Case Study 1 - Sanlu Melamine-Tainted Milk Crisis in China

Sanlu Melamine-Tainted Milk Crisis in China Case

Background

Sanlu Group (“Sanlu” / “Shijiazhuang Diary Company”),  founded in 1956. It was a state-owned Chinese dairy products company, and based in Hebei. It mainly sold milk products, powdered milk and infant formulas. Later, it become the largest infant formulas seller in China, as it provided quality control procedures and tests for the milks products. As the milk collection stations acted as an intermediary between Sanly and farmers, then, Sanlu can focus more on its core business, which is manufacturing dairy products and marketing. However, Sanlu involved in a milk scandal in 2008, then Sanlu declared bankruptcy and greatly reduced the customers’ confidence.

How did the Sanlu milk crisis arise?

In September 2008, Sanlu involved in a milk scandal, which was reported that its infant formula contaminated with melamine and those milk products contained melamine was available in the market. Melamine is an organic based chemical, when melamine mixed with milk powder, infant and children may suffer from kidney failure after drinking this infant formula. It was the largest scandal in these years, around 54,999 children were affected because of drinking the melamine milk products, and there were 6 infants died. However, Sanlu tried to conceal the truth by paying money to the victims. Luckily, Fonterra (Sanlu’s joint venture partner), exposed this issue to New Zealand Government, then the China milk products were recalled and banned from many countries. After the milk scandal broke out, this greatly destroyed the confidence of consumers and other business parties.

Major reasons for Sanlu milk crisis

Who should be deemed responsible for
the crisis?

Suppliers: Dairy farmers

Most dairy farmers especially for rural farmers did not have much knowledge about the methods to maintain large yields and high-quality milk. Without contractual agreements with those dairy companies, they facing keen competitions in the raw milk market did not have high bargaining power to ask for higher prices for their milk. Sanlu even cut the sourcing prices of their raw milk. All these leaded to the low prices of raw milk. However, they would incur a huge cost to feed the cows. As the revenues generated from selling the raw milk were unable to make up for the feeding costs, they chose to add melamine to the raw milk and stretch milk with water for higher money in return so as to produce higher volume of milk with high protein content. Due to lack of a proper monitoring system, the disqualified milk was not discovered.

Intermediary: Milk collection stations

For the of milk collection stations, there are several flaws in their operations. There is a lack of unified supervision system for those milk stations.  Some milk collection stations even operated without legal licenses and did not formally enter into contractual relationship with the dairy farmers. Many milk-collection stations in countryside had poor infrastructure, inadequate management systems and insufficient milk-safety awareness. Without a formal contract, dairy farmers and milk stations could freely trade their raw milk to who could pay the highest price. Due to perishability of raw milk, dairy farmers had less bargaining power , so they were unable to secure high revenues by selling out their raw milk.  some milk collection stations operate without legal licenses and did not formally enter into contractual relationship with the dairy farmers.

Manufacturer: Sanlu & Partner(Fonterra)

Sanlu:

Sanlu had poorly managed the crisis. Having received a first complaint about its milk products, Sanlu kept this concern as a secret and covered all the negative comments. After the scandal broke out, although Sanlu had openly apologised for the contamination of milk powder, it did not explain for the procrastination of announcing this incident. Moreover, it had made use of government-granted loopholes. As Sanlu enjoyed a inspection-free-status, it was qualified for exemption of state- or province-level quality inspections and enable to print national inspection labels on its products. Besides, Sanlu paid dairy farmers less than US$0.07 per pint of milk. Since farmers only had produced small volume of raw milk, they could not earn much profits from selling out the raw milk. It offered high incentives to farmers to misbehave.

Fonterra:

Sanlu formed a joint venture with Fonterra that enabled Fonterra representatives to be one of the members of Sanlu board. However, they bore no operational responsibilities that they did not require to engage in production. What Fonterra only needed to do is that share distribution channels and expanding sales. With collaboration with international manufacturer of milk product, this partnership consolidated Sanlu as a leader in the milk-powder market.

Retailers: Supermarket and other distribution channels

Before the launch of the milk products, retailers had not adopted any strict assessment to evaluate the quality of the products to facilitate proper selection on products. Thus, the quality of the product could not be guaranteed, leading to the food safety issues. After discovering post-dated products, it had not taken the first action to investigate into the quality of milk products and had not recall the defective products instantly. It also failed to report to the related departments when Sanlu had recalled back the products publicly.

Customers - Parents

Customers had not been alerted enough to check product details before they brought the milk products. They might be only emphasized on the selling prices of those products instead of their quality and safety.

Local & State Government

Local government:

After the milk scandal broke out, the local government had accepted Sanlu’s request that manage the media to hide the scandal and create a good environment to call back the products to minimize the negative impacts on its business.

To avoid the milk scandal from being reported to the central government, some local government persuaded the parents and lawyers to tackle the case through out-of-court compensation payments. they supposed to covering the issue up while pacifying victims’ families with compensations.

The State Government

Since the government capped the price of milk in early 2008,  dairy companies and milk stations faced greater pressures to cut the costs. Thus, dairy farmers took in cost pressures, receiving lower payments from them. To earn higher, they had adopted invalid methods to handle the raw milk.

Apart from the prices, the central government also failed to impose regulations and guidelines related to food safety for the suppliers. Therefore, those suppliers lacked clear mandatory standards for them to treat the raw milk.

For the societal value, the idea of breastfeeding is not generally accepted in the traditional Chinese society. Without adequate promotion, people with conservative minds would mistakenly think breastfeeding is unethical.

Central government had not consolidate the scattered farmers. Milk collection centres took the responsibilities to collect the raw milk from different scattered farmers. After collection of the raw milk, the origins of the milk were difficult to be distinguished. Therefore, it was hard for the milk collection centres to monitor and maintain the quality of the milk.

Why company outsource?

Outsourcing is also same as “contracting out”, which is a process of shifting tasks, operations, jobs to an external contracted third party for a significant period of time. It is a business practice used by the company to reduce costs and improve efficiency.

There are some reasons that why Sanlu choose to outsource. Sanlu can focus on its core business, which is manufacturing of milk products and marketing). Moreover, Sanlu can transfer the cost pressure to upstream producers and control the cost for managing the milk stations. Due to the high demand of milk products, Sanlu choose to outsource to face the demand. Below are the advantages and disadvantages of outsourcing.

Pros for outsourcing

Reduce cost
Outsourcing can help Sanlu to reduce different type of costs. The production of milk can be costly in order to ensure the health of cows. Therefore, outsourcing can shift some cost to farmers. For example, time cost, labor cost, raw material cost, land cost, feeding cost, manufacturing set up fee, overhead cost etc.

Focus on core business
Sanlu shift the responsibility to upstream, it can focus more on its core competence, which is dairy product manufacturing and marketing. Sanlu ensured low production costs to support its low cost strategy. Therefore, this can maximize Sanlu’s profit and enhance the efficiency.

Production flexibility
Sanlu modifies its order quantity to adjust the demand changes when the demand fluctuates. For example, when there is high demand for milk products, Sanlu can produce large quantity of milk. While the low demand period, Sanlu can reduce its production order.

Increase supply sources
Furthermore, outsourcing can help Sanlu to enhance the milk supply. As Sanlu need to meet the high demand of milk in market, therefore, it needs to expand the sources from other places. For instance, China rural areas.

Diversify risks
In addition, Sanlu can diversify their business risk to other third parties by outsourcing. For example, Sanlu can get milk supplies and milk cow rearing from farmers. Therefore, Sanlu can transfer some risks and liabilities to farmers.

Meet high demands
Moreover, the demand of milk products in China market is higher and higher, which may exceeds the supply of dairy products. Therefore, with the limited resources, outsourcing is a good option for Sanlu to satisfy the high market demand.

Cons for outsourcing

Loss of control
If company outsourced to other partners, there will be loss of control. In this case, when Sanlu outsourced to other parties, it outsourced to milk collection stations and farmers. It is very difficult for Sanlu to manage, control and monitor the quality of the raw materials production. For example, milk collection stations used melamine to Sanlu’s milk products, and there was bribery between the farmers and milk collection stations to conceal the accident. As a result, it is difficult for the companies to control, manage and monitor the outsourced parties.

High dependency on suppliers ＆ Delayed Production

Moreover, when companies outsourced, there will be time consuming to collect the products. Also, it will be costly when outsourcing to other parties. In this case, Sanlu might rely on farmers and milk collection stations, therefore, if there are any delay process on producing milk products, this might affect the other procedures and influence the whole production.

High potential damage of brand reputation
Besides, outsourcing may affect its brand image and reputation when outsourcing.  From this case, farmers and milk collection stations staff added melamine to the milk products, and then milk crisis broke out. The responsibility should be milk farmers, however, the consumers think that it was a part of Sanlu’s management. Therefore, they shifted the blame from farmers to Sanlu. As a result, when outsourcing to other parties, there is a higher chance for others to damage the brand image.

Arousal of conflicts

In addition, conflicts may easily occurred because of outsourcing. It is because there are different goals, plans and operational objectives in different companies. For instance, Sanlu concerned on the milk product quality while the farmers focused on the speed of production. There are many differences between different companies, and this creates conflicts between parties easily.

What is business ethics?

Business ethics is a set of moral rules that governs the business operation, decision-making and labor management. By applying this code of conduct in the business environment, these values, norms as well as cultures will guide companies to decide conduct business in an ethical way. Thus, both the individual  and organisational behaviours are effectively governed.

Roles of ethics for upstream suppliers

Ethics should not be merely applied in a stakeholder, but the entire members throughout the supply chain. However, do you know why ethics play an important role in the supply chain? There are four roles that ethics plays in supply chain management as follows.

1. Encourage collective responsibilities
2. Maintain the connections along the supply chain
3. Promote the ethic standard in the society
4. Prevent upstream suppliers from being deprived

How to restore consumer confidence?

Government:

Reinforce supervision-apply strict testing system

Government should reform testing, which should be tested dairy products based on true nitrogen content, instead of . At the same time, government should conduct dairy products testing randomly and frequently. Customers will feel confident about the dairy products.

The reason why testing should be conducted frequently and randomly is as follows:

It gives consumers a sense that dairy products are closely supervised by government and therefore the quality should be secure.

On the other hand, it avoids in cheating of manufacturers. If regular testing is conducted, manufacturers may intentionally use better raw materials in manufacturing when testing period are approaching. Random checking can force manufacturers to use high quality raw materials and keep good manufacturing process.
As a result, because of the strict testing system conducted by government, dairy products industry can gain back consumers' confidence.

Release testing results to the general public

After government finishes testing, government should release the whole testing results to the general public every time. Without hiding any information, high transparency makes consumers trust on the testing results.

Manufacturer:

Arrange factory site visiting tour

During site visiting tour, manufacturers can show all manufacturing process to visitors, from processing raw materials to producing milk products. Through disclosing manufacturing process, public have more understanding about how the products they consume are produced. Because of high transparency of production process, consumer will have more confidence on the milk products.

Admit mistakes and apologies to the public and provide follow-up action

Manufacturers are responsible to provide qualified products to consumers. When they fail to do so, they have to admit the mistakes and apologise to public through press release. It makes consumers still be willing to trust manufacturers. It is because it is hard for manufacturers to admit mistakes, most of them will choose cover the scandals, instead of admitting the mistakes. Admitting  mistakes is responsible behaviour in consumers’ eyes. At the same time, manufacturers needs to recall the problematic products.

Sign formal contracts with milk dealers

It is time to have formal agreements about sourcing milk with milk dealers for all manufacturers. Manufacturers need to highlight that “milk dealers cannot undergo any artificial processing to the sourcing milk, such as adding chemicals. Once violated behavior occurs, manufacturers will terminate the collaboration with the milk dealers.

Do fair trade with farmers

To avoid Sanlu’s milk crisis happen again, manufacturers should do fair trade with farmers. Fair trade can protect the rights of farmers to ensure that farmers can earn what they deserve. Manufacturers can first do the research on how much money farmers expect to get by selling the sourcing milks. Then, if the price is too high for manufacturers, manufacturers can negotiate sourcing price with farmers to get a price that both parties are satisfied with. Setting the minimum sourcing price to farmers can prevent farmers being exploited. Price pressure is the main reason why farmers adding chemicals into milk to boost the nitrogen content in Sanlu’s case. Having fair trade with farmers can ensure alleviate the price pressure of farmers and hence prevent similar crisis happen in the milk industry again.

If manufacturer relies on milk dealers to collect sourcing milk from farmers, then the minimum sourcing price should be written into the agreements to assure tag farmers still get what they deserve.

If manufacturers operate its own milk collection station, then manufacturers can have formal contracts which include the minimum sourcing price.

Hold education program for farmers

Because of the low education level and lack of information, farmers and dealers may not recognise the importance of food safety. It is time for manufacturers to educate them about food safety. “How to get milk with high yield naturally” can be taught in the education program as an incentive for farmers to join. In the program, farmers will learn about the importance of food safety in order to build the concept of being a responsible and ethical farmer.

Give funding to improve the infrastructure of milk collection station

Many milk collection stations have poor infrastructure and hygiene environment. Poor collection environment may pollute the raw milk in the storage and delivery process. Therefore, manufacturers can give funding to improve the overall environment of the milk collection station for their milk dealers. In order to ensure that the funding is used properly, manufacturers should send representatives to monitor the improvement of milk collection station and also a spending report of funding are required.

Invite specialists to prove the nutritional value of the milk product

Because of previous scandals and negative testing results, public loses trust in China’s milk product manufacturers. Consumers may think manufacturer can make false statement on the nutritional value of the milk products. One of the effective ways is to invite specialists, including chemists, to test and evaluate the nutritional value of the products. With the proof from specialists, it shows the product quality to consumers and consumers will be willing to trust the manufacturer again.

If you were the parents in Mainland China, do you still trust the baby formula produced in China?

If I were the parents, I will still trust the milk industry in China if they can fulfill the following requirements:

Keep high transparency of the products

Manufacturers maintain high transparency of the products to the public is a must criterion for me to trust China’s manufacturers again. For example, manufacturers need release all the testing results after every test, show its manufacturing process in the factory, disclose the source of raw materials, assure what measures taken to keep the raw materials safe and so on. High transparency gives public a sense that the manufacturers do not hide any information from the public. Hence, parents are more willing to trust China’s manufacturers again if they know all the information.

Exceed International standard

If the standard of milk products produced by manufacturers exceeds International Standard set by International organization, such as World Health Organization, or the manufacturers can obtain International Organization for Standardization, then the milk products of these manufacturers is proven to reliable and are safe to take.

Get support from government

Parents will trust those manufacturers obtaining support from government. Parents actually particularly pay attention to China’s manufacturers which are given support by government. It is because government is the most reliable organization in the nation and is responsible for protecting the right and safety of public. Citizens will think as long as government is willing to provide support to the manufacturers, such as funding, these manufacturers are more reliable and reputable than others. Therefore, parents will trust these manufacturers.

Reflection

References

https://www.thebalance.com/what-is-outsourcing-2533662

http://www.yourdictionary.com/business-ethics

(Business ethics def)