Three Resources on Product Recalls

If you're interested in the ongoing product recall issue, Jennifer Toney at Haas, who knows this material as well as anyone, recommends the following readings:

• Widmer, Lori.  “When Your Name Is at Risk" BNET Research Center.  November 2000.
• N. Craig Smith, Robert J. Thomas, and John A. Quelch.  “A Strategic Approach to Managing Product Recalls” Harvard Business Review, 1996.
• Chu, Teng-Heng, Che-Chun Lin, and Larry J. Prather.  “An Extension of Security Price Reactions Around Product Recall Announcements.”  Quarterly Journal of Business and Economics, Summer-Autumn, 2005.

There is a reasonably thorough literature around stock price reactions to product recalls, but it seems to me to mostly miss the point.  The real damage of a recall is likely to be reputational, so any impact on the stock price is going to occur over time.  I think it would be better to try and focus on the long-term valuation effects. 

Johnson & Johnson's response to the Tylenol incident (good briefing here) is regarded as the classic blueprint for how to handle a safety problem.  But not all companies do so successfully.  Perrier's leadership in the premium bottled water segment once seemed unassailable, until small amounts of benzene were found in the product, prompting the recall of 160 mm bottles.  But in both cases the ultimate impact on firm value wasn't apparent until long after the fact.

I don't know if recalls can be studied quantitatively - the big ones are rare enough that it might be better to use the case study method.  One thing that seems apparent is that each situation has its own logic.  At a minimum the analyst needs to consider:

• The direct economic impact of the recall (usually small)
• How well the recall was handled
• The completeness of the recall (is there still potentially dangerous product out there)
• The company's brand and reputation before the recall
• The company's reputational exposure (consumer-facing companies might have more sales risk)
• The initial impact of the recall on the brand
• The potential for follow-on news (reports that the company hid problems, etc.)
• The likely efficacy of the company's damage control measures

This is a probably a good example of something that can't be measured, but matters.  I doubt we'll ever have an 'R' score that quantifies the impact of lost reputation of firm value.  But analysts ignore reputational effects at their peril.