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Editor's Desk

Special Columns
Arindam Chaudhuri, Editor-in-Chief, 4Ps B&M Chief Consulting Editor's Desk
Rajita Chaudhuri
A.Sandeep Editor’s Desk
A.Sandeep
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Product Recalls A Curse or a Good News?
Product recalls have earned much criticism over time. First, it was considered a taboo with consequences that could spell doomsday for the accused. Then, it made the shareholders utterly uncomfortable. Today, the CEOs are being forced to embrace it as a part and parcel of their lives. After all, is a product recall so unforgivable an act?
 
What’s it with product recalls that gets the world staring at the accused with a frown-filled sceptical look? Profit-seeking investors count such actions on behalf of the corporations as just another signal of failure heaped upon failure. But the inevitable truth is – the buck stops at the CEO, or in other words, the man at the top! My discussion focuses on the recent slamming of Akio Toyoda, whose family-founded Toyota Motor Corporation has amassed recalls of 8.4 million vehicle units so far during the year, which included the iconic Prius, Corolla and Camry models. The US government, of course, gave him a stick of its own – $16.4 million in fines payable to US Safety Regulators for failing to warn about the defects on a proactive basis. Meanwhile, work went on at Toyota’s plants.

A majority of the studies conducted over decades on product recalls comment that recalls, in general, tear down both investor and consumer sentiments. Some have gone to the extent of even quantifying how disastrous recalls can prove to bottomlines and share prices. One such report published in the Quarterly Journal of Business and Economics claims after analysing 269 product recalls over a period of 20 years that the mean cumulative abnormal returns (MCAR) were negative over the post event period, hovering around 3% from day 13 to 36, with the largest MCAR being -3.55% on event days 19 and 20. Several studies in the past by Jarell & Peltzman (1985), Pruitt & Peterson (1986), Hoffer (1987), Bromiley & Marcus (1989), Davidson and Worell (1992), Thomsen & McKenzie (2002), Chu, Lin & Prather (2005), Heerd, Helsen & Dekimpe (2007), Chen, Ganesan & Liu (2008), Zhao & Stephen (2009) have also proven that product recalls are associated with decrease in shareholder value.

But that’s where I realised that many of these studies, perhaps all of them I dare say, got it critically wrong. All these abovementioned works suffered a common ailment – the observation window was “limited” to anywhere between -1/+1 (days) and -60/+60 (days) of the recall announcement. What about the longer term effect? The fact is that contrary to what these reports mention, product recalls in fact should have been improving the customer perception about a corporation’s commitment to quality. Especially as the company helps ‘correct’ a past mistake transparently and truthfully. Was this hypothesis of mine correct?

I decided to do a deeper and a wider time window analysis of the five most publicised product recalls in history (considering volumes as well), and see whether these recalls added to or negated from the company’s future performance.

 
1. Toyota’s recall of 8.4 million vehicles in 2010: After posting losses of $4.8 billion in FY2009, the Japanese carmaker had the worst start to the new year amongst all automakers, at least as far as brand image and goodwill were concerned. But that’s where the black suit ceremony ends. The Japanese car manufacturer is extremely confident about a quick recovery and has predicted a net profit of $892 million for FY2010 – a far improved situation as compared to the previously forecasted loss of $2.2 billion by the company. Better still, as per estimates by Thomson Reuters, the automaker is set to record $1.74 billion in net profits during 2010, a figure which will skyrocket to $8.32 billion by 2011. And here’s a treat for shareholders who have been plagued by hearsays about how recalls lead to value erosion. Even as news of how Toyota planned to exceed its initial recall estimates started doing the rounds on February 5, 2010 (with an additional recall of 270,000 Prius units in US & Japan, to fix their brakes), the company’s share surprisingly rose 4.1% to close at $74.71 on the NYSE. That was a day when even the Nikkei 225 fell by 2.9% to a 60-day closing low. The five year comparative analysis of the Toyota share performance on NYSE vis-a-vis the S&P 500 shows that the automaker has beaten the benchmark index consistently over the past half-a-decade, and that the recalls haven’t spoilt Toyota’s game. Lesson learnt – if you’ve earned a goodwill already, even a couple of record-setting recalls won’t hurt, as Bob Johnston, Deputy Dean (Operations and Finance), Professor of Operations Management of Warwick Business Schools puts it in a line: “Companies can get away with recalls once or twice in a period of time!” I should add, “Too profitably!”

2. Ford’s recall of 14.1 million vehicles in 2009-10: Another auto major, another record. Having recalled 4.5 million vehicles in October 2009, Ford Motor Company recorded the highest aggregate number of recalls in history in a single stretch. The record – 14.1 million units. That should have destroyed all hopes for the Detroit carmaker, which was supposedly in the worst shape when 2009 began, having made $17.3 billion in cumulative losses during FY2007 and FY2008. But instead of moving downhill, the figures climbed and share prices shot up. In the past one year, the Ford stock has gained 98% in value, outperforming the S&P 500 by a long way. When FY2009 came to a close, instead of recording a negative bottomline (as was anticipated amidst the recalls), the Alan Mulally led giant got the better of cynics, scoring a positive bottomline of $2.71 billion. Even the first quarter of FY2010 was good news, with the company announcing $2.09 billion in profits. Learning: Having a super dual-role perfoming man on top (CEO & President) like Mulally helps. Recalls do too!

          
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