First it was E. coli in spinach, then Salmonella in peanut butter, then melamine in pet food. When quality controls in the food supply chain break down, the results can be deadly. The risks dwarf anything faced by makers of khakis, couches, or most other consumer goods. The human cost is incalculable; the financial consequences just keep multiplying. They include not only the immediate cost of recalling tainted product, but also the future cost of damage to the company’s brand and reputation, and loss of future sales.

In 1990, for example, the makers of Perrier mineral water had to pull that product off store shelves after it became contaminated with benzene, a carcinogenic chemical. The recall cost its manufacturer about $200 million, but the subsequent hit to revenues as customers fled the brand was far more expensive. Sales of Perrier, which had peaked at nearly $110 million in 1989, slid to $32 million by 1995 and are only now, under the guidance of $69.2 billion Swiss food giant Nestlé SA, which acquired the brand in 1992, approaching their previous record.

Fall Out from Free Trade?

The challenge of keeping food safe has become more daunting, in part due to global sourcing, which has fueled consumer expectation of cheap produce all year round. “We’ve become a society that expects to be able to have the same meats and fruits and vegetables in our grocery stores 24/7, 12 months a year,” observes attorney William Marler of Marler Clark LLP, a Seattle law firm that specializes in representing food-poisoning victims. “We’re not inclined to think of anything as seasonal anymore. That means you have to get stuff outside the United States, and that means a longer supply chain.”

While Marler points out that most cases of food-borne illness today can’t be linked to foreign-grown products, he suspects that supply-chain risks will increase as food imports continue to rise. The U.S. Department of Agriculture forecasts that the United States will import a record $70 billion of agricultural products in the fiscal year ending this September, up from $64 billion in fiscal 2006 and $41 billion as recently as fiscal 2002. By 2012, the DoA predicts, imports could reach $81.6 billion.

The most recent high-profile food scare, of course, originated offshore. Canada’s Menu Foods Corp., a $316 million producer of pet foods for other companies, including Procter & Gamble, was forced to recall more than 100 brands of dog and cat foods this year after they were found to contain melamine, an industrial chemical suspected of causing kidney and liver failure. The melamine was traced to wheat gluten the company had bought from a U.S. supplier who, in turn, had sourced it from China. (Chinese producers added the chemical to gluten to artificially boost protein levels.) Wheat gluten is a component of many processed foods as well as feed for chickens and hogs. Although the United States produces a major share of the world’s wheat, about 70 percent of wheat gluten is imported because producers can buy it cheaper overseas.

The pet-food incident has put the entire food industry on notice. “Gluten is in a lot of different products and raw materials in the food industry,” notes Rick Puckett, executive vice president, CFO, and treasurer of $730 million snack-food manufacturer Lance Inc. The Charlotte, North Carolina, company acted quickly to verify that it hadn’t received any contaminated gluten.

So did McCormick & Co., in Sparks, Maryland. “Whenever an event like that happens,” says Roger Lawrence, vice president of corporate quality, assurance, and regulatory affairs for the $2.7 billion spice company, “even if it’s not really related to our business, we immediately take a look to see if even in the remotest sense we could be vulnerable, and what we could do right now proactively.” For example, when ConAgra recalled its Peter Pan peanut butter because of Salmonella contamination, and it appeared the problem might be environmental, McCormick went so far as to reevaluate its environmental monitoring program to verify that it wasn’t at risk.

Who Checks the Food?

The U.S. government is supposed to monitor the safety of the food supply. The USDA’s Food and Safety Inspection Service inspects and regulates meat, poultry, and eggs, and is responsible for issuing or overseeing recalls of those products. “We have full-time USDA inspectors in both our plants all the time,” notes Harold Boone, CFO of $180 million Odom’s Tennessee Pride Sausage Inc., in Nashville. Among other things, he says, they ensure the plants are adhering to their written safety procedures.

The Food and Drug Administration regulates all other foodstuffs, including feed for pets and farm animals. In response to the gluten scandal, the FDA is appointing a food-safety czar. But as a practical matter, the FDA can inspect only a small fraction of all food imports — about 1.3 percent of the total last year. In fact, a recent analysis by the Associated Press found that between 2003 and 2006, the number of food-safety inspections conducted by the FDA declined by 47 percent, which academics and other industry observers blame on underfunding.

That puts the bulk of the safety burden back on industry. In addition to adhering to best-practice safety procedures, attorney Marler recommends that food companies sign indemnity agreements with their vendors and make certain those vendors are well insured. “You may still get whacked in the media and in sales,” he says, “but ultimately you can push the cost of litigation and settlements and judgments off on someone else.”

Of course, as supply chains stretch around the world and into countries where food safety doesn’t always get the same respect it does in the United States, the value of such agreements is wholly dependent on the strength of the counterparty. “If you want to make it work, you have to have not only indemnity agreements with parties that have sufficient assets or insurance to cover a loss, but, depending on what you’re buying, you may also want to actually go out and do your own auditing,” Marler says.

Ultimately, then, prevention is still the best medicine. “The key thing for food companies is to test, test, test,” says Alan Schoem, senior vice president for the global product risk practice at Marsh Inc., a risk and insurance services firm, and a former director of compliance for the U.S. Consumer Product Safety Commission. “You have to know your suppliers, you have to know that what you intended to get from them you are getting, and you have to be particularly vigilant when sourcing from Asia.”

Procter & Gamble, the $68.2 billion consumer-products company ensnared in the recent pet-food recalls, is no longer allowing suppliers to obtain raw ingredients from new sources unless P&G has first vetted them. ConAgra Foods has not only embarked on an upgrade to its Sylvester, Georgia, peanut butter plant, but also has filled a new vice president of global food safety position and is putting together a Food Safety Advisory Committee composed of leading third-party food-safety experts.

ConAgra executive vice president and CFO André Hawaux says that in the past, food safety was the responsibility of a ConAgra director reporting to a vice president. He said Paul Hall, the new vice president of global food safety, will report to a senior vice president. Hall, he says, “will be responsible for bringing additional focus and leadership to developing and implementing programs that continuously improve product safety and design.” ConAgra said its Food Safety Advisory Committee will provide guidance to the company as part of its ongoing work with government agencies, research institutions, and scientists, and assist the company in its plans to fund basic research involving the detection, control, and elimination of food-borne pathogens.

Given the potential risk to their income statements, their reputations, and, ultimately, their customers’ lives, food manufacturers have no other responsible choice.

Randy Myers is a contributing editor of CFO.

It’s What’s Inside that Counts

The flood of recent food-poisoning cases costs consumers and companies.

PET FOOD. In March, Menu Foods Corp., a Canadian manufacturer of pet foods sold by other companies under their own brand names, began recalling pet foods contaminated with melamine, later traced to wheat gluten imported from China. A mid-April poll of dog and cat owners by USA Today/Gallup found that 17 percent had changed what they were feeding their pets as a result of the recall.

PEANUT BUTTER. On February 14, the U.S. government announced there had been 290 cases of Salmonella poisoning in 39 states linked to consumption of Peter Pan and Great Value brand peanut butters made by ConAgra Foods, leading to a recall of those products. ConAgra, which promised to make significant changes to its manufacturing environment, estimated that the recall will cost approximately $50 million to $60 million.

SPINACH. An outbreak of E. coli poisoning last fall linked to bags of spinach sold by $5.9 billion Dole Food Co. resulted in 205 confirmed illnesses and three deaths. In its annual 10-K report for 2006, Dole said the E. coli matter did not have a “significant impact” on its 2006 financial results, but since the spinach recall, sales of its packaged salads have declined 10 percent.

LETTUCE. According to Yum Brands Inc.’s earnings release dated May 1, 2007, its U.S. operating profit declined 11 percent in 2006 due primarily to the performance of its Taco Bell restaurants. They were negatively affected by an E. coli outbreak that was ultimately traced to tainted lettuce, and by publicity around a rodent infestation at a Taco Bell in New York City. In its first-quarter earnings report, Yum said same-store sales at all of its U.S. restaurants, including Taco Bell, KFC, Pizza Hut, and Long John Silver’s, fell 6 percent, with Taco Bell the chief culprit. Yum also said it is now requiring, among other things, that its suppliers test lettuce at the farm where it is grown. — R.M.

A Better Burger Industry

Scared Straight

Seattle attorney William Marler earns his living suing food producers and restaurants suspected of selling contaminated food. In 1995, he won a $15.6 million settlement on behalf of Brianne Kiner, who suffered severe E. coli–related health problems after eating an undercooked hamburger from a Jack in the Box restaurant. Lately, though, he’s not earning much money on the back of the burger trade, and for that he credits the meat-packing industry for embracing end-product testing of its products for pathogens, partly in response to customer demand.

“From 1993 to 2002, 95 percent of my revenues came from cases involving E. coli tied to hamburger,” Marler says. “That has dried up to nearly zero since 2003. Once producers started testing and getting a lot of positives, they began looking at their procedures and processes to figure out how to eliminate the contamination. The fact that they were able to eliminate it to such a degree has put me out of the hamburger business, and I’m happy about that, candidly. I never thought I would say this, but I think the food industry across the board needs to take a really hard look at what the hamburger industry has done.”

Dexter Manning, national food and beverage practice leader for accounting and consulting firm Grant Thornton, says much of the industry is already moving in that direction. “The government continually comes out with new recommendations and rules for food safety, but nothing as stringent as what companies themselves are doing,” he says. “They’re doing audits and bringing in consultants. Nobody wants an E. coli scare, and nobody wants people to get Salmonella.” — R.M.

The Spice Trade

How McCormick Manages a Global Supply Chain

While most food company supply chains are still relatively short — the less distance perishable goods have to travel, the better — the supply chain for Sparks, Maryland-based McCormick & Co., the world’s largest spice company, spans the globe several times over. McCormick buyers trek to Uganda and Madagascar for vanilla, to China and Nigeria for ginger, to Yugoslavia and Albania for sage, and to India, Turkey, Pakistan, and Syria for cumin seed.

To keep that vast supply chain an asset rather than a liability, McCormick goes to great lengths to ensure the quality and safety of its products, from source to sale. “It is of paramount importance to us,” says Francis Contino, McCormick’s CFO and executive vice president for strategic planning. “We’ve been doing it for over 100 years, and we like to think we do it better than anyone else in the world.”

Although not dissatisfied with its existing safety processes — the company developed a comprehensive sourcing program with extensive quality-assurance components 25 years ago — McCormick nonetheless undertook a major enterprise risk management (ERM) review of its policies and practices last year. “We didn’t have any great ‘ah-ha’ moments,” he recalls, “but we did find great value in engaging the top 10 people in our leadership team and then extending that down to another 40 or 50 people. It spread the awareness of how important their jobs are to the greatest risk the company has, which is damage to the brand.”

While most of the herbs and spices McCormick imports are dry, and consequently not subject to the same array of risks inherent in perishable poultry, meats, or vegetables, the company nonetheless maintains rigorous safety controls. It prescribes microbiological testing programs for its suppliers and requires that they provide a certificate of analysis with each of their shipments. It also does its own redundant testing on many incoming goods, and subjects some that are more susceptible to possible contamination to a steam sterilization process. Since the terror attacks of September 11, 2001, the company has also beefed up physical security at its facilities and incorporated more security issues into its vendor-certification program. Meanwhile, two of its employees spend the year auditing suppliers around the world.

Although the company keeps an eye on costs associated with its safety protocols, Contino says safety projects aren’t always required to meet the same return-on-investment hurdles that other capital projects must satisfy. “When we undertook our ERM initiative last year, for example, we did not do our typical investment analysis for ROI. It was just a governance requirement, and it was clear to us that we had to do it,” he says. “I wouldn’t say we don’t care what it costs, but in some ways that’s true.” — R.M.