Case Study 3 - Sanlu

Sanlu Milk Scandal

Case background

In 2008, Sanlu Group Inc (Sanlu) melamine-tainted milk scandal in China shocked the world. Melamine, an industrial material of plastic product which will lead to kidney stones especially the new born babies. Fatal level of melamine, 5000 times higher than the standard, were added in infant formula and sold in the market. The scandal destroyed Chinese dairy industry and still not yet recovered till now. Chinese dairy products were recalled and suspended in different countries. An official reports indicated more than 200,000 babies are ill, around 50000 were hospitalized, and 11 deaths. In this case, two managers and suppliers of raw milk were sentenced to death and Sanlu filed to bankruptcy on Dec 2008. Through analyzing the background of the scandal and supply chain management problem, we hope we can have better understanding of the details in this tragedy.

Timeline

Late 2007	Sanlu received the first complaint
May 2008	Sanlu formed the investigative team and found excessive nitrogen in the milk powder
Sept 2008	Fonterra informed New Zealand’s Prime minister about this issue
Sept 2008	Central Government suspended the production of Sanlu
Dec 2008	Sanlu declared bankruptcy

Q1. Why Sanlu Milk crisis arise ? Who should take up the responsibility ?

The demand of milk in China is high. There is over 23% increase in each year. In 1980s, the dairy industry runs as self-sufficient basis caused the limited supplies of milk. Until 1987, Sanlu set up the milk station providing cows to the farmers and collected the milk as return. Sanlu outsourced the raw milk production to the milk station and they could focus on mass production and marketing. Due to the loophole of Sanlu’s supply chain management and regulation of the government, tainted milk is produced and hurt so many citizens. We are going to analyze each component of supply chain.

Dairy farmers à Collection Stationà Sanlu à Distributor (Fonterra)à Consumers

Dairy farmers

Some of the farmers had little knowledge about how to take care of their cattle to ensure large yield and high-quality of milk. In addition, since the payment to the farmers were based on the volume and protein content, it provided incentives for the farmers to cheat the company by watering down the milk and adding melamine.

Milk station

By 2008, 80% of the milk from the farmers were sold to milk stations which have absolute bargaining power. They delay and reduce the payment to the farmers which increase the incentives of the farmers to cheat. In addition, there were no unified supervision system in China. And, the milk stations are poor infrastructure, inadequate management and insufficient milk-safety awareness. Some of them even without owning the valid license.

Sanlu

The company shifted to use the outsource model to get its raw milk from the externals and Sanlu didn’t aware and monitor the milk quality. The first complaint about melamine tainted milk was happened on Dec 2007. Yet, Sanlu refused to admit the quality problem of their products and continued the production. Until May 2008, one of the victim post the case to the internet. Sanlu still didn’t announce the incident to public and used different ways to cover this incident, like paying money to the victim and bribing the officers. The delayed notice to the pubic worsen the situation and causing over 50000 illness babies.

Distributor

In this case, Fonterra should also take up the responsibility because they never checked Sanlu’s dairy products prior to melamine crisis which draw out the problem of vertical control strategy. Fonterra – Sanlu’s foreign partner and major stakeholder with 43% holding did not show adequate oversight led to the melamine being added to the milk powder during production

Consumer

Enterprises are supposed to take the responsibility of reasonable care to prevent consumers’ health from being damaged and these kind of moral responsibilities should be determined and monitored by the consumers themselves. In this case, the consumers fail to do so. The victim chooses to accept the compensation from Sanlu instead of inform the others about this incident.

Government

In addition to Sanlu’s supply chain problem, the government should also bare the responsibilities because of the poor regulation. The Central government wanted to promote self-regulation in China’s companies, exempting the inspection of the company with large market share. Yet, this method is not useful for the countries with low ethic and this policy was cancelled right after this incident. At the meantime, Sanlu could still get the national inspection printed labels on their products which provided the wrong message to the citizens that these products are well-checked. Furthermore, the government set the price celling, it reckoned Sanlu to lower the production cost and the farmers had higher chance to cheat.

Q2. Why did Sanlu outsource? What are the advantages and disadvantage ?

Originally, Sanlu collected milk itself but the supply is very limited and not all of the citizens are affordable to buy milk. In late 1980s, there were more foreign companies joined China’s dairy industry. In order to lead the competition intensified industry, Sanlu set up the first milk station in 1987 and outsource the raw milk production. They outsource part of their business activities to some external service providers, because the milk stations are specialized and have extended networks with the small farmers to collect the milk, which can help Sanlu to lower the production cost and lower the selling price to attract the customers. In addition, Sanlu didn’t need to worry about the raw milk collection, which are not Sanlu’s specialization, and they could focus on marketing and products diversification. 

Advantages

n  More technical knowledge in providing higher quality and quantity milk

n  Reduce costs : Sanlu saved an estimated investment cost of about 100 million 

-        Less workers for manufacturing milk

-        Less in-house milk production machine

n  Risk sharing : Party of risk is shifted to the milk station

Disadvantage

Sanlu and milk stations are two different companies. Their goals and objectives may be different. For example, Sanlu may expect high quality of product but the outsourced parties would try to lower the cost by providing lower quality product. The followings are the disadvantage of the outsource relationship in this case,

n  Lower milk quality

n  Lower the transparency

n  Difficult to control over the outsourced activities of manufacturing milk:

-        Sanlu might not have first -hand information about the working conditions in the outsourced parties, like poor infrastructure and material origin.

n  Chance to endanger the brand image by third-party

In conclusion, when choosing to use the outsource relationship, the companies should consider the strategic positioning of the firm and also balance the product quality and cost. We also recommend the companies, who outsourced their business activities, should have better supervision and clearly stated product requirements contract. 

Q3. What is the role of ethics in Supply Chain Management of Sanlu ?

 How to define ethics ?

Economic responsibilities:	Supply high quality products and services
Legal Responsibilities:	Obey laws
Ethical Responsibilities:	Conduct business in a way that is morally consistent with the beliefs of society

1.     Relationship management

       Vertical integration: 
-        Offering acceptably price to the farmers in order to prevent causing cost pressure

-        Share the knowledge with the farmers and management method to milk center

-        Clearly clarify the company ethical expectation with the suppliers and distributors

-        Hiring consulting companies to monitor the supply chain process

      Example :
         

2.     Channel management

        Direct and indirect connection to Supply Chain

-        Sanlu should have more direct connection with milk center
-      Supervise the process of  collecting the raw material whether conduct is ethical or not

-        Ensure High visibility in Supply Chain
  ^Sanlu covers the problems at the beginning which increase the seriousness of the scandal

       

3.     Competition in the industry

 -        Compare the ethical values of supply chain with other competitor in dairy industry
        (e.g.  How Mengniu source the milk)

-        Ensure the raw material from the suppliers reach the standard of province-level or                               international standard in order to rebuild the confidence of the customers

-        Sanlu grows too aggressive causing the shortage of milk and lower the quality

-        Create stronger corporate culture :

     ^Ethics Training programs and seminars

     ^Anti-Corruption & Enforcing Regulation

-        Recruit talented individuals with high moral standard  

4.     Society expectation

-        Distinguish the expected ethical values between business operations and society

-        Influence by external factors (e.g. media and pressure groups)

Q4. What can be done to restore consumer confidence in Chinese dairy products 

1.     Corporate Social Responsibility

a)     Visibility and Transparency:

-      Increase visibility between trading parties - trace system

         e.g Labeling and Database

      

-        Establish receive feedback and recall defected product channel

-        Encourage the customer to set up a consumer council

b)     Advertisment:

-        Promotion

               e.g Offer discount, coupons product samples

-        Cooperation with other dairy companies  

               e.g Experience sharing

-        Milk station open-day / exhibition

-        Invite foreign expertise to monitor the process  

-        Emphasize the importance of fair trading ( Farmer – Milk station )

2.     Supervision and Regulation

-        Enhance Information transparency, e.g. real time database

-        Random inspection and investigation of infant formula producers

-        Strictly regulation to dairy product

-        Grading system to the dairy product based on different criteria

-        High penalties

-        License system

 3.     Integrated Management

-        Direct control of the supply chain

-        Corporate culture and guideline

-        Training to the staff

-        Management process sharing

-        Upgrade and replace the facilities

-        Terminate the contract with the bad record suppliers

Reference:
https://books.google.com.hk/books?id=6MpYCdz08K8C&pg=PA213&lpg=PA213&dq=why+sanlu+outsource&source=bl&ots=cL8RYvE3zV&sig=7TkTz2obe1m4-eW4FmCiGtWqH68&hl=zh-TW&sa=X&ei=8L8fVff0MIPRmwXzn4EQ&ved=0CDQQ6AEwAw#v=onepage&q=sanlu%20saved&f=false

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