The hidden impact of product recall

Transcription

1 The hidden impact of product recall May 2018 Lockton Companies Product recalls are on the rise, and recently there have been some high-profile food recalls. For some companies, they can have a devastating effect. In 2017, the Food and Drug Administration (FDA) recorded more recalls than it had in the previous four years. This increase in recalls appears to be here to stay, and companies with products that can be recalled should consider appropriate During the fall of 2017, Lockton Companies and Master of Finance students from the University of Illinois partnered on a research project to help uncover the hidden impact of product recall. controls and risk management strategies. FDA recorded recalls What s behind the recall climb? 9,361 9,288 9,469 9,178 9,199 8,065 8,044 8,305 A complex, global supply chain The Food Safety Modernization Act 8,061 5,585 5, % Increase between Food trends Scientific advances L O C K T O N C O M P A N I E S

2 Who suffers the most? Through an in-depth financial study of recalls on public companies in the food and beverage space, the University of Illinois research team found that recalls can have a major impact on a company. However, that impact varies drastically by type of company. Key factors which drive significant financial strain are greater for small and mid-sized pure play companies. While these types of companies may have the greatest need for risk mitigation and financing mechanisms to protect their financials, all companies can be adversely impacted. Of the eight small to mid-size company recalls studied, only one company saw a decrease in revenue the quarter following the recall. How are companies maintaining their sales post-recall? It s common to see a substantial increase in marketing, discounting, and rebating efforts to recapture consumer loyalty, reestablish the brand, and sustain or even increase gross revenues post recall. So, while the impact of a recall may not be immediately reflected on top line growth, the effects are clear on the bottom line. The net result from the recalls sampled (88%) was a deterioration of gross margin. Having a properly constructed insurance policy with adequate limits plays an integral role towards offsetting the cost of the activities that help maintain sales. Financial impact in the quarter following a recall % change in revenue Change in gross margin 20.0% 15.0% Increased 10.0% 5.0% 0.0% -5.0% Decreased -10.0% 1 out of 8 companies saw reduction in revenue 7 out of 8 companies saw reduction in gross margin -15.0% -20.0% Company

3 May 2018 Lockton Companies How long is financial performance impacted? The financial impact can last much longer than the next quarter. The study found that it can take up to two years for a company s stock to return to the pre-recall state. The chart below, which shows the change in capital asset pricing model (CAPM) beta at different periods following a recall (three months, six months, one year, two years), suggests that while the impact varied, all companies studied experienced a lag in stock performance. Financial impact of a recall on return to investors compared to S&P 500 for 14 mid to small size public companies 3 months 6 months 1 year 2 year 2 Change in CAPM Beta (Stock return relative to S&P 500) Beta is used in the capital asset pricing model (CAPM), which calculates the expected return on a company s stock relative to expected market returns (e.g. S&P 500). This is a measure of the volatility, or systematic risk, for the company compared to the market as a whole. -1 Company D-1 D-2 D-3 D-4 D-5 I-1 I-2 I-3 I-4 I-5 N-1 N-2 N-3 N-4 Decreased Increased No Relationship Note: In order to control for other changes in the marketplace, the returns were set relative to the S&P 500 using a Capital Asset Pricing Model Beta. 3

4 What can be done to minimize the impact? With the increase in food-related regulations (e.g., Food Safety Modernization Act), it is expected that governmentrelated recalls and food security will continue as high-risk areas for food and beverage companies. The impact is compounded by the social trend towards small-format, local and sustainable food sources. This trend has significantly increased the number of food companies, particularly in the US, during the past 10 years. As a result, there are more companies than ever that have heightened exposure to recall-related risk. Prudent mitigation strategies are critical to protect companies from operational and financial impacts of recall. Effective internal controls and external resources support operational risk mitigation, while risk transfer (e.g., product recall and liability insurance) supports a financial mitigation strategy. Advance preparation Committed response Risk finance Designate a crisis team: Select the appropriate team members and assign responsibilities. Review contracts and supply chain partnerships: Work with safe and compliant partners, while making sure your contracts protect you from all sides. Maintain regulatory compliance: Remain up to date with current and impending requirements. Set protocol and procedures: Create internal standards and procedures that are best in class. Create a response plan: Implement and test your response and notification plan regularly. Avoid additional penalty: Meet all regulatory standards post-incident. Build a public relations strategy: Quickly and clearly communicate your message to the public. Implement tested, fitfor-purpose coverage: Put coverage in place that will respond when you need it most in the event of a recall. Set adequate limits: Test and validate limits as your company changes, including benchmarks. Optimize your retentions: Evaluate the deductible level to ensure it is aligned with your volatility. 4

5 May 2018 Lockton Companies CONTRIBUTORS University of Illinois ANJALI BANSOD CANDICE LU LI REN GAUTAM SINGH Lockton Companies KELLY BILLINGS AMANDA RUBACK FRANK STRENK CAITLIN MCGRATH BROOKS HICKMAN 5

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