Question

FDA Liability Concerns (a GVV case) Gregory and Alex started a small business based on a secret-recipe salad dressing that got rave reviews. Gregory runs the business end and makes all final operational decisions. Alex runs the creative side of the business. Alex’s salad dressing was a jalapeno vinaigrette that went great with barbeque or burgers. He got so many requests for the recipe and a local restaurant asked to use it as the house special, that Alex decided to bottle and market the dressing to the big box stores. Whole Foods and Trader Joe’s carried the dressing; sales were increasing every month. As the business grew, Gregory and Alex hired Michael, a college friend and CPA, to be the CFO of the company. Michael’s first suggestion was to do a five-year strategic plan with expanding product lines and taking the company public or selling it within five to seven years. Gregory and Alex weren’t sure about wanting to go public and losing control, but expanding the product lines was appealing. Michael also wanted to contain costs and increase profit margins.

At Alex’s insistence, they called a meeting with Michael to discuss his plans. “Michael, we hired you to take care of the accounting and the financial details,” Alex said. “We don’t understand profit margins. On containing costs, the best ingredients must be used to ensure the quality of the dressing. We must meet all FDA requirements for food safety and containment of food borne bacteria, such as listeria or e coli, as you develop cost systems.” “Of course,” Michael responded. “I will put processes in place to meet the FDA requirements.” At the next quarterly meeting of the officers, Alex wanted an update on the FDA processes and the latest inspection. He was concerned whether Michael understood the importance of full compliance. “Michael,” Alex said, “the FDA inspector and I had a discussion while he was here. He wanted to make sure I understood the processes and the liabilities of the company if foodborne bacteria are traced to our products. Are we doing everything by the book and reserving some liabilities for any future recalls?” Michael assured Alex and Gregory that everything was being done by the book and the accounting was following standard practices. Over the next 18 months, the FDA inspectors came and Michael reported everything was fine. After the next inspection, there was some listeria found in the product. The FDA insisted on a recall of batch 57839. Alex wanted to recall all the product to make sure that all batches were safe. “A total recall is too expensive and would mean that the product could be off the shelves for three to four weeks. It would be hard to regain our shelf advantage and we would lose market share,” Michael explained. Alex seemed irritated and turned to Gregory for support, but he was silent. He then walked over to where Michael was sitting and said, “Michael, nothing is more important than our reputation. Our promise and mission is to provide great-tasting dressing made with the freshest, best, organic products. A total recall will show that we stand by our mission and promise. I know we would have some losses, but don’t we have a liability reserve for recall, like a warranty reserve?” “The reserve will not cover the entire expense of a recall,” Michael said. “It will be too expensive to do a total recall and will cause a huge loss for the quarter. In the next six months, we will need to renew a bank loan; a loss will hurt our renewal loan rate and terms. You know I have been working to get the company primed to go public as well.” Alex offered that he didn’t care about going public. He didn’t start the business to be profitable. Gregory, on the other hand, indicated he thought going public was a great idea and would provide needed funds on a continuous basis. Alex told Michael that he needed to see all the FDA inspection reports. He asked, “What is the FDA requiring to be done to address the issue of listeria?” “I’m handling it, Alex,” Michael said. “Don’t worry about it. Just keep making new salad dressings so that we can stay competitive.” “Well, Michael, just answer what the FDA is asking for.” “Just to sterilize some of our equipment, but it shouldn’t be too bad.” “Michael, it’s more than that,” Alex responded. “The FDA contacted me directly and asked me to meet with them in three days to discuss our plans to meet the FDA requirements and standards. We will be fined for not addressing issues found in prior inspections. I want to see the past inspection reports so I can better understand the scope of the problem.” “Listen, Alex,” Michael said. “I just completed a cost–benefit analysis of fixing all the problems identified by the FDA and found the costs outweighed the benefits. We’re better off paying whatever fines they impose and move on.” “Michael, I don’t care about cost–benefit analysis. I care about my reputation and that of the company. Bring me all the inspection reports tomorrow.” The three of them met the following day. As Alex reviewed the past inspection reports, he realized that he had relied on Michael too much and his assurances that all was well with the FDA. In fact, the FDA had repeatedly noted that more sterilization of the equipment was needed and that storage of the products and ingredients needed additional care. Alex began to wonder whether Michael should stay on with the company. He also was concernedabout the fact that Gregory had been largely silent during the discussions. He wondered whether Gregory was putting profits ahead of safety and the reputation of the company. Questions Alex knows what the right thing to do is. As Alex prepares for a meeting on the inspection reports the next day, he focuses on influencing the positions of Michael and Gregory, both of whom will be involved in the meeting. Put yourself in Alex’s position and answer the following questions.

1. What are the main arguments you are trying to counter? That is, what are the reasons and rationalizations you need to address?

2. What is at stake for the key parties, including those who disagree with you?

3. What levers can you use to influence those who disagree with you?

4. What is your most powerful and persuasive response to the reasons and rationalizations you need to address? To whom should the argument be made? When and in what context?

Answer 1

1. The main reasons and rationsalizations that I (as Alex) needs to address are:

(a) Company reputation - The cost of losing the brand reputation needs to be considered which Michael (CFO) is not taking into consideration. Cost benefit analysis takes into consideration only the monetary impact but not the cost of dent on the intangibles such as company goodwill, brand loyalty, etc.

(b) It might be rationale to meet the FDA requirements and pay all penalties rather than the total recall of the product from the market. They may lose the current shelf space as well.

(c) Total recall can also affect the future credibility of the comany in order to get loans and cxan also impact the share prices when the company goes public.

(d) Due to repetitive notifications from FDA, they need to consider the option of total recall as FDA might take more aggressive steps againt the company which might ind up in closure of business.

(e) Hiding of important discussions/documentation of the FDA with Gregory and me(Alex) to be discussed as a huge issue.

2. Key parties at stake are:

Alex(me) - The whole business idea of salad dressing is at stake along with the reputation and maintaining the quality standards. Cost-benefit analysis is the least priority for now as the continuation of the business itself is at stake.

Gregory - He is not proving to be a good owner of the company and have lost its interest as he is being silent and not supporting any of the other stakeholders.

Michael - His job can be at stake due to such unethical practice and not working towards the goal of maximising the wealth of the owners. He might want to make the company pulic and get out of it as early as possible.

Company - The reputation of the company is at stake due to selling unhealthy products in the market and can end up losing the goodwill of the businees and loyalty of customers. It can become difficult for the company to raise funds and the IPO will be adversely effected.

FDA - It can impose heavy penalties on the company and can even close the business due to repeated notices.

Customers - With the consumption of unhealthy product, the consumers might get sick and get hospitalised.

Employees - The employees of the company might lose jobs to be stoppage/reduction in market demand.

3.

• The ethical principle of running the business and well being of the society are the most important levers to influence Gregory and Michael.
• Using the cost benefit analysing and treating the total recall as a one-time expense. This will help them keep the brand loyalty and keeping the customer base.
• Also, the company is going public, so, any IPO (Initial Public Offer) may require the FDA requirements to be published. So, any negative FDA comments and no actions taken on them can prove to be very costly i.e. the share prices will be effected and there may not be full subscription as well at the time of IPO.
• In the long-run, the running/existence of the business can be at risk.
• Michael can also be terminated from the company due to misconduct and will impact his reputation in the market. It might get difficult for him to get new job at least in the current industry.

4. Gregory may want to get out of business as mentioned in question 2. The most powerful and persuasive resposnse can be refered to Gregory. I (Alex), who is most attached to the business and giving out quality product to the society, can ask Gregory to not keep silent on what is happening in the business and remind the fact that they both started the business with a clear set of objectives. The objective of providing the best quality product to the customers and not striving for the profits only needs to be given top priority. He needs to understand that even if they make payments of all penalties levied by FDA, the reputaion of the company will be lost. Also, if the total recall is done, the customer base might not be lost as they will think that the company is doing good for maintaining the high standards of quality which they have been doing in the past.