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BLOG biotech : Sep 8, 2010

Perpetuating Risk: Why Are Companies Slow in Addressing Potentially Serious Hazards?

  • Suresh Daniel
J&J’s recent recall of Motrin and other products is more than a cautionary tale in crisis management. This example raises the more important question of why companies are not more proactive in addressing known risks. As Douglas McIntyre, editor of 24/7 Wall Street, stated in a recent posting, "Acting early would probably be harmless at worst and might be critical to success," but goes on to say that few companies have gotten that message. Why?

Many managers may assume “it won’t happen to me,” or that there is a quick solution such as an alternate process or source of critical inputs that can keep things on track. This blog suggests that perpetuation of risk in many companies is complex and related to (a) the resources required to make any changes in the production process; (b) the time required to address an actual or potential problem; and (c) the nature of incentives that encourage risk taking but work against proactive management of those risks.

For the bio-pharmaceutical industry, the effects of these factors are compounded by regulation. Because much government and company regulation designed to preserve product integrity and protect the public is toothless, new firms, products, and processes that reduce risk and improve efficiency can’t get a foot in the door.
 
Reliable supply is one problem faced in biopharm industries. Common risks include disruptions in the supply chains for critical ingredients and problems in manufacturing processes that could compromise product quality. Beyond large inventories, bio-pharm companies need alternate suppliers for their resources and a strategy for unforeseen calamities. Supply chain risks are addressed through a range of measures including inventories as well as qualifying alternate sources, products, and processes.

The costs of addressing these risks can be significant and companies commonly opt for less costly solutions where they continue to have significant exposure. Factoring in the mathematical probabilities that a company acting as a secondary source will be able to supply critical ingredients when needed in the wake of serious supply problem goes considerably beyond most companies’ supply chain management strategy.

Addressing manufacturing problems may require suspension or delayed initiation of production, which could directly and dramatically affect revenues; thus there is a tendency to postpone addressing these issues. Revising production tactics may, at first, cost more in time and efficiency, but major recalls, negative public, perceptions or even legal action affecting the companies, and products involved is more costly. Of note is the cost in revenue and reputation with the recent multiple recalls of Johnson & Johnson products.

Companies can opt for risky short cuts to get production on line and new products on the market ahead of the competition. A recent Sparta Systems white paper notes, “It’s incredibly easy for issues to go unnoticed, because today’s leaner manufacturers are always doing much more work with far fewer people…. quality can easily take a backseat to production and profit.

"But with ever expanding government regulations cropping up, particularly in the manufacturing of perishable goods or medicines, ensuring that quality issues can be immediately solved can make the difference between a profitable business and a company-wide shutdown.”

Decision makers are often given incentives that encourage assuming risk rather than the reverse as the experiences with Enron and mortgage-backed securities illustrate. And those responsible frequently don't suffer significant personal consequences when things go wrong. Successfully dealing with a crisis receives greater recognition than do measures that avoid the occurrence of a crisis.

Biopharmaceutical consultant Michael Breggar argues for a shift from what he terms "reactive compliance" to "strategic quality management (SQM).” With regard to why companies delay making that transition, Breggar says, "I have never seen a quality group so proactive that it can truly act in a strategic and anticipatory manner.

"A few have managed to at least develop a proactive approach…the future is in developing, executing, and managing an approach that is risk-based and collaborative with stakeholders, with regulators, suppliers, and business partners."

We believe that adopting some version of strategic quality management is in the interest of all companies and the public as a means of proactively and creatively managing risk. To facilitate this, incentives to reduce risks should be at least as compelling as those
that now favor taking risks.

As Warren Buffet said in a recent interview, “CEOs should suffer the same as the person that is laid off four layers down the line…If you participate in an activity that places great strains on society [and disaster strikes, as CEO], you should go away ‘without much’.” Otherwise, reactive compliance will remain the path of least resistance for most companies, despite evidence that early action is good for business.

Individual decision makers may have progressed beyond reactive compliance in their thinking, but many risks are not easily compartmentalized as business or production issues. There is often a diffusion of decision-making responsibilities on matters relating to risk management, particularly within large companies, which works against change. The disconnect between production managers and those responsible for managing risks was a factor in the recent BP disaster in the Gulf.

In our experience, companies purchase products on the basis of price, comparable performance, and experiences (good or bad) with existing suppliers. Risk mitigation is not a significant consideration, despite the possibility that a problem with the supply chain could quickly translate into millions of dollars in lost revenues.

Risk cannot be completely avoided in any company. Risks and actual disasters can stimulate innovation; in the case of the cell culture media sector, the quest for animal-free media was initiated in part by risk considerations, but such innovation is more commonly sustained when it promises to reduce costs and/or increase profits rather than reduce risks. Risk is inherent in innovation that gives rise to better processes and products. The issue is whether those risks can be more effectively managed than they are in most companies at the present time.

For every disaster there are near misses that the public as well as senior management never hear about. Companies should encourage discussion (at least internally) and learn from all significant near misses rather than ignoring or covering them up. As Starbucks CEO Howard Schultz put it in a recent interview in the Harvard Business Review, “We had to own our mistakes.”

Finally, government and companies should consider providing incentives for addressing risks. The regulatory environment seems to be shifting toward stricter enforcement, which should encourage companies to move towards strategic quality management.

A positive incentive could be tax credits that partially offset the costs of suspending production to fix problems that could result in major financial losses and/or endanger the public. Individuals should be rewarded for ideas and actions that reduce risk. The recent experiences of J&J and BP ought to encourage those and other companies to become more proactive in addressing risk in the future and not wait for another disaster before taking action. How a company deals with risks is as much a reflection of the company’s culture as the quality of its products and its financial performance.


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Suresh Daniel (sdaniel@rmbio.com) is president and CEO of Rocky Mountain Biologicals, Inc. (RMBIO). Elon Gilbert, PhD., who serves on the company's board of directors, also contributed to this blog.  RMBIO is a life sciences company specializing in the manufacture of proteins for use in cell culture.