Food Safety Economics: The Cost of a Sick Customer

 
 
When restaurants source from local growers, it can be more difficult to assess product safety—just another wrinkle in high-stakes efforts to keep our food from harming us. Just ask Chipotle. John A. Quelch discusses a recent case study on food testing.
 
 
by Dina Gerdeman

Chipotle Mexican Grill’s ongoing struggle to win customers back months after a contaminated food crisis highlights the challenges companies face with keeping food safe.

Chipotle has seen its shares tumble and recently reported its first-ever quarterly loss after the incident, which began in October when more than 50 people in 11 states were sickened by an initial E. coli outbreak.

“Do those smaller local organic growers have the experience, resources, and commitment to test their products for various food safety risks?”

The chain restaurant, which uses the tagline “Food with Integrity,” has prided itself on avoiding artificial ingredients, opting instead to use a relatively short supply chain of local growers for many of its ingredients.

That strategy just might have been part of its problem, says John A. Quelch, the Charles Edward Wilson Professor of Business Administration at Harvard Business School and Professor in Health Policy and Management at the Harvard T.H. Chan School of Public Health.

Even though Chipotle’s supply chain is shorter, with fewer intermediaries between supplier and restaurant, the use of local suppliers means that the chain can be complex and fragmented, perhaps harder to control for safety. Instead of having three or four sources for a particular ingredient, for example, it might have 30 or 40.

“Do those smaller local organic growers have the experience, resources, and commitment to test their products for various food safety risks?” Quelch asks. “In an effort to differentiate by being more locally sourced and thereby fresher, as perceived by consumers, Chipotle was perhaps putting its brand at greater reputational risk.”

Companies are increasingly outsourcing their food inspection services. Source: AlexRaths

Quelch, who teaches a course to Harvard business and public health students called Consumers, Corporations and Public Health, says food safety is more challenging than ever for three reasons:

  • The globalization of the food business: Food products and ingredients travel across borders to a much greater degree today, making it tough to keep close watch over them. In 2015, Dr. Margaret Chan, director-general of the World Health Organization, highlighted the problem. “A local food safety problem can rapidly become an international emergency,” she wrote in a statement. “Investigation of an outbreak of foodborne disease is vastly more complicated when a single plate or package of food contains ingredients from multiple countries.”
  • Prevalence of food-related claims: Food safety claims, which are often ambiguous and even unreliable in some cases, attract more attention from an increasingly health-conscious consumer. This has prompted a greater demand for food testing in order to verify the authenticity of the claims.
  • Increasing consumer consciousness about food safety and healthfulness: Consumers have high expectations about the safety of their food, so a great deal of public interest is focused on the issue. Whenever a significant food safety problem arises, publicity quickly follows.

“Twenty years ago, norovirus outbreaks, for example, would not have resulted in the same level of publicity that they receive today,” Quelch says. “Some people say that the food supply may actually be safer today than 20 years ago, but heightened consumer awareness and expectations make this appear not to be the case.”

Global food safety standards are lacking

Unsafe food, such as fruits and vegetables contaminated with feces, clearly creates a huge public health risk, with the potential transfer of harmful bacteria, viruses, parasites, or chemicals to consumers.

In 2010, 582 million cases of 22 different foodborne diseases resulted in 351,000 deaths worldwide, with salmonella, E.coli, and norovirus resulting in the greatest number of fatalities, according to a September 2015 case Quelch co-wrote with HBS research associate Margaret L. Rodriguez, Mérieux NutriSciences: Marketing Food Safety Testing.

Food safety problems can be quite costly. An E. coli outbreak in Germany in 2011 caused $1.3 billion in losses to the global agricultural industry.

Yet, a worldwide standard for food safety is lacking.

“Different countries and regions have different food safety standards,” Quelch says. “We’re accustomed to taking food safety for granted. When you peel back the onion, you find a tremendous amount of nuance affecting the reliability and specifics of food safety testing around the world.”

“If Chipotle suffers a sustained period of flat revenues or declining revenues, that sends a message to everybody in the food industry…”

China, for example, has seen its share of well-publicized cases of food contamination. In 2008, melamine was found in milk products that killed six infants and made 300,000 sick. Keeping a good handle on food safety there may be challenging because China has a highly fragmented agriculture system, Quelch says.

For instance, one Chinese milk brand may be taking its supply from hundreds of individual farmers—a potentially risky situation because, if one of the farmers introduces a contaminated product, it can affect the entire supply for that brand.

China implemented stricter food safety laws in April 2015, but the country may not have enough qualified enforcement staff. And inspectors don’t always enforce regulations as thoroughly as they should, critics complain.

“In fairness, it takes a long time to build up a culture of integrity for any inspection service,” Quelch says.

Plus in China, some suspect that foreign brands are at times unfairly targeted, accused of food safety violations that may be fabricated or exaggerated by those hoping to impede the market progress of successful foreign firms.

In the United States, government officials have attempted to shift food-safety efforts to prevention with the passage of the Food Safety Modernization Act in 2011. One result: Produce is now subject to preventative controls, including more raw material and environmental testing, and, in some cases, less finished-product testing.

Outsourcing food safety testing

A growing number of food manufacturers, grocery stores, and restaurants are choosing to outsource some or all of their food testing—and in many cases, they are saving time and money in the process.

The market for food safety testing by third-party labs in the US in 2015 was about $1.5 billion, compared to the estimated $8.5 billion value of food safety tests conducted by companies in-house. Mérieux NutriSciences is one of the largest providers of food safety testing for food companies, with a network of 80 laboratories located in 20 countries and annual revenues of more than $450 million. The majority of its recent revenue growth in the US has come from companies that previously did their own testing but that have decided to outsource.

In-house testing has its drawbacks. Regulations are increasing and evolving, requiring more expertise than many food companies can muster. The sensitive nature of testing and upgrades in the tests required also mean companies need to make an investment in sophisticated equipment, which involves high fixed costs.

Plus, food companies recognize that using one of the three or four leading global food safety firms gives their testing a certain level of external validity that they may not enjoy by doing their own testing, although big companies such as Nestle remain strongly committed to in-house monitoring.

In the case study, Gallus (name disguised)—a large American poultry manufacturer that sold processed chicken parts to both retailers and fast food restaurants—was debating whether to outsource food safety tests to Mérieux NutriSciences at a cost of $1 million for 12 months of testing.

As it turned out, the economics were a wash: Gallus would save money compared to the cost of operating its own in-house lab, while Mérieux NutriSciences would still make a profit. Gallus officials, who knew that using a third-party testing vendor would likely provide a certain level of comfort to the large retailers it supplied, ended up accepting the outsourcing deal.

“If they have an opportunity to outsource at equivalent or lower cost to a world-class independent food safety (company), that’s going to be a win-win,” Quelch says. “”They’ll save money and have more credibility with their tests.”

Chipotle’s tarnished image

It can take a long time for a company to bounce back from the financial and reputational hit that comes with a food safety crisis.

In Chipotle’s case, the Centers for Disease Control and Prevention announced in February that the E. coli outbreaks appeared to be over, yet federal officials said they were unable to pinpoint the root cause of the contamination problem. When a company like Chipotle has a complex supply chain, it can be a needle-in-a-haystack search to find a precise cause, Quelch says.

“The CDC often finds it difficult to pin down the exact source because once a contaminant comes into contact with other ingredients as part of the production process, it’s no longer separate unto itself,” Quelch says. “That’s another reason you have to be ultra-careful and get your food safety testing capability in line with the risk associated with your supply chain because, obviously, if there is an outbreak and you can’t identify the source of the problem, the damage just lingers.”

Chipotle’s uphill battle to recover has likely sent a collective shudder through the food industry.

“If Chipotle suffers a sustained period of flat revenues or declining revenues, that sends a message to everybody in the food industry that the consumer is paying attention and is effectively punishing brands that do not deliver 100 percent food safety,” Quelch says. “The consumer is voting at the cash register.”

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About the Author

Dina Gerdeman is a senior writer for Harvard Business School Working Knowledge

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