THE CHINESE UNIVERSITY OF HONGKONG

Sanlu’s Melamine Tainted Milk Crisis in China

Jasvin Bhasin 10/21/2011

Student ID: s1155006888 Email ID: jasvin.bhasin@cuhk.edu.hk

The following document analyses the answers to three very important questions regarding the the tainted milk crisis in China.

1. What are the major causes of this crisis?

Answer:

The tainted milk crisis in China is perhaps one of the most disastrous

scandals to occur in the history of Chinese dairy industry. In

September of 2008, the infant formula powders produced by Sanlu

group, China’s biggest milk powder manufacturer and 21 other dairy

companies was found to contain melamine- the ingestion of which

could cause kidney stones. This sent shock waves across country

affecting thousands of infants and young children and leading to

casualties.

Many factors can be considered as contributory to this crisis:

1. Low Supply High Demand: China’s dairy and milk production had

slowed down due to surging inflation and increased cost of production

but the national consumption remained high due to China’s growing

income per capita and increased desire for western diet. To take

advantage of this flourishing business industry some infant formula

producers made and sold low quality milk products for personal gains.

Hence, a high demand low supply situation led to dairy companies

becoming dishonest in their activities to save costs make more profits

by using cheap alternatives for milk production.

2. Improper Operation Model: Most of China’s dairy farming was

operated on a small scale and less structural basis. Small dairy farm

complexes functioned like a trust company in very scattered set ups

with no central control and no unified supervision over the actions of

the farm owners or independent milk stations. This led dairy

companies to rely on the raw milk provided by multiple and scattered

milk sources. There was no central organization that could vouch for

quality of this milk.

3. Seller’s Market: Initially, the dairy companies had been selective

with milk collection stations that were eager to sell. However, after

2005 when more and more dairy industry players appeared in the

market it converted the dairy industry to a seller’s market with more

buyers than sellers. Operating without any formal policy or contract,

milk dealers sold their milk to companies that offered them the

highest bid. During peak operational period, desperate dairy

companies paid for milk source regardless of quality. However, during

off peak season farmers had to accept whatever price the companies

offered. Also, individual farmers were exploited via delayed payments

since they did not have collective bargaining power. Also, all the cost

pressure generated by the dairy companies who reduced prices to

compete effectively was transferred on the head of the farmers. Hence,

the farmers were no longer making money due to rise of inflation in

the country and rising cost of dairy feed. All these situations led to the

farmers trying to use cheaper alternatives to increase production and

at least break even.

4. Lack of Knowledge and Quality Control: Small scale rural

farmers had little knowledge about milk safety awareness. Since

payment to the milk farmers was based not just on milk volume but

also on the protein content the milk suppliers resorted to artificial

means like adding nitrogen rich urea. The traditional approach of

measuring milk’s crude protein level could be tricked by mixing non-

protein nitrogen rich compounds such as melamine but it was still

very widely adopted in China.

5. Quality Inspection Exemption: The Chinese government gave

Sanlu group a check-exemption since it was considered to have a good

product quality record, had a large market share and had standards

equivalent to and beyond national and international levels. Hence,

Sanlu was allowed to print the national inspection labels on their

products signifying a quality assurance to customers despite no tests

having been actually performed. This was quite a risky proposition

given the fact that there was no way to check if Sanlu had actually

performed any real testing at their end.

6. Ignoring Early Complaints: The complaints regarding

contaminated formula first appeared in 2007 but Sanlu ignored the

seriousness of the situation and let the problem boil further. If Sanlu

had taken more responsible actions when the news first surfaced may

be the crisis could have been controlled more effectively. Also, in 2008

there was a big delay by Sanlu in notifying the public and concerned

government authorities about the contamination situation.

2. How should the crisis be handled and how product recall

strategies influence company in terms of corporate social

legitimacy, customer response and company’s competitiveness?

Answer:

The disaster of the Sanlu tainted milk crisis in China generated an

irreversible health hazard, caused casualties and shut down one of

the most popular companies in China.

Looking back at the crisis one can make a few suggestions about what

could have been done to handle the crisis in a better way.

1. Acknowledge Early Complaints: Sanlu ignored the early

complaints when they were made in the year 2007 and did its best

to do maximum damage control to its company name at that time.

It resorted to acts of bribery to remove any trace of the existence of

this This was not right, since an effective realization of the

seriousness of the situation at this time could have saved many

more lives.

2. Pro-active reporting: Sanlu delayed the reporting of this incident

to the government authorities and the public which was not the

most ethical way to proceed with such a serious situation. If Sanlu

had pro-actively notified everyone of the situation before hand it

could have saved a bit of dignity for itself. In this case the news

came out to the public when Sanlu’s foreign partner Fonterra

communicated the news to its government.

3. Honesty in Actions: It was noticed that Sanlu tried to gain help

from local government to manage the media and to create a good

environment for the recall of the company’s products and tried to

buy out critics by offering money to internet search engines such

as Baidu when the situation occurred. If Sanlu showed more

responsibility and had honestly shared this news with the central

government on high priority the situation could have been

controlled a bit better.

4. Better Control on Supply Chain: In relation to the Sanlu case,

the state investigators did not recover melamine purchase records

at Sanlu and found no evidence to suggest the company had

actually added the chemical to its formula during production.

Hence, if Sanlu had handled its supply chain better via a

centralized quality control over all its suppliers then this crisis

could have been prevented.

Product Recalls are major problems to supply chain management in

China. A product recall is a request to return to the maker a batch or

an entire production run of a product, usually due to the discovery of

quality and safety issues. The recall is an effort to limit liability for

corporate negligence (which can cause costly legal penalties) and to

improve or avoid damage to publicity. A product recall definitely has

an impact on corporate social legitimacy, customer response and

company’s competitiveness as discussed below:

1. Corporate social legitimacy: From an ethical standpoint product

recalls if done in a pro-active way are indicative of a good social

responsibility on the part of the company. A company has to bear

the brunt of loss made on recalled goods, has to suffer negative

publicity and possible brand image damage during a product

recall.

2. Customer response: Following product recall the customer

response to the products of the company is usually negative. The

customers become more doubtful of the safety of the company

products. This is in sync with normal human psychology where the

concept of “Once bitten twice shy” comes into place. A customer

might start looking for alternatives to replace the original company

products.

3. Company’s competitiveness: Product recalls definitely create

challenge for the company. Many a times it is observed that the

company’s stock price crashes post a product recall and as a result

its competitors gain significant competitive edge. Also, when

customers are wary of the company post a product recall they look

for alternatives in the competitor products and this can cause the

company to lose customer base.

3. What advice would you give to companies in this industry in

terms of how to design and manage their supply chains to avoid

future crisis such as this?

Answer:

A close look at the Sanlu Melamine Tainted Milk crisis indicates that

the biggest loophole that caused this disaster was the supply chain

structure that the company had in place.

The supply chain structure in place before the crisis is illustrated

below:

It can be observed that Sanlu did not have direct control over the

workings and activities of the cattle farmers who provided the raw

milk to the scattered independent milk stations/dealers.

These milk dealers transferred the cost pressure of price reduction to

the heads of cattle farmers forcing them to resort to dangerous cost

saving measures such as adding melamine and other nitrogen rich

materials to sell more milk since the volume of milk was not the only

criteria to make sales any more and more emphasis was laid on the

protein content of the milk.

Also, lack of a central supervisory agency to monitor the workings of

the different chunks of the supply chain would have resulted in better

management of quality aspects.

My suggestions to control such crisis are as follows:

1. Iron out the “Middle Man”: It is observed that the presence of

middle man in most supply chains can result in ambiguity of

information flow and hence it is important to make sure that the

middle man does not become the most powerful deciding authority

in the supply chain. In the Sanlu case the independent milk

dealers/stations were supplying adulterated milk to Sanlu for

years without its knowledge.

2. Central Quality Supervisory Agency: There should be a central

quality supervisory agency which manages the testing and quality

aspects of products passing at every stage. The central agency

should have multiple branches at different points in the supply

chain to manage quality at every checkpoint.

3. Balancing out Cost Pressure: The supply chain should be so

designed that the cost pressures from the price reductions are not

really borne by one part of the supply chain and are evened out

effectively to avoid excess pressure on any one division.

4. Uniform Plan of Action: In a supply chain where multiple parties

are involved it is essential to have a common plan of action with

defined rules and strict measures in place. In case of Sanlu all

constituent parties were following their own course of action

without any coherence with a common goal.

5. Better Management: It is very important to coordinate all process

flows in a supply chain effectively. Management is responsible for

overseeing that the process decisions made at every stage are

ethical, legal and risk-free. The management needs to keep a keen

eye on the workings of various divisions to yield benefits in the long

run and reduce scope of error.

The proposed supply chain model design is as follows: