Pharmaceutical offshoring makes recalls more costly with more quality headaches

I spent some time working on a study of how offshoring impacts quality issues, specifically product recalls, with a number of researchers at the University of Palermo, led by Manfredi Bruccolori.  Our research led to some very interesting findings on the relationship between the common practice of offshoring, which is increasingly common, and product recalls, which are also unfortunately becoming increasingly common. Our sample in this case was the more than 1452 drug recall events compiled from the FDA website from 2012 to 2016.  Analysis of this dataset revealed some interesting findings.

First, our results demonstrate that product recalls may differ enormously in term of the volume of products to be withdrawn and, consequently, in term of the cost sustained by the company in dealing with the recall. For this reason, our research draws attention to the magnitude of the recall in terms of the scale of the recall (volume of products that must be withdrawn from the market). The damages coming from the recall consist primarily of logistics and direct costs, so the size of the recall matters more than the number of recalls. To our knowledge, no research in the field of product recall has established the relevance of this issue. In addition, our research introduces the concept of product recall magnitude as something an organization wishes to dampen in order to minimize the scale of recall impact. Our paper sought to address the academic call for more research in the field of recalls (“So many recalls, so little research”, Wowak and Boone, 2015, p. 1) and, more specifically, for research on the topic of mitigation approaches to product recall, i.e. mechanisms firms can employ to reduce the impact of recalls .

Second, our findings create new insights in the global sourcing and offshoring literature. Our results suggest that offshore outsourcing and captive offshoring have a different and opposite effect on the magnitude of a product recall. Results suggest, in line with our expectations, that captive offshore renders the supply chain less capable to dampen the impact of a product recalls in terms of its magnitude. This insight runs counter to prior research, and suggests that having a facility under one’s financial control may lead to a perception of heightened operational control as well. This is clearly not the case, as shown by our analysis; the increased complexity associated with an extended (but financially controlled) supply chain does not lead to lower product recall volumes. Firms in our captive offshoring sample displayed an increased magnitude and exposure to supply chain disruption. The risk of information asymmetry and opportunistic behavior of parties within a captive offshore plant appears to increase, while the ability of managers in the extended supply chain to detect product quality failures decreases, and thus the magnitude of the product recall increases. Foreign ownership of plants may lead to perceptions of control, but in fact the inability to manage communication protocol, cultural and process factors may exacerbate a recall incident. Our results are unequivocal in concluding that captive offshoring leads to difficulties in managing the entire supply chain, and reduces the ability to respond to product recalls efficiently. Our findings link product recall difficulties to reduced quality failure detection and consequent product recall magnitude, and results in increased levels of product quantities having to be withdrawn from the supply chain as a manifestation of such behaviors.

A number of results also run contrary to our predictions. Our results suggest that when the production and/or distribution is outsourced in a non-domestic region, on average the volume of products to be withdrawn is lower. Thus, in offshore outsourcing environments product recall damages related to its magnitude decreases, as opposed to captive offshoring. A possible explanation of this finding is that offshore outsourcing, while crossing national borders, delegates the production to a specialized foreign company, which guarantees that their production is “on the hands” of those whose made manufacturing their “core activities” (Lamming, 1993). In contrast to the case of captive offshoring, a foreign third-party supplier appears to be better able to select and manage its local supply base, and achieve required levels of quality and delivery performance. Outsourcing to a local third party in another region of the world requires special skills related to cultural and procedural norms, leading to improved quality control and adherence to other required production controls that are specific to the FDA. Conversely, brands who own an offshore plant may appoint a foreign ex-pat to manage the facility, who has little understanding of cultural norms, and even less knowledge of how to manage complex relationships with an unknown network of suppliers. Our results suggest that the agency problems associated with captive offshoring outweigh the transactional complexities that are posited to occur with offshore outsourcing. Several reasons may underlie this result.

First, when selecting a foreign supplier, quality and procurement personnel may be more rigid in their supplier selection process: quality related criteria are, no doubt, the most important used in gauging supplier attributes. Once the supplier has been selected, inbound quality control processes become easier given that the company has to control only its selected supplier, and fewer suppliers may be used. However, in the case of captive offshoring, even if the facility is managed as a fist tier supplier, controls may be more relaxed, and the local employees may be more prone to the risks of opportunistic behaviors; in this manner, offshoring environmental agency problems may become more relevant.

Second, when crossing national borders in distant countries, companies are aware of the high risks and costs the company incurs if the supply chain is not responsive to a quality failure. For this reason, very high quality manufacturing standards are imposed on outsourced supply firms for them to adhere to during contractual negotiations. Furthermore, the more distant the supplier is the more likely the company will require stringent and rigorous controls and monitoring practices (country distance in offshore outsourcing has a negative effect on magnitude). In other words, it seems that when companies move production or distribution to foreign third parties, they deploy standardized and rigorous quality failure detection measures to contrast typical agency issues, such the risk of opportunistic behavior, that in turn reduce the damages caused by the product recall disruption.

We thus conclude that it is not global sourcing that uniquely determines the lack of ability of supply chains in dampening recall disruptions, but rather the primary root cause is captive offshoring practices. This counterintuitive result is enriched and endorsed by our sub-group analysis : contrary to our predictions, even in the case of captive offshoring, country distance contributes to reduced product recall magnitude. This leads us to conclude that it is not a matter of cultural, geographic, and economic differences in global sourcing that increases the scale of the product recall, but the inability to effectively manage captive offshore supply chains. A parallel argument suggests that when an organization establishes a plant in an offshore location that is ‘close’ to home country, it perceives a false sense of security, which leads to relaxed demands for quality failure detection, controlling, and monitoring activities. This perception of control is an issue that requires further work to magnify these insights.  It also provides warnings to supply chain executives; offshoring costs may look a lot lower on the front end, but can lead to a lot of headaches later in the relationship life cycle.