterintuitive, when all costs are considered, companies have an incentive to
implement the most effective recalls possible; that incentive being improved
financial performance. It may be the case that companies that do
not go the extra mile to locate defective products and communicate with
consumers quickly are budget constrained, but more likely they are too focused on direct costs.

[1] Mattel 10-Q, September, 2007

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