Case Study: Sanlu

Company Background

Sanlu (formerly Shijiazhuang Dairy Co.) was established in 1956 and started out as a small dairy in Shijiazhuang, a city in northern China's Hebei Province. In 1983, it became the first enterprise in China to launch an infant formula. The company had been a leading state-owned enterprise in both the agriculture and food-processing sectors of China. Over the years, the company concentrated its core business on dairy-product manufacturing and marketing. It was also diversifying its milk-powder products to suit different age groups. Sanlu Group was eventually formed in 1996 and. By adopting a low-pricing strategy (products were priced one-third lower than those of other major brands in China), Sanlu dominated the medium- and lower-end market and successfully became the cost leader in the industry. However, by the December 24 2008, Shijiazhuang Sanlu Group Co.Ltd filed for bankruptcy because of Implication in the “Big Head Disease” Scandal.

Company History

1996 The Sanlu group officially registered in Hebei province.

February 2006 The group opened a dairy plant in Tangshan. At the time

of signing the joint venture contract with New Zealand

dairy cooperative Fonterra, with the aim of forming a national industrial network over the next three years.

2007 Sanlu’s sales reached ¥10 billion, with brand value

estimated at ¥25 billion.

Sanlu’s milk powder sales of the group ranked No.1 for

15 consecutive years and dominated the market

with 18 percent share in the milk powder sector.

January 2008 To that end, on, Sanlu won one of China’s top industrial awards at the National Scientific Techniques Awards

in the category of Innovative infant formula research and

other related techniques.

Case Background

In 2008, the Chinese government ordered to suspend Sanlu's production due to the disclosure of selling melamine-tainted milk to the public.

Melamine, a lethal chemical found in Sanlu’s milk powder which added by suppliers for increasing the protein content level in order to gain a higher price. The tremendous drive brought to the society is the infant and children may suffer from kidney failure after ingestion. Due to the seriousness of this scandal, the Sanlu Group declared bankruptcy and their top managers had faced a lawsuit and sentenced a long term imprisonment.

The milk supply chain in China

The milk supply chain in China is divided into six major parties, including milk farmers, milk stations, manufacturers, retailers, consumers and the government. In the view of the upstream party, the milk farmer is responsible for feeding cows and acquiring milk from them. Then, the milk becomes the original sources of making milk powder. However, the education level of them are low, and they do not have enough skills to handle the production. As a result, their bargaining power is the lowest in the milk chain.

For the milk stations, they will collect the milk from the farmers and resell it to the manufacturer. According to the report “SANLU’S MELAMINE-TAINTED MILK CRISIS IN CHINA”, around 80% of the milk in milk stations came from the small-scale farmers (LU & TAO 2009). Although the milk station will handle relative amount of milk, the station is less organized and structured.

In order to transform the milk (original sources) into the milk product (final goods), the manufacturer will process the milk which come from milk stations and farmers. In 2008, Sanlu is one of the largest milk manufacturers in China. Since the milk manufacturers contain a lot of resources and experts, they received a high bargaining power in the milk chain.

Being a downstream party, the retailer is responsible for distributing the milk product to the customers and consumers. It is undoubted that it is a bridge connecting manufacturers and consumers. The consumers is the end user of the milk supply chain, and they purchase and consume the milks in the market.

Even though the government is not directly involved in the milk supply chain, they are acting an important role of monitoring the operation of the milk supply chain. One of their duties is to ensure the quality of the milk products are up to standards. In the meanwhile, they are also responsible for the milk safety in the country.

How did the Sanlu milk crisis arise?

All the parties in the supply chain involved in the development of the milk crisis. The detail will be given from upstream parties to downstream parties in the following.

Farmers

Due to the low educational level in producing high quality milk products, they tried to increase their income by stretching milk with water and adding melamine in order to raise the protein content level of milk. Also, most of them are dispersed so there is difficulty in controlling the quality of these small entities. In a result, the farmers added the toxic chemical in the milk recklessly.

Milk Stations

Referring to the case, there was no supervision among these stations, even some of the milk stations did not have governmental license for operation. These resulted in an increase in illegal operation and low standard of working environment. Moreover, there was no formal contract with farmers so that the milk station cannot trace back the source of origin of milk effectively and assure quality hardly. Therefore, the contaminated milk was easily sourced by the stations.

Manufacturers – Sanlu and Fonterra

As the largest dairy products manufacturer in China, Sanlu only offered an unreasonable low price for purchasing the milk from milk stations. Also, they underwent a simple and low standard quality test in sourcing stage. These points mentioned above inclined the farmers for putting melamine in the milk.

Fonterra, as a joint venture partner, they turned a blind eye on the “open secret” – adding melamine and water into the milk and did nothing on the milk crisis.

The Chinese Government

The Chinese Government capped the price of milk products due to the high inflation level so the pressure was transferring to farmers. Besides, they allowed exemptions of quality test for companies who have passed the test in three consecutive years, thus, the quality of milk may not be guaranteed after the exemption. Additionally, the government covered up the public new intentionally until the end of Olympics held in Beijing. Consequently, the consumers lost their trust in dairy product in China.

Who should be deemed responsible for the crisis?

Each party in the supply chain should share a responsibility for the crisis arise.

After our analysis, the responsibility of each party could be ranked as follows:

The Government - Main responsibility

Lacking regulations and supervision provide a loophole for the crisis. The Chinese Government did not enforce its law when it comes to product quality inspection, such as chemical protein - Melamine. Supervision for milk station was not exist at that time which has made the quality of milk not standardized.

Manufacturers (Sanlu) - High responsibility

Due to the fierce price competition in milk products, it has been demanded for lowering price of dairy products. While manufacturers, like Sanlu, put the pressure back to upstream suppliers. They diluted the milk and added melamine as the only mean for them to survive. Furthermore, they had tried to cover the news by bribing Baidu to avoid the public attention.

Sanlu’s business partner, Fonterra - High responsibility

They did not oversee the whole supply chain system. It has been an open secret that farmers add water and melamine into the milk so as to increase income by interfering the reading on protein level. They did not take any action to alleviate situation despite they could have a better monitoring and quality-checking system.

Milk stations - Slight responsibility

They pay only US 0.07 per pint of milk to farmers, which was adopting a low cost strategy at farmers’ expense. Moreover, lack of quality checking guidance makes supplementing melamine in raw milk becoming a common practice.

Farmers - Slight responsibility

Despite the fact that farmers are the sources of adding melamine in dairy products, we could not blame on them as they could survive only if they do so. Also, they have no skills for better yields and no collective bargaining power, which means they could only dilute milk to rising their income.

Retailers - Slight responsibility

They did not ensure safety in dairy products in which there is no regular product quality checking policy in store. No standard have been set for product inspection.

Customers - Little responsibility

They ignore the fact that highly-priced infant formula does not necessarily means higher quality. They should not only relying on the brand name or inspection label as a criteria to choose dairy products. Also, neglecting the benefits of breastfeeding makes them truly believe milk powder is the only choice.

Why do companies outsource? What are the pros and cons of outsourcing?

While outsourcing can have substantial advantages for businesses mainly focusing on cost reduction, there are also some drawbacks to be considered.

Advantages related to costs of outsourcing for Sanlu include a lower purchasing price for milk, cutting labor costs, less controlling and contracting costs, lower regulatory costs, and overall lower administrative costs. Other pros of outsourcing are being more flexible in reacting on demand, an ability to focus on marketing and other business parts in which then a competitive advantage can be gained, the ability to switch suppliers more easily, and a lower initial investment.

Drawbacks of outsourcing can be a worse risk management, having less control on quality with a possibility of being deceived by farmers, a low relationship with farmers, the risk of not being able to fulfill demand, having no planning security, no synergy with farmers, and no transparent information flow (Flatworldsolutions.com, 2016).

In Sanlu’s case it turned out to be a disaster, even though it seems like the pros outweigh the cons. This suggests a very careful analysis of the weight of each item on the list.

References:

Flatworldsolutions.com,. (2016). Outsourcing pros and cons, outsourcing pros, cons

of outsourcing, disadvantages of outsourcing & effects of outsourcing. Retrieve

d 2 February 2016, from https://www.flatworldsolutions.com/articles/pros-cons

-outsourcing.php

What is the role of ethics in Supply Chain Management?

In addition to the recognition of outsourcing, companies have to consider ethics in their business decisions. In ethical decision making all stakeholders have to be considered, including customers, suppliers, retailers, people in the area and other stakeholders. The goal is to maximize total stakeholder welfare and to minimize supply chain risk. For these decision making processes in a company's supply chain, the firm can consider PESTLE analysis. Relating to the Sanlu case, the dairy producer has to consider the environment, the sustainability of its business, the safety and health of their suppliers and customers, as well as the consumer rights.

In the following analysis, we will look at the specific Sanlu case and look at each different stakeholder in the Sanlu milk supply chain. The most upstream part in the supply chain is the farmer. The farmer needs to ensure good and healthy nutrition for the cows as a basis for good quality milk. In line with good nutrition is the safety of the raw materials, which is in this case the health of the cows.

The next step in the supply chain are the milk stations, which need to provide better control quality of the delivered milk. Moreover, contractual agreements with not only downstream manufacturers, such as Sanlu, but also contractual agreements with the upstream suppliers of milk – the farmers – have to be set up, in order to have more control over the quality and quantity of milk delivered. This can drastically reduce the issues regarding melamine contaminated milk.

The central part in the supply chain is Sanlu itself. Sanlu has to ensure a positive working environment, having trust in a central role. Trust can be built by having strong stakeholder relationships. Furthermore, Sanlu has to pay a fair price for the milk, resulting in higher prices the milk stations can pay to the individual farmers, ensuring a good working environment. A critical part in ethical decision making is that Sanlu actually does honest advertisement and shows where the milk comes from. However, high completion and price wars between different manufactures can alleviate the reliance on ethical decisions. Downstream in the supply chain are the customers and retailers. The last quality checks have to be done by retailers, to ensure that customers only receive healthy and correct products. The customer finally has the right to choose between the different products and the right to be heard by the different firms. However, recently a trend has emerged that customers focus ever more on sustainable and high quality products, meaning they are willing to pay a higher price for healthy and good products. If this focus on ethical and sustainable products is brought through the entire supply chain, as explained above, product quality can be enhanced and another crisis like this prevented.

In addition to the direct supply chain, external factors, such as the government, can play a crucial role in having raising awareness about ethics. The first thing a government can do is to provide continuous monitoring of the quality processes. Therefore, certain rules, laws and regulations have to be implemented. A few being, that the exempt rule is abrogated and that the government introduces regulations on animal nutrition. Moreover, price wars and monopolistic or oligopolistic market situations have to be taken care of. Finally, the government can create awareness about ethics and sustainable businesses by providing education to all stakeholders.

References:

Supplychainbrain.com,. (2016). Ethics Issues Are at the Heart of Supply-Chain

Management. Retrieved 2 February 2016, from http://www.supplychainb

rain.com/content/research-analysis/chainlink-research/single-article-pag

e/article/ethics-issues-are-at-the-heart-of-supply-chain-management-1/

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

Both the government and the manufacturer play a crucial role in restoring consumer confidence in Chinese dairy products.

The government needs to develop a better inspection system while also implementing new laws and regulations concerning chemical use. Frequent company visits should be established consisting of quality control with sampling of the products, a penalty if the rules are not followed, and an education for companies concerning those rules and safety standards. There should be no privileged status for any dairy company, concerning tax regulations and controlling procedures. Also a prohibition of monopolies should be in place, ensuring perfect competition. Licenses should also be handed out for manufacturers, further enforcing quality control.

The manufacturer should recall the affected products immediately, as Sanlu has done it. Also, an extended customer service is important to answer any questions. The promotion of the product should be done in a different way, to not remind consumers of the scandal. Cooperative work with the government is recommended and international quality standards should be applied, as for example ISO. To inform consumers, a documentary of the production processes might be a good way to start. Also a higher relationship with farmers should be a priority, for example through frequent visits to also be able to ‘trace back product labels’.

All in all, a cooperative working environment between the government and manufacturers in the dairy industry can restore customer confidence again.

Reflection

Sanlu’s melamine-tainted milk crisis has brought a tremendous drive to the society. Due to the unethical act Sanlu’s top management, consumers started losing their faith in dairy products in China. This scandal revealed the problem of quality assurance in dairy industry. There were some pitfalls in their supply chain practice: lack of regulation, untraceable sources, and uneducated workers. To gain back consumers confident, organizations must establish a sound and ethical supply chain management.

In fact, business ethic plays an extremely important role in supply chain management which can effectively influence the business environment and decision making. To implement business ethic, we should considers three aspects: labor practice, society and environment. For labor practice, company need to ensure a positive and safe working environment provided to their workers, pay them reasonable salary with further training and do not encourage child labor. Moreover, corporate social responsibility should be promoted in the workplace which may develop a strong ethical organizational culture that influence future decision making and the conduct of employees. For the society, company should grow together by sharing insights and ethical practices with partners along the supply chain. For example, lying and covering up the fact are not the correct way to solve problems, what they should do is to face the public and fix the crisis. For the environment, company should focus on using more sustainable resources that may have less impact on the environment. If all the companies in the supply chain are being ethical, it would create a better and efficient business environment, even society.