CSCMP's Supply Chain Quarterly

Quarter 2 2011

Consumer product fraud—how to stop it now

By JAMES E. MOREHOUSE and LOLA CARDOSO
The melamine scare and similar incidents show that consumer goods remain vulnerable to tampering. Here are five strategies for detecting and deterring this type of fraud in your supply chain.

In 2008, the food and beverage industry was rocked by a major scandal when milk products from the People's Republic of China were found to have been adulterated with the chemical melamine. Melamine is a nitrogen-rich chemical that is sometimes added illegally to watered-down milk to make it appear to have a higher protein content. When ingested by humans or animals, the chemical can cause renal and urinary problems. At least 290,000 people were affected by the contamination and nearly 52,000 were hospitalized. More than 30 local and global milk brands were affected, the giant dairy producer Sanlu filed for bankruptcy, and more than 60 countries banned or recalled Chinese dairy products and other affected products, such as pet food. The total cost of the melamine adulteration has been estimated at US $10 billion.

This incident demonstrated how vulnerable to contamination and disruption the food supply chain can be, despite our modern safeguards and technology. Moreover, industry stakeholders recognized that a single instance of economic adulteration (where a product is altered for economic gain) can have global consequences, with broad and deep implications for a company's brands, an industry's performance, peoples' lives, and entire countries' reputations.

Unfortunately, the 2008 melamine contamination was not an isolated incident, and the number of consumer product- fraud incidents has been growing. In response to this increase, the Grocery Manufacturers Association (GMA) and its Science and Education Foundation (SEF) partnered with A.T. Kearney to study consumer product fraud in the food, beverage, and consumer packaged goods industries. Supported by 13 leading consumer packaged goods companies, the resulting report, Consumer Product Fraud: Deterrence and Detection, recommends immediate actions companies can take to stop consumer product fraud within the supply chain.

The study explored leading practices and success stories related to fraud deterrence and detection, and it examined opportunities for manufacturers, governments, and the industry at large to reduce the risk of economic adulteration, protect brands, and enhance consumer product safety. Its findings were based on approximately 100 interviews with senior managers in the food, beverage, and consumer products industries; a repository of information on 150 incidents of product adulteration; and A.T. Kearney's research and expertise.

After reviewing the study's findings, it became clear that even the best companies could find opportunities to improve their food safety and quality programs. As we will discuss in this article, the keys to doing so lie in companies gaining a better understanding of their supply chains' vulnerabilities and in strengthening their existing deterrence strategies. Yet industry cannot be expected to solve this global problem on its own. If we are to prevent economic adulteration, manufacturers, governments, and other relevant institutions will need to share pertinent information that will enable them to take concrete action.

Economic adulteration—a real risk
It is estimated that on a global basis, economic adulteration and counterfeiting of food and consumer products may cost those industries US $10 billion to US $15 billion per year. The consequences of fraudulent adulteration range from lost sales and bankruptcies to adverse health consequences and possibly even fatalities. Since 2007, prominent contamination cases such as diethylene glycol found in toothpaste, melamine contamination in milk and pet foods, leadtainted toys, and salmonella-contaminated peanuts have resulted in an estimated US $15 billion in costs and damages combined (see Figure 1).

The impact of such fraud on an individual company could be significant. The cost of one adulteration incident averages between 2 percent and 15 percent of yearly revenues, depending on company size. This could translate to a 4 percent impact for a large (US $10 billion) company, or as much as a 12 percent impact for a small (US $500 million) company, as shown in Figure 2.

The prospect of high profits and the low risk of detection (or if detected, punishment that is often fairly lenient) have always been motivating factors behind economic adulteration and counterfeiting. Today a host of new factors have further complicated industry's and government's ability to detect and deter fraudulent activities. These include:

An expanded global marketplace. As companies increasingly outsource manufacturing, sourcing, and logistics, they have less visibility and control of key processes. At the same time, more companies are engaging in sourcing and offshoring in emerging markets, which makes them vulnerable not only to domestic sources of fraud but also to international ones. What was once a local effort to stop economically motivated fraud has become an international challenge.

Within that global market, product adulteration is more common in some markets than others. There is a common misconception that local values in certain countries condone economic adulteration. In reality, it is the interplay between economics and the legal and regulatory infrastructure that makes adulteration acceptable. Instances of adulteration that threatens consumer health can be traced to markets with severe economic tension, weak regulations, poor legal frameworks, and, in many cases, poverty. Brokers and distributors in these markets sometimes have little knowledge or accountability for the products they handle and are mostly concerned about their personal economic situation.

Markets where product adulteration is common (because of less scrutiny) have become key sources of global supply—exposing manufacturers, brokers, and other purchasers to risk of fraud. Already, approximately 40 percent of all trade in agriculture, fisheries, and forest products occurs between developing and developed countries. A recent, unpublished A.T. Kearney study, titled "GMA Economic Adulteration/Counterfeiting Incident Survey," found that ingredient suppliers are the leading sources of economic adulteration and counterfeiting.

The power of the Internet. The Internet serves as a retail channel not only for legitimate consumer products but, increasingly, for counterfeit products as well. Counterfeiters can use the Internet to reach once unreachable consumers while also remaining anonymous, thus reducing the likelihood of being caught and prosecuted. Furthermore, Internet transactions are difficult to monitor and prosecute due to different rules and jurisdictions across geographies.

More sophisticated perpetrators. Because they now have practically unlimited access to information, perpetrators are becoming more sophisticated in how they commit fraud. They have a better understanding of processes and standards, and they are constantly looking for ways to game the system. For example, in the melamine incident, the guilty parties knew that the methods used to test for protein levels in milk are unable to distinguish between nitrogen in melamine and nitrogen that occurs in milk's amino acids.

Tighter economic conditions. In bad economic times, when commodity prices fluctuate, ingredients are in short supply, and buyers are pressing suppliers to lower their prices, there is often a spike in fraudulent activity as suppliers are squeezed by costs and surrender to temptation. This is particularly common in the aftermath of natural disasters or in other situations when agricultural supplies become short.

The "silent" global food crisis. In the last two years, the world's attention has primarily focused on the financial and housing crises. Comparatively little attention has been paid to the global food crisis that is developing as population growth outstrips agricultural output in some parts of the world. On a political level, food shortages appear to be one of the key triggers of the current uprising in the Middle East.

While the looming food crisis might appear to be unrelated to economic adulteration, the two are closely linked. Food shortages, economic instability, and rising demand for goods create an imbalance between supply and demand that can motivate fraudulent activity. For example, in China demand for milk was outpacing supply; this reportedly led some farmers to water down their milk to increase volumes and then adulterate it with melamine so that it would appear to meet quality standards.

On a macro level, the world population is expected to double by 2050, with the fastest growth occurring in developing countries, and crop production from arable land in these regions is expected to remain flat. To meet demand, some suppliers may be tempted to provide and use ingredients that do not meet quality standards and might otherwise be rejected. Such actions, however, could cause the food crisis to worsen if already declining food supplies are intentionally adulterated.

Raising the bar on safety and quality
How can we meet these new challenges? We can start by integrating additional fraud-prevention strategies into existing programs.

Anti-fraud measures can be incorporated into existing food safety and quality programs through the following five-step approach. This approach was developed by synthesizing the research findings and insights gained from the GMA study with the best business practices in the food industry as well as those of other industries.

Step 1. Understand the product portfolio's vulnerabilities
To incorporate prevention of economic adulteration into an existing quality and safety program, companies need to begin by understanding all of the vulnerabilities in their product portfolio. This requires creating a data repository of potential threats, and then using models to forecast potential risks.

Such a repository, or data bank, consolidates relevant historical information about internal incidents and industry insights into external incidents. It can contain information about internal adulteration incidents, including specific details such as ingredient, adulterant, source, date of incidence, cost to the company, and actions taken. Information about external incidents can be gathered through participation in structured industry clearinghouses like the nonprofit Fair Factories Clearinghouse used in the apparel industry, informal communication networks, and alert tools such as price monitoring systems.

This type of repository can be useful in spotting trends and identifying themes. For example, it can answer such questions as: What types of products or ingredient characteristics are most frequently targeted? What conditions in the supply chain can make certain products vulnerable? What methods of adulteration are used? This kind of information will help companies to identify where the risk of economic adulteration exists.

A good way to predict potential risks is through a risk-forecast model. Because a single, industrywide model has not been identified, companies use a variety of sources to forecast and prevent threats internally. Figure 3 demonstrates a potential framework for identifying and prioritizing product risk. First, information captured in the repository can be used to develop key criteria needed for identifying targeted products and developing scorecards to prioritize targeted products. Next, market intelligence on supply and demand distortions is embedded into the risk assessment, and scientists and industry experts conduct simulations to predict future threats. Finally, the assessment is adjusted depending on the "riskiness" of a supplier. This process will not only help identify current risks but will also predict emerging ones. It is not a one-time procedure, but rather an ongoing rating process that should be reviewed and reprioritized periodically so that it will remain relevant.

Step 2: Enhance detection programs
Most leading companies already use a number of sophisticated testing methods for detecting common, known quality and safety issues. Yet the inherent variability within natural raw materials makes it difficult to test for every unknown threat. Verifying the authenticity of an ingredient, therefore, can be simpler than verifying the absence of every possible adulterant. At this time, however, authentication testing remains challenging due to variability in farming conditions and the limited availability of suitable ingredient reference standards. Given these challenges, companies can adopt the following methods to improve their existing detection programs:

Step 3: Employ a comprehensive set of deterrence strategies
The costs associated with testing for all known and unknown contaminants are enormous. A more cost-effective way for a company to protect its brands and its consumers would be to apply a comprehensive set of deterrence strategies to prevent adulterated products from entering the supply chain in the first place. For example, most manufacturers already have strategies in place to manage complexity within their supply chains, including streamlining product quality and safety processes and reducing costs. One example of streamlining is outsourcing testing and validation procedures to 3PLs.

Many companies also enforce the highest manufacturing standards using programs such as Hazard Analysis and Critical Control Points (HACCP), International Organization for Standardization (ISO) standards, and accredited third-party certification schemes like the British Retail Consortium (BRC), Safe Quality Food (SQF), Dutch HACCP, and International Food Safety (IFS). By setting the bar based on very clear industry standards, these programs help reduce the risk of problems and provide added security within the supply chain.

There are additional strategies that can enhance existing deterrence programs. They include:

Step 4: Understand the implications of local risks
Some regions of the world are more vulnerable to the risk of economic adulteration than others. It's important, therefore, to understand local risks and their potential impact on operations. As discussed earlier and shown in Figure 4, the potential risks are driven primarily by the interplay between economics and legal infrastructure and not by a cultural acceptance of fraud. Companies can expand their understanding of the potential risks that exist where they source materials or manufacture products by partnering with federal regulatory agencies, academia, and research institutions that monitor and analyze international economic and industrial developments. It also helps to develop local relationships and monitor reports on the regions where they conduct business.

Once a company has developed a good understanding of the local value system, it can find ways to encourage change within the local community. For example, it can work with local governments, establish communication channels with local industries, and jointly develop deterrence strategies with local companies to form a united front against economic adulteration. It can also create incentives that will drive change, by providing modest rewards to community members who help identify fraudulent practices and operations, to name just one option.

Step 5: Deploy a holistic program across the organization
The steps we have elaborated so far are all proven strategies for detecting and deterring economic adulteration. But any approach to fraud prevention can only achieve its maximum effect if the entire organization is fully committed to that mission.

The final step, therefore, is to implement an orchestrated program with a designated project leader and top management support. In such programs, industry experts lead workshops and conduct risk assessments to identify threats and develop a more comprehensive strategy for addressing economic adulteration.

The supply chain organization, of course, must be a pivotal player in any such effort. That is why it is necessary to shore up strategies and bolster investments that have already been committed to supply chains, such as in brand protection and product safety. A good approach involves explicitly integrating antifraud approaches into food safety and quality programs, and educating procurement and supply chain personnel to become more sensitive to these increasing threats. For example, these professionals could question unrealistic bargain pricing, reevaluate the use of brokers for sourcing ingredients, and make changes where possible to minimize exposure to potential problems.

In addition, procurement and supply chain professionals can leverage their industry networks to ensure brand protection and maintain consumer confidence in branded products. Working closely with suppliers, retailers, and consumers in the value chain, for instance, can ensure that everyone has up-to-date intelligence on any product quality issues. Procurement professionals who share information about recent encounters with adulterated ingredients and information about best practices for protecting consumers have a powerful tool for building true partnerships with companies within their supply chains. This is especially important during times of significant economic pressure.

The value of collaboration
The rapidly evolving, increasingly complex global marketplace and the recent adulteration incidents have created a new "baseline" of expectations regarding product safety. New sourcing locations, new suppliers and vendors, new and emerging distribution channels, and increasing consumer activism and government regulation constitute a call to improve how industry detects and deters fraud.

To answer that call, companies need to become more proactive in addressing economic adulteration. While many have already begun to transform their organizations to respond to recent fraud threats within their global supply chains, more action is needed. But no company can be expected to solve the problem of economic adulteration alone. Indeed, the melamine incident, which disrupted both the dairy and pet food industries, made it clear that product fraud is not just a company-specific issue.

Collaboration—among industry, government, academia, and trade associations—is a necessary and powerful tool for addressing product fraud. As an adjunct to the five steps outlined earlier, collaboration can further minimize the risk of economic adulteration by protecting internal competitive intelligence, safeguarding against additional liabilities, and improving regulatory deterrence.

That is why the food, beverage, and consumer packaged goods industries should operate more collaboratively and intelligently, but in a secure environment to avoid exposing strategies and tactics to those seeking ways to produce fraudulent products and cheat the system. A collaborative culture such as that observed in the pharmaceutical industry—which has mechanisms for sharing information about risky suppliers and has been exploring shared audits and industrywide validation of suppliers—could be tailored to fit those industries.

This level of cooperation will have to pass the legal test to ensure that antitrust laws are not compromised. Moreover, collaboration must be seen as a way to minimize risks to product safety and, ultimately, consumer health and welfare; it must not be misconstrued as benefiting certain industry participants. This will require a fundamental shift in mindset before leaders can mobilize the industry for a collaborative journey.

The critical next steps are first, to identify a formal approach to collaboration that includes industry, government, academia, and nongovernmental organizations; and second, to increase global collaboration through industry groups. The industry has already begun taking steps in that direction through the Consumer Goods Forum, GMA, and other organizations, including ongoing discussions exploring the development of a standard forecasting tool to help identify emerging fraud risks.

In the Asia-Pacific region, concern about food safety has led to a high-level, collective mandate to restore consumer confidence. Authorities there also agree on the need to improve regulators' and manufacturers' technical competence and understanding of food safety management. Accordingly, the Asia- Pacific Economic Cooperation (APEC) member countries have created a Partnership Training Institute Network (PTIN) through its Food Safety Forum to bring together public- and private-sector representatives, including scientists, to promote the use of international food safety standards. PTIN was endorsed by APEC leaders in 2008 and is now in the implementation phase.

The APEC example highlights the importance of engaging governments in the fight against economic adulteration. Governments can establish global standards and share intelligence on emerging threats. Additionally, they can improve product safety by implementing and enforcing policies and regulations, and by working with small and medium-sized companies that may need funding to implement detection and deterrence programs. Indeed, some governments are now putting more resources into ensuring safe products for global consumers. They can continue this momentum through collaboration with industry, trade associations, consumers, and other international trading partners.

Such collaboration can take the food, beverage, and consumer packaged goods industries to the next level in safety and quality and reduce the risk of devastating incidents such as the one involving melamine. It may not be easy to achieve, however, as there has been some concern about collaborating and sharing information for fear of compromising a competitive advantage. While this concern may be valid with respect to competitive intelligence, food safety should not be considered or treated as a competitive advantage. Rather, it is an issue the whole industry can and should collaborate on for the protection of consumers worldwide.

A senior partner in the consulting firm A.T. Kearney and a well-known name in the supply chain field, James E. Morehouse has directed global studies on such topics as strategy, productivity, organization, deregulation, and globalization. His work on a recent study on food safety and the supply chain in China was one of the inspirations for this article. He's also a longtime member of CSCMP. Lola Cardoso is a director of strategic planning at A. T. Kearney. Prior to joining the firm, she was an investment banker. She has more than 10 years of experience advising clients across several industries, including pharmaceuticals, biotechnology, consumer products, chemicals, and the public sector. Her current work focuses primarily on corporate strategy development, top-line growth, risk management, and organization and process transformation.
Article Figures
[Figure 1] Timeline of major consumer product safety incidents


[Figure 2] The high cost of fraud


[Figure 3] Framework for identifying and prioritizing product risk


[Figure 4] Influence of economics and infrastructure on local value systems