MARKETING
SPECIAL The Hidden Cost of a Product Recallhe Hidden Cost of a Product Recall
Product failures create managerial challenges for companies but
market opportunities for competitors, says Ariel Dora Stern. The stakes
have only grown higher.
Drivers on Interstate 25 in Colorado have been speculating about the fate of hundreds of Volkswagen cars
sitting in a lot near Pikes Peak International Raceway. It’s one of 37 sites in
the United States where the automaker is storing 300,000 diesel cars it recalled after admitting to
cheating American emissions tests.
Volkswagen estimated that fines, repairs, and legal costs would
total more than $30 billion. And worse, the company ceded its
command of America’s diesel car market—producing more than
one-third of the models
available in 2015—to companies such as General Motors, Ford and Mazda,
which expanded their
diesel lineups .
Large recalls are the ultimate nightmare for senior executives
at companies with considerable research and development (R&D) operations.
Beyond the staggering remediation and legal expenses that recalling companies
incur, there are also costs to rework manufacturing processes and stem
reputational damage. In one of the costliest recalls in history, Johnson &
Johnson spent more than $100 million in 1982 (more than
$260 million in today’s dollars) to recall 31 million bottles of Tylenol
capsules and re-establish the brand.
There’s also a second, less studied wave of damage, as
competitors ramp up product development efforts to snap up displaced customers
and solidify market share gains. This double whammy makes recall prevention and
effective remediation more important than previously thought, says Ariel D. Stern, an assistant professor of business
administration at Harvard Business School, where she is the Hellman Faculty
Fellow in the Technology and Operations Management Unit.
“Product recalls slow many types of innovation for the firms
that experience them,” Stern says. “At the same time, we see that competitors
are likely to accelerate their own innovation activities to take advantage of
these weaknesses.”
Stern, along with Indiana University Assistant Professor George
P. Ball and Georgetown University Professor Jeffrey T. Macher, set out to
quantify the innovation risks and opportunities that recalls pose in one of the
most R&D-intensive industries, medical technology. Product failures in
medtech, where the cost to bring a device to the market can top $90 million,
can not only hobble a firm, but cause catastrophic harm to patients.
“The extremely high profit margins in medical devices offers a
setting in which the risks are often overwhelmed by the potential rewards to
innovate, especially when competitors face their own product failures,”
according to the team’s working paper, Recalls,
Innovation, and Competitor Firms: Evidence from Medical Device Firms, released in
January.
Bigger recalls, bigger reactions
Using 13 years of US Food and Drug Administration data and a
novel set of competitor classification algorithms, the team created a detailed
history of product development submissions and recalls in the medical device
industry. That allowed the researchers to evaluate how a recall’s severity and
proximity—the degree of product market overlap between recalled and competing
products—may stall or speed innovation in a product market. Among their
findings:
A recall can delay a company’s incremental innovations by six
months. Medtech product development teams typically focus on a single
product category or line, allowing them to apply their expertise more
efficiently. However, recalls force these teams to shift their attention from
making meaningful improvements to addressing flaws. The revenue impact can be
significant, the researchers say.
Competitors ramp up major innovation efforts in response to
rival recalls. Large-scale new product development projects cost more,
take longer to complete, and require specialized teams to manage complex
processes, such as clinical trials in patients. However, if a medtech firm can
bring a new product to the market even one month earlier following a rival’s
recall, it could bring in an additional $10 million in revenue.
The more severe a recall, the faster competitors speed up
innovation. Major product failures, such as ones that can lead to serious
injuries or even patient fatalities, provide the biggest opportunities for a
competitor to grab market share. A well-timed incremental or major innovation
can provide the toehold a company needs in a competitive market.
“Low-risk mistakes, like a typo on a label, constitute reasons
to recall a product, but those aren’t driving the big responses that we see by
firms and their competitors,” Stern says. “It’s the really severe recalls,
where perhaps the materials turned out to be unsafe or there’s a major
malfunction that are leading to competitor responses.”
Prevention is key, but preparation
also matters
The team’s research suggests that recall prevention is even more
valuable than previously thought, given the higher stakes of product failures.
Companies would also be wise to develop more internal expertise to not only
manage their own recalls but react quickly to those of rivals. Two specific
steps could help most R&D-centric companies:
·
Create recall recovery teams. A specialized group of managers
with deep knowledge about a company’s products and the recall process might
keep a company from diverting time and resources from product development
efforts, thereby undermining the roll-out of future innovations.
·
Develop competitor recall intelligence tools. Companies
that develop the capabilities and tools to react quickly to other companies’
recalls stand to gain more when market opportunities present themselves.
While Stern’s past research has focused primarily on innovation
in health care, these new findings could apply broadly to any company that
invests heavily in R&D, even those in industries that lack a formal recall
process.
“Whether your firm is making phones or drones or self-driving
cars, recalls can divert efforts from subsequent innovations and spur your
competitors to take advantage of the market opportunity,” she says.
Danielle Kost is senior editor at Harvard Business School
Working Knowledge.
https://hbswk.hbs.edu/item/the-hidden-cost-of-a-product-recall?cid=spmailing-25184955-WK%20Newsletter%2002-27-2019%20(1)-February%2027,%202019
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