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Background Information

The outbreak of the scandal

By the end of January 2009, approximately 300,000 children were sickened by melamine-contaminated milk powder. Being held mostly responsible for this tragedy and the demise of at least six children, Sanlu was burdened with US$160 million debts and declared insolvent by October 2008.

Grown as the baby formulas giant in China

Founded in 1956, Sanlu was the first enterprise selling infant formula in China. With the advent of a reform policy outsourcing its raw milk to third parties in 1987, Tian, the president of Sanlu, successfully transformed the company from being agriculturally intensive to a manufacturing and marketing-oriented profit-maker. Having 30 production plants scattered across major provinces in China (including Beijing, Hebei, Shandong, etc.), Sanlu was accounted for a workforce of 10,000 employees, 30,000 sales and administrative staff, backing its 18% share in the China milk-powder sector.

The turning point

On 11 September 2008, however, the “acclaimed” Sanlu’s powdered baby formula products were found to contain melamine, a nitrogen-rich chemical that would cause kidney stones upon regular consumption. In accordance with tests ran by the State Administration of Quality Supervision, Inspection and Quarantine (AQSIO), the previously inspection-free Sanlu formulas indicated a up to 2,564mg/kg of melamine in its samples, which was 1,000 times higher than acceptable standards.

After failing to conceal the incident (as Fonterra, a New Zealand joint-venture partner informed the New Zealand government of the concerned damages), 10,000 tons of tainted milk powder were being recalled by Sanlu. Later, top executives of Sanlu (Tian included) and other culprits were trailed and arrested.

Result: The notorious milk powers in China

Whilst the Sanlu Scandal was ended, China consumers still lack confidence in locally-manufactured infant formulas. Therefore, in the following, Sanlu scandal, its repercussions and potential measures for rectifications would be discussed in an attempt to restore consumer confidence.

Question 1

How did the Sanlu milk crisis arise? Who should be deemed responsible for the crisis?

The Sanlu milk crisis arisen, in general, was due to negligences of various stakeholders, namely Sanlu, government officials of the PRC, milk station staff and milk farmers. In order to show their responsibilities, individual stakeholders, supply chain (from upstream to downstream) and their respective roles are being reviewed as follows.

1.Individual cow farmers: providing Sanlu with main source (~80%) of raw milk

The reason why those milk farmers kept adulterating the milk in a savage way was because nobody had got penalise for their behaviour. Also, farmers did not have no any contractual obligation with suppliers, so they kept on performing this bad behaviour.

Therefore, ignorant farmers who suffered surging stock feed price were exploited by buyers of raw milk, though pitiful, should take partial responsibility for the associated damages.

2.Unscrupulous cow farmers, who knewcow-farmers of the damages caused by melamine, should be held responsible for watering down and tampering raw milk with melamine. However, the lack of education and exorbitant price of melamine cast doubt on whether they were misled and ignorant of the consequences or were the acts deliberated and elaborated. In some point, greed maybe be one of the factors that motivated them to commit such act. 

3. Milk collection stations: collecting raw milk and rewarding cow farmers based on the amount of protein content in milk (no matter the protein is real or not)

mulkActed as intermediaries and consolation centres, milk collection stations should establish a clear and stringent policy concerning the regulations and supervision of raw milk; with regards to the case of Sanlu, milk collection stations (some without valid licenses) awarded cow farmers based merely on the content of nitrogen, instead of  the real protein content, providing incentives for cattle rearers to tamper raw milks with melamine (a nitrogen-rich chemical). They were the ones directly contribute to artificial milk powder. Alongside the inadequacy of equipment in ensuring product quality, milk collection stations should be regarded as one of the accomplices inducing the Sanlu scandal.

4. Melamine suppliers: providing melamine for raw milk adulteration. Without doubt, melamine suppliers, knowing melamineof the buyers’ intentions, channelling the sales of harmful additives to milk-powder manufacturers, should take full responsibility for the damages associated with the Melamine scandal. Zhang Yujun, one of the biggest sellers of fake protein powder (which contains melamine), knowing buyers would fuse melamine in infant formulas, should be heavily penalised and should apologise to concerned victims.

5. Dairy Manufactures (Sanlu and Fonterra): Further processing, inspecting, packaging and marketing powdered-milk product

a) Sanlu

In order to stay competitive in the baby milk formula market, Sanlu adopted low cost mastrategy, and this made the farmers suffered the most. Furthermore, Sanlu failed to exercise control over its partners and had ignored unregistered milk stations’ participation, soliciting the Sanlu scandal.

Sanlu management, after knowing potential effects of affected baby formulas, not only concealed the incident, but also made no remedy. Therefore, the company should be penalised on the ground of lack of quality control, exploitation of farmers, negligence in supplier management and the sale of faulty products. It is, Sanlu, a well-rusted company’s, responsibility to guarantee consumers’ health and the food safety issues. They should recall contaminated products if found suspicious immediately. Sanlu seemed to show no ethics at all in the whole incident. Thus, Sanlu should hold equivalent responsibility as melamine suppliers and should be severely punished.

b) Fonterra

Fonterra must have known Sanlu had been producing problematic milk, however, they chose to ignore them. But in the end, due to the public pressure and Sanlu scandal’s far-stretched , it stood out and alerted the New Zealand government, exposing the tragedy.

6. Retailers: Distributing, selling Sanlu products
Prior to the exposure of Sanlu Scandal, some of the infant formulas sold in certain retailing stores were reported (by a consumer) with a discovery of post-dated products. After knowing that, not only did the concerned branch not initiate investigation in the source of problem, but also continued selling Image result for Sanlu Retailersaffected products. They should have the social responsibility and served as a recourse for customers to file complaints and ask for help if they were in need. They should have those problematic products off shelf, instead of kept on selling them.

Moreover, all the retailers should have higher standards for the control of food, especially for children. Therefore, stores retailing Sanlu products should be blamed for not having a system monitoring the quality of goods and for not having sophisticated channels for customer recourses.

7. AQSIO and government officials: Certifying, inspecting and regulating powdered- milk products; controlling prices of raw materials (Stock feed)

The Chinese government failed to reinforce the Image result for chinese governmentrestrictions on using melamine as they should have strict guidelines on using chemicals, especially comes to food. They should have more safety guidelines in the food safety. Also, they need to have much more supervision on the whole operation process starting from the milk farmers collecting milk.

State Administration of Quality Supervision, Inspection and Quarantine (AQSIO), established an inspection exemption policy in year 2000, allowing companies possessing state- or province- pass (quality previously assured) to print national inspection labels whilst conducting spot checks on a yearly basis. Doubtless, the policy is lenient and flawed; and with such policies, AQSIO should be accounted for prompting food adulteration. Therefore, by not having rigorous standards in certifying quality labels, AQSIO let consumers misconceived that Sanlu’s products were safe to consume. Due to the fact that the public trusted the government and the led to such a catastrophic food safety crisis.

Apart from lenient quality inspection policies, the central government, who capped the price of infant formulas while sustained the price of stock feeds, had indirectly contributed to the dishonest practices of the cow farmers. As a result of this ill-conceived policy, merely a reported 30% made a slim profit in the industry whereas the others lost money or broke even. Hence, the central government should be blamed for such ill-consideration.

Moreover, as mentioned in the case, the government should have promoted more on the benefit of breastfeeding, as some studies have already proven that breastfeeding is better than using baby formula.

8. Consumers: Buying problematic products
Image result for 奶粉consumers

They were being too price-focused, they just chose those which were cheap in price. They seldom thought of the reliability of the milk powder.

Furthermore, the public at that time heavily relied on milk powder, they thought that milk powder was convenient and it covered most of the nutrients the babies needed for every day. Therefore, the consumers themselves should also take up a part of the responsibilities in this incident.

9. Media/ Social Media: Seek for truth

Image result for social mediaThe role of the media/ social media was to seek for the truth. Once they knew some consumers had already suffered from the problematic milk powder, they should interview them immediately and reported back to the public, in order to let the others knew that Sanlu’s milk powder had been contaminated and they should stop purchasing any milk powder from them.

In this case, they were being too passive in reporting and reflecting the whole story of this incident which led to the serious consequences of babies dying because of drinking the problematic milk formula.

Question 2

Why do companies outsource? What are the pros and cons of outsourcing?
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Reasons for outsourcing:

a) Cost and business focus incentives

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Companies outsource part of its business functions to third parties primarily because they wish to lower costs and focus on company’s core competencies. In order to achieve company goals, it would be essential to focus on specific events under a limit source of investment. Take the case of Sanlu as an example, since Sanlu shifted its corporate strategy from being agricultural-oriented to marketing, mass production or even research and development -centered, it is justifiable for Sanlu to outsource cattle rearing to individual cow farmers and concentrate on more value-adding activities.

b) Lack of skills or resources

Apart from the consideration of cost and corporate strategy, companies outsource certain business functions to third parties mainly because of the lack of sophistication in skills and resources scarcity. With limited self-production and increasing demand for milk in China, the industry requires other sources of supply. For instance, Sanlu’s major competitors, Yili and Mengniu, produced merely about 10% of total milk volume and relied heavily on domestic scattered farmers for its major inputs.

Pros of outsourcing:

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a) Increase company source of supply

i) Higher bargaining power from suppliers

Regarding Sanlu’s outsourcing strategies, since its raw milk suppliers are small, disorganised and individual cow farmers, Sanlu was in an advantageous position for having high bargaining power. As it could easily switch to other suppliers if incumbent suppliers try to raise raw milk prices. In addition, since suppliers are plentiful, Sanlu can cope with peak seasons with flexibility and make a better response to volatile/fluctuating demands throughout the year.

ii). Alternatives to raw milk

milk_625x300_41416559876Other than self-production, outsourcing can provide other sources for raw milk. For example, Sanlu procured 6,800 tonnes of fresh milk daily, from at least 80,000 cows. 80% of the output from small-scale farmers was resold to dairies company in 2005. Competition between milk suppliers on quality and prices will be formed. As a result, it can provide more alternatives and an additional source of supply.

b) Better cost control

i) Lower investment on non-core activities

Through outsourcing, equipment and fixed assets for producing the products will be afforded by the suppliers, whilst investment cost require on the non-cost activities can be reduced. For instance, the co-operative farms used by Sanlu shared investment cost and risk among different parties, with about 100 million of estimated investment cost saved through outsourcing.

ii) Lower cost of materials

As the cost pressure transferred from final product manufacturers to upstream producers, companies can procure with lower cost while comparing to self-production. If the cost rise on current suppliers, they can easily shift to other farmers. With a lower cost of materials, they can shift the money to other aspects or core focus.

Cons of outsourcing:

Image result for cons

a) Risk on quality

After outsourcing raw milk, it would be difficult to control the overall farming process. As the company shift the cost pressure to the dealers, they may want to increase their revenue by reducing cost. In the Sanlu milk scandal, milk dealers reduced their cost by adding melamine to undercover their inadequate level of proteins. Due to outsourcing, Sanlu may require additional cost and efforts on quality inspection.

b) Difficulties in developing long-term relations

handshake-close-up-of-executives_1098-1384Outsourcing involves cost down activities which price determines the most in the transaction. Arm’s length relationship may be their usual practice. In the milk station for sourcing raw milk, dairy companies involved no formal sales contract with them. Thus, sales were made mainly according to the price given. Through this operating model, it would be a problem for tracing origins of milk and suppliers after the procurement process. The quality and its source cannot be ensured due to the short-term relationship between the dealer and dairy companies.

c) Risks on bearing suppliers’ responsibility

Regarding the quality control problem mentioned, the company may be implicated by the misconducts of their partners. If problems arose after using the outsourced materials for manufacturing the product, customers will complain about the product and the manufacturer. Although it may not be merely suppliers’ responsibility, people will only retain poor image towards the manufacturer. Sanlu’s reputation dropped after the milk scandal and later went bankrupt. Finally, it was sold to the Beijing Sanyuan Group Co. Ltd. by an undervalued price.

Question 3

What is the role of ethics in supply-chain management?marketing-research-ethics.jpg

Wen Jiabao, prime minister in China at the time when this crisis happened, stated it “has exposed many problems along milk supply chain” and “reflects the lack of professional ethics”. “Ethics” is rather an abstract term and is not easy to categorize. Having said that, quoted from Serbian Journal of Management, the terms “ethics” and “quality” hold intimate relationship with each other, and can be assessed with three main factors: “moral attitudes as a result of consciousness or awareness-raising, culture as a result of education and the use of know-how, and the application of standards as results of learning and training.” With these factors, the role of ethics in different supply chain parties are discussed as follows.

Role of ethics in supply-chain management: suppliers, producers, retailers, customers

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Suppliers:

Suppliers stand at the most downstream part of a supply chain. Ethics plays a role with them being quality raw material providers. Dairy farmers should know how to make standardised finished products and collect raw materials, making sure no toxic elements are contained. Ethics dictate that farmers should not add water to boost milk quantity and chemicals to enrich the milk’s nutrition level. Instead of mixing milk with  complicated chemical compound, farmers should work on taking better care of the cattle. This ensures sustainable large yields and high-quality milk.

Producers:

Dealing with suppliers’ materials and retailers’ orders, all producers have to decide what rights to give the downstream parties and what values to offer to the upstream ones. Hence ethics plays a role with producers being fair price setters and educators. Stated in the case, there was a serious underpayment for dairy farmers. 40% of them suffering loss, 30% breaking even and 30% making a slim profit. By setting fair prices, milk powder manufacturers sent a message that farmers are to make a living while retailers receive quality products. Apart from fair prices given to manufacturers, milk powder companies should not educate their employees to cover up any food safety incident. There is a big contrast between Sanlu’s and Fonterra’s behaviour. Sanlu tried buying out critics through bribing them to avoid the crisis from going public. The crisis management trained its employees to gradually reduce melamine levels instead of doing a complete recall. Fonterra did an opposite approach by proposing to issue a recall and even made donations.

Retailers:

Again, retailers have downstream and upstream parties at both ends. Ethics plays a role with them being good learners and trainers. They have the responsibility to train producers to be sensitive about food safety issues. Products without reliable sources should be prohibited from selling in stores. Through active participation in food safety supervision, retailers are able to build customers’ confidence. To further secure customers’ trust, retailers should never handle customers’ complaints via no indirect channels, such as quietly removing substandard products.

Customers:

At the top of the supply chain, ethics plays a role with customers being reporters and spreaders. They should help bring companies’ unethical issues into the spotlight. In the case of Wang Yuanping, one of the victims of Sanlu baby formulas, is both a positive and negative example. When he discovered fake milk products, he requested a product test report from Sanlu and created an Internet post to enhance public awareness on food safety issues. However, he stopped his publicity stunt after receiving company goods. Without death reports, this milk powder contamination incident may still live in the shadows.

Mini conclusion:
Some supply chain parties tend to ignore the role of ethics because they regard being ethical to be cost inefficient. However, ethics is also a key determinant of quality. When problems are found, costs increase from rework in manufacturing as well. All parties should sit back and reflect on their roles, while keeping company and public interests in balance. The government also has a role in creating this good business culture. The government should help set the ethical values by creating an environment where regulations, guidelines and supervision are adequate.

Question 4

What can be done to restore consumer confidence in China dairy products?MilkDrink_large.jpg

Diary products of China are generally regarded as cheap and are thought to be of substandard quality since the outbreak of Sanlu scandal. In a hope to restore general public’s confidence in China dairy products, the following measures are suggested as to rebrand company images and better channel company core values.

Product quality-wise, we suggest China dairy companies to:Quality-Control.jpg

a) Hire third parties for running more authoritative and neutral tests,

Bribery and embezzlement are common practices in China; and the fact that quality of China dairy products is in doubt mainly attributable to the lack of trusted tests, and the disclosure of test results.

In light of the lack of publicity and trust regarding quality control tests. It is suggested China dairy manufacturers to comply with international standards, instead of lowering general standards to accommodate manufacturers with inferior quality. For instance, according to United States Department of Agriculture, dairy product manufacturers are mandated to disclose information such as manufacturing origins of raw material ingredients, nutrition information, etc. as to facilitate monitoring.

What’s more, third party testing agencies (such as The Pony Testing International Group) (See figures) should be hired as to conduct extensive tests and communicate said results to the general public.

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b) Re-certify company in regular intervals, and

Moreover, companies doing business in the powdered milk sector, in the U.S., need to pass the U.S. Extra Grade Test and comply with the Federal Food and Drug Administration’s Standard of Identity. On top of that, a sample of 400g should be prepared for sporadic inspections from five random samples. Thus, the China government should consider referring to the U.S regulation framework and require regular and frequent checks from dairy market players. See here.

With sporadic checks, previously certified manufacturers are motivated to strictly follow guidelines set up by monitoring agencies on a continued basis that leads to a gradual increase in general dairy quality and consumer confidence.

c.) Adopt initial rigorous screening of suppliers

suppliers-segmentation-and-screening-in-srm_orig.jpegAlthough there are limited number of market players in the pasteurised dairy industry, the central government should not yield and should set up rigorous screening in qualifying dairy product suppliers. To do so, the central government should consider evaluating and qualifying supplier based on the following criteria:

1.) Fair Treatment

lawyer-scale-fair-and-just-mike-savad.jpgThe central government should establish guidelines or mandate dairy market players to comply with Fair Trade standards. Besides requiring them to compensate cattle rearers reasonably, the central government should provide Infrastructural assistance (such as offering subsidies or teaching them how to increase yields with the use of technology) for milk farming.

2.) Encourage the use of scorecard

The use of scorecard can clearly list out all the areas for monitoring and potential improvements, facilitating continuous assessment. See example below

q3_2016_english_scorecard_placemat

The use of scorecards can keep track of the company performance multi-facetedly, such as from a.) the perspectives of customers b.)internal measures c.)innovations and learnings d.) financial measures.


3.) Tracking system

milk-factoryThe central government should mandate milk powder manufacturers to keep strict record of and disclose ingredient origins and other important information (such as nutrition details, etc.) on packagings. For great examples please refer to Vegetable Marketing Organisation and Food and Environment Hygienic’s regulations against different industry players.

Brand building and public relations-wise, we suggest market players to:

1. Establish channels for showcase of works done and for recourses:

farm-fresh-milkCommunication is always important; therefore, pasteurised-milk manufacturers only did half the work if they provide good quality products to consumers. To do the other half, they should channel their efforts in safeguarding the health of consumers. Regarding this, it is suggested that companies should set up effective channels, be they TV commercials or company webpages, to communicate company core values to the public; meanwhile, all ingredient origins should be trackable under the management of such channels.

On top of that, costumer voices should be heard and stressed, so the company should set up costumer complaint hotline or forums for discovering potential improvements.

2.Offer public tours to media and general public, not only milk stations but also milk farms

Factory-tour.jpg

To enhance company transparency and showing that there’s nothing to hide, the best way is to invite general public (or interested patrons) to visit different stages of the company supplier chain. With consumers first-handedly witnessed company facilities, would they be convinced that ingredients sourced and management facilities are top-notched.

3.Internationalise or cooperating with foreign brandhandshake.jpg

As mentioned, the tag “Made in China” is often conceived as inferior comparing to foreign-imported goods; hence, during such transitioning phase where China consumers lack confident in locally-manufactured goods, companies should operate in a Joint-Venture mode with foreign partners. On one hand, they can advertise their brands as foreign to attract import-crazed consumers; whilst on the other, they can learn from strategic partners in enhancing production technology.

References:

Bislev, A. & Thøgersen, S. (2012). Organizing rural China, rural China organizing (1st ed., p. 213). Lanham, Md.: Lexington Books.

Halisa, O. Akovab and H. Tagrafc (2007). THE RELATIONSHIP BETWEEN ETHICS AND QUALITY: CONFLICTS AND COMMON GROUNDS [Abstract]. Retrieved January 21, 2017, from http://www.sjm06.com/SJM%20ISSN1452-4864/2_2_2007_November_101-280/2_2_127-145.pdf

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