2009

Avoiding the High Hidden Costs of Noncompliance

EU RoHS, China RoHS, Korea RoHS, California RoHS, ELV, REACH – the list of environmental regulations for reducing hazardous substances in products keeps growing. What, exactly, are the costs if your products fail to comply? Missed customer requirements, blocked shipments, costly redesigns, and scrapped parts are just the tip of the iceberg. No doubt, the stakes are high, with potentially millions of dollars in lost revenue and related costs.

To avoid these costs, manufacturers must identify, track, and control a constantly evolving list of high-risk substances, both in their products and in their supply chain. Spreadsheets, homegrown databases, and manual processes simply can’t meet this enormous data management challenge.

When a manufacturer is compelled to preemptively remove a product from the market, potential revenue is lost. In the time it takes to introduce a new compliant product, the company may also lose market share. Even after a new replacement product is introduced, ongoing operating costs may increase, especially if the company must manage two versions of the same product – one that is compliant and one that is not. In each of these cases, no fines are levied, but the cost of noncompliance is significant.

Manufacturers, particularly those attempting to address compliance for the first time, tend to underestimate the true costs of noncompliance. As a result, compliance programs may not receive sufficient commitment from senior management. Compliance initiatives may be neglected, delayed, or if undertaken, result in inadequate solutions, which can expose the company to a significant risk.

The first step in mitigating these risks is to fully understand all the costs of failure in each of nine broad categories – costs that will be unique to your company and products.

Modeling the Failure Scenario

The total cost associated with a compliance failure can be modeled by looking at the cash flows generated by a product over its lifetime (see Figure 1). The upper curve represents the typical product cash flow. At first, cash flows are negative as the company invests in design and development. Cash flows turn positive as the product goes into production. Cash flows decline slightly as the product matures, and decline sharply when it is retired. The lower curve shows what happens when there is a compliance failure. The area between the two curves represents the total cost to the company due to this compliance failure.

The total cost of compliance failure will depend on many factors including where in the product’s lifecycle the failure occurs and what corrective action the company takes. The company may decide to simply retire the product. It may decide to halt shipment and later introduce a compliant version of the product. In some cases, the company may be forced to rework or replace units that have already been shipped. One high-tech company took this approach in 2001 after Dutch authorities determined that its product contained cadmium levels that exceeded the limits set by Dutch regulations. This particular company took action on several fronts, including reworking units in inventory and replacing units that had already shipped. At the time, the estimated total cost of the failure, including rework, was 110 million Euros in sales and 52 million Euros in profits.

Quantifying the Nine Components of Cost

There are typically nine cost components associated with an environmental compliance failure. These costs fall into three main categories: lost revenue, short-term crisis mode costs, and longterm capability building costs.

Lost Revenue

Cost #1: Lost Revenue - Short-Term. A compliance failure will likely lead to a period of time in which the product is taken off the market – perhaps several months. This means immediate, short-term lost revenue. In addition, if the product is early in its lifecycle, the window of opportunity in which the product may have 100% market share – and therefore greater pricing power and higher margins – is reduced. Cost #2: Lost Revenue – Long-Term. A late or interrupted product launch due to a compliance failure will have a longterm revenue impact as well. The total sales life of the product will be shorter. In addition, a late introduction may mean a missed opportunity to lock in buyers if there is a transition cost associated with the product. Long-term lost market share is generally never regained. Finally, a late introduction may have a lasting effect on profit margins since the delay opens the door for competitors to reduce the manufacturing learning curve ahead of the company.

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