Magazine article Risk Management

The Hidden Risks of Outsourcing

Magazine article Risk Management

The Hidden Risks of Outsourcing

Article excerpt

Outsourcing manufacturing to China and other countries around the world can save companies a lot of money. But as the standards of doing business change along the supply chain, will these moves end up costing companies more in the long run?

In July 2013, pharmaceutical company GlaxoSmithKline came under investigation in Shanghai for what authorities alleged were "economic crimes." A whistleblower accused executives in the Chinese market of "widespread bribery of doctors to prescribe drugs." The company had reported possible violations of the Foreign Corrupt Practices Act to the Justice Department and the SEC as early as 2010, but it was not enough to stop the allegations from taking their toll. In the second quarter of 2014, GlaxoSmithKline's profits had declined amid both sluggish sales and news of the bribery claims.

One year later, several U.S.-based companies were apologizing to consumers and taking a reputation hit for a scandal involving tainted meat. Shanghai Husi Food, a subsidiary of Illinois-based OSI Group, sold meat products to Burger King, Papa John's, McDonald's and other stores operating in China and Japan. Video footage shows workers dropping meat products on the floor and using bare hands to package expired products. OSI Group apologized and launched an investigation that revealed operations that were "absolutely inconsistent" with the company's standards, according to its owner and CEO. OSI also allocated $1.62 million toward establishing an Asia Quality Control Center to provide quality control for all of its Chinese sites and launching a three-year food safety education program in the country.

Outsourcing operations can be a cost-effective move, but if companies are not aware of the inherent risks, that move could end up costing more than the anticipated savings. And it is not just suppliers and distribution channels that are at risk. Key vulnerabilities such as cultural misunderstandings, different ethical standards and out-of-sight operational misconduct can bury a business in legal, ethical and operational problems.

Hits to the brand can come from almost any area of the business, but nowhere are those risks more prevalent than deep within the supply chain. Some even believe the term "supply chain" itself is misleading--it has become a catch-all term that includes logistics, materials sourcing, delivery distribution warehouses, physical facilities, product manufacture and the overseas labor force. In other words, the supply chain envelops the entirety of outsourced business operations, and it is where some of the largest vulnerabilities lie.

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Mark Robertson, head of marketing and communications for Sedex, a London-based nonprofit that helps member companies develop ethical business practices within their global supply chains, said that the cases of GlaxoSmithKline and OSI illustrate the challenges companies face when doing business in other parts of the world. To Robertson, it also punctuates the importance of consistency across the organization. "It can get very complicated when you move down through the tiers of suppliers," he said. "A lot of companies, we find, have a pretty good idea who their first-tier suppliers are, but in terms of the people further down the supply chain, that's when it can be tricky."

Ethical sustainability and governance risks also get worse as you move down the supply chain. "That's where the skills, capabilities and resources are lacking to deal with them," he said. "You've got a worsening of risks, but fewer resources to tackle them."

This is often because many companies go into an outsourced arrangement not fully understanding the true cost. Companies need to consider the risks as well as the rewards, said Brion Callori, senior vice president of engineering and research at FM Global. The only time a company should consider outsourcing is if there is a true economic benefit to doing so. …

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