How Do Recalls Affect a Company?

Companies face many types of risk—both internal and external. Some risks can be accounted for and eliminated through strategic planning, while others aren't so easy to identify at first. One of these risks is the recall—something that usually happens after a product or service has reached the market. No company ever wants to have to deal with a recall. That's because a recall can change a company's financial profile, its performance in the market, and can have a negative impact on its reputation. But how does this happen? Read on to find out more about the basics of product recalls, how they affect companies, and some of the most notable recalls in history.

What Is a Product Recall?

A product recall is the process of retrieving and replacing defective goods for consumers. When a company issues a recall, the company or manufacturer absorbs the cost of replacing and fixing defective products, and for reimbursing affected consumers when necessary. Faulty merchandise, food-borne illnesses, or harmful drugs can result in tarnished reputations, heavy marketing costs, leading to the accumulation of multi-billion dollar losses.

Recalls aren't bound to one particular industry. In fact, they spread across the spectrum and include car manufacturers—like Toyota (TM), General Motors (GM), and Honda (HMC)—as well as the food, medicine, and consumer electronics industries.

Government agencies are responsible to test products and recognize faulty ones before they reach the market. The Consumer Product Safety Commission (CPSC), Food and Drug Administration (FDA), and the National Highway Traffic Safety Administration (NHTSA) are among the most common. But for the most part, recalls are issued by the supplier of a product if any of these agencies recognize or are informed of an unsafe or defective product released to the public.

Where to Find Recall Information

You can find information about recalls from many different sources. Companies post recalls on their own websites for products that they manufacture, supply, and sell. You can also find recall information from local and national media. But the most important and comprehensive source of information about recalls comes from government agencies—those listed above as well as others. For instance, the FDA lists product recalls and withdrawals on its site. These lists are updated on a regular basis.

Causes 

With quicker and more efficient means of transportation, the global supply chain has undergone an unprecedented transformation. A number of everyday products contain parts manufactured from around the world. In an attempt to remain competitive, companies have increased global supply chains, offshoring, and outsourcing at the cost of product reliability.

For instance, Apple (AAPL) iPhones are rarely produced in just one part of the world. They can be broken down into different parts—software, hardware, and casing from China, Korea, and Europe. Each region has different laws about products and services, but the final product must comply with regulations in the country in which it is sold. So even if the casing passes regulations in China, it might not under U.S. laws. It would, therefore, have to be recalled. 

Financial Implications

Public confidence has a major influence on consumerism. If consumers can't trust the companies they buy from, they won't pay for their products in the future. That's why recalls have devastating effects on a company. Smaller ones operate without robust cash flow and brand recognition, making them more susceptible to financial losses and brand degradation. This doesn't mean that large companies are immune to product recalls. Unlike their smaller counterparts, they're better equipped to withstand the short-term effects of recalls and rarely suffer any long-term financial consequences.

Consumer protection laws require manufacturers and suppliers to bear the costs of all product recalls and any associated costs. Though insurance may cover a minimal amount to replace defective products, many product recalls result in lawsuits. Between lost sales, replacement costs, government sanctions, and lawsuits, a significant recall can become a multi-billion dollar ordeal. For multi-billion-dollar companies, an expensive short-term loss can be easily overcome, but when shareholders and customers lose confidence, there may be greater long-term effects such as plummeting stock prices.

For instance, Toyota’s stream of gas pedal recalls resulted in a $2 billion loss consisting of repair expenses and lost sales. The company's stock prices dropped approximately 30%, or $35 billion, in conjunction with the financial crisis. Keurig saw a 2.2% drop in stock prices in light of its recall of 7.2 million coffee machines.

Recovery

The impact of a recall on a company's finances and reputation may be insurmountable. Many small companies have declared bankruptcy as a result of defective merchandise as was the case of Peanut Corporation of America—more on that below. Larger corporations with more flexibility must work quickly to maintain customer loyalty and, most importantly, shareholder confidence.

Taking responsibility and fast action are the safest ways to save brand recognition from product recalls. While settlement claims and repair expenses can be robust, a decrease in stock prices generally has a much larger effect.

Notable Historical Recalls

Peanut Corporation of America was a small company with about 90 employees but suffered immensely because of an extensive recall of almost 4,000 products using the company's ingredients. The company filed for bankruptcy after a salmonella outbreak resulted in hundreds of illnesses and about a dozen deaths between 2008 and early 2009, forcing the company to cease operations.

Ford (F) issued a recall of 6.5 million vehicles with Firestone tires in the early 2000s. The defective tires resulted in 5,000 complaints, 800 injures, and 271 deaths in the U.S. Toyota has issued a number of massive recalls beginning in 2009, ultimately recalling over 10 million vehicles due to numerous issues including sticky gas pedals and faulty airbags.

The drug industry has also suffered from devastating recalls. Drug manufacturer Merck (MRK) recalled its arthritis medication Vioxx, because of the increased risk it posed of heart attacks. The drug cost Merck $4.85 billion in settled claims and lawsuits.

Coffee machine manufacturer Keurig recalled 7.2 million single-service brewing machines due to claims of overheating. Regardless of the industry in which the recall occurs, it is evident that large companies are able to withstand both financial and reputation costs. 

The Bottom Line

The effects of a product recall may be detrimental in the short run, but there is no evidence to support long-lasting decreases in sales or stock prices. Toyota and Merck experienced brief financial consequences as a result of product recalls, but were able to rebound, with their brands and stock prices showing a strong recovery.

With the supervision of government agencies, product recalls seem to have become almost weekly occurrences. This may be attributed to the increasing complexity of the global supply chain. To cut costs and remain competitive, modern merchandise incorporates manufactured parts from around the world, sometimes at the cost of reliability.