Corporate Social Responsibility: Its Economic Impact and Link to the Bullwhip Effect

Abstract

This paper examines the economic impact of implementing Corporate Social Responsibility (CSR) in the supply chain operations of multinational corporations (MNC). Because they have global supply chains in emerging markets, MNCs face certain operational challenges. For example, unethical operations often result in a huge loss to MNCs in the long run, even though their initial cost seems to be low. In this paper, we extend the Bullwhip Effect theory in supply chain management to the ethical operations context, and define and evaluate a special Bullwhip Effect due to Unethical Operations (BEUO). Using economic data from various sources including Ford, Toyota, and GM in the auto industry, we first estimate the indices of BEUO for the three companies and demonstrate the economic necessity for MNCs to incorporate CSR with supply chain operations. We then propose a coherent approach, blending what we term the bottom-up and proactive methods, to achieve such an outcome. The bottom-up approach requires MNCs to switch their focus on stakeholders, shifting from shareholders to consumers and workers, and on decision levels from public relationships to supply chain operations. The proactive approach recommends initializing specific CSR operations to mitigate the negative impact of BEUO. Both theoretical analysis and case studies are conducted to evaluate our developed propositions that MNCs adopting the proposed CSR operations will in the long run achieve better economic performance. Recommended actions for implementation, based on best practices, are also presented.

Appendices

Appendix 1: Quantitative Model of Evaluating Profits

We developed two production functions for a profit maximizing firm.² In one case the firm makes an ethical decision, and in the other the firm will proceed with an unethical decision, holding everything else constant. Assume the unit operating cost of the firm be x with unethical operations and x (1 + α%) with ethical operations where α% is a positive constant. In addition, ethical operations may require an initial investment, whose amount we denote as B. We denote the remaining cost that is independent of the operating cost of this particular firm as M. We also denote the production quantity of the MNC per period as β and the unit price of each end product as y. Unethical operations will lead to a profit β (y – x − M) for the MNC supply chain in each period, but ethical operations will reduce the profit to β [y − x (1 + α%) − M] − B. Thus, the unethical operations are beneficial to the supply chain in a short run from a cost point of view. We assume the additional costs brought by ethical operations are shared by the whole supply chain, which represents the “best scenario” case. In reality, many MNCs actually leave the firm alone responsible for the additional cost, which further motivates the firm to adopt the unethical operations and hide such information from the MNC.

When a disruption happens due to unethical operations of the firm, a segment of consumers will be disturbed and choose not to buy the product from the MNC. We denote the percentage of this type of social awareness consumers as γ%. Meanwhile, the MNC will also have to pay additional damage costs such as product recalls, victim compensation, lawsuits, and public relations rehabilitation. We denote such a cost as N. We also model the forecast updating factor of the consumer on the MNC’s reputation as δ ⁱ⁻¹ where δ is a constant larger than 1 and i is the times of unethical violations discovered by the consumers. Thus, if an unethical violation is first known to consumers, the consumer base will reduce γ% and the damage cost is N in the first time; if the violation is repeated, the consumer base will be further reduced δ γ% and the one-time damage cost will increase to δ N. Now consider the probability between unethical operations and the disruptions. We denote this probability as ε%, which suggests that a disruption will happen in every (100/ε) time periods on average. For example, if ε% = 1 % and the time unit is day, then on average within each 100 days, one disruption will happen. The following formulations compare the cost difference between the ethical operation and the unethical operation in 3(100/ε) time periods. For simplicity, we assume the time unit is day and two disruptions happen in 3(100/ε) days: one on day (100/ε) and another on day 2(100/ε).

Total Profit of the MNC in $\frac{300}{\varepsilon }$ days:

• (A) Total Profit with unethical operations

$$\begin{aligned} TP\left( {Unethical,\,\frac{300}{\varepsilon }} \right) = & \left[ {\beta y*\frac{100}{\varepsilon }\beta y(1 - \gamma \% )*\frac{100}{\varepsilon } + \beta y(1 - \gamma \% - \delta \gamma \% )*\frac{100}{\varepsilon }} \right] \\ & - (1 + \delta )N - (x + M)y*\frac{300}{\varepsilon }. \\ \end{aligned}$$

The total profit $TP\left( {Unethical,\,\frac{300}{\varepsilon }} \right)$ has two parameters, in which “Unethical” identifies type of operations and $\frac{300}{\varepsilon }$ is days of performing the operations. TP consists of three components: $\beta y*\frac{100}{\varepsilon }\beta y(1 - \gamma \% )*\frac{100}{\varepsilon } + \beta y(1 - \delta \gamma \% )*\frac{100}{\varepsilon }$ is the total revenue in 3(100/ε) days; (1 + δ)N is the damage cost caused by two disruptions; and $(x + N)y*\frac{300}{\varepsilon }$ is the total supply chain costs in $\frac{300}{\varepsilon }$ days.

• (B) Total Profit with ethical operations

$$TP\left( {Ethical,\,\frac{300}{\varepsilon }} \right) = \beta y*\frac{300}{\varepsilon } - [x(1 + \alpha \% ) + M]y*\frac{300}{\varepsilon } - B.$$

With ethical operations, the supply chain of the MNC will avoid the two disruptions that happened in the unethical operations scenario. Thus, the total profit of the ethical operations in $\frac{300}{\varepsilon }$ days is equal to the total revenue $\beta y*\frac{300}{\varepsilon }$, minus the total cost $[x(1 + \alpha \% ) + M]y*\frac{300}{\varepsilon }$ and the initial investment B for ethical operations. Note here we imply two somehow “unrealistic” assumptions in order to simplify the model: (1) the supply chain costs of the ethical operations remain constant in time and (2) the sales of the ethical operations remain constant in time. In reality, most MNCs will enjoy decreasing costs and increasing sales simultaneously without disruptions. Therefore, formulation (B) represents the most conservative estimation for the profit of ethical operations; the actual profit could be much higher.

Appendix 2: Case Study: Ford in 2000

By 2000, a large number of rollover accidents had happened to Ford’s Explorer, a popular sport utility vehicle (SUV), which resulted in 174 deaths and over 700 injuries on US highways, and more than 40 deaths elsewhere in the world (Greenwald 2001). And the blowouts of Firestone tires mounted on the vehicles were the reasons for these accidents. Bridgestone/Firestone recalled 6.5 million tires in August, 2000, and Ford recalled 13 million Firestone tires that had been installed on Ford Explorers and pickup trucks in May 2001. The business relationship of the two companies was also broken soon after, and both companies blamed the other for the wrongdoing. Salsbury and Davis (2003) wrote a comprehensive case on the quality problems at Ford and Firestone, which clearly demonstrated how “the different quality problems accumulate overtime and across organizational boundaries, to the point where there are major consequences for all the parties that are involved.”

Facing the quality problems, both Ford and Firestone made unethical decisions in various operation areas. In automobile design and manufacturing, Ford decided to use the suspension system that was known to be defective on the Explorer because it allowed Ford to manufacture its new SUV on existing assembly lines. The Explorer prototype demonstrated a rollover response with such a suspension system. Instead of changing the design, however, Ford decided to lower the recommended tire pressure to help the vehicle pass rollover tests. On tire design and manufacturing, Firestone decided not to install a nylon cap that makes the tire robust in order to reduce the cost, while the cost to include the cap can range from pennies to as much as $1.00 per tire. Meanwhile, Bridgestone/Firestone didn’t put enough effort in educating the consumer on the importance of maintaining proper tire maintenance and safety until 2001 when, after the tire recall, the company agreed to fund a $5 million consumer educational campaign to do it. In supply chain management, the two companies lacked effective communications and mutual trust, even though they had been partners for nearly 100 years, which led to slow responses to consumer complaints and problem solving.

The financial impact of the recall was significant for both Ford and Bridgestone/Firestone. The latter suffered a $510 million loss in 2000 and $200 million in 2001. The company’s net profit was 80 % lower in 2000 than in the previous year and its tire sales dropped 40 % in January 2001. Meanwhile, Ford incurred $550 million in the 2000 recall and $3 billion in the 2001 recall.

If Bridgestone/Firestone had chosen to install the nylon cap on the tire and educate the consumer properly, the recalls in 2000 and 2001 would probably have been avoided. Each cap costs $1.00 per tire (Healey and Nathan 2000). The total cost for installing the cap on all recalled tires would be $19.5 million. This cost plus the $5 million education fund would have required $24.5 million of direct total costs by 2001 for ethical operations. The direct total cost by 2001 for unethical operations would have been $4,260 million, which includes $710 million from Bridgestone/Firestone and $3,550 million from Ford.

Appendix 3: Case Study: Toyota in 2009

In 2010, Toyota stated that massive recalls of 8.1 million vehicles due to gas pedal problems estimated costs of $2 billion in repairs and lost revenue. The recall cost estimates do not include any expenses or lost sales (Valdes-Dapena 2010). In March 2014, ABC reporters noted that Toyota agreed to pay $1.2 billion to avoid prosecution for covering up the severe safety problems of unintended acceleration. And the court documents showed that Toyota made cars with parts that the FBI said were known to the company to be “deadly.” Toyota “admitted” that it “misled U.S. consumers by concealing and making deceptive statements about two safety-related issues affecting its vehicles, each of which caused a type of unintended acceleration.” And according to FBI Assistant Director George Venizelos, Toyota “put sales over safety and profit over principle.”

In 2002, when Lexus ES cars were on showroom floors, the company’s US engineers sent a test report to Toyota’s leadership stating the luxury sedan shifted gears so roughly that it was “not acceptable for production.” The warning was also reported to a Toyota executive vice president in Japan, who stated that despite misgivings among US officials, Lexus was “marginally acceptable for production.”

Other studies (i.e., Finch 2010; Cole 2011) have provided detailed explanations of Toyota’s recall history. Finch stated that “Toyota has avoided the’root cause’ of sudden acceleration defects because it will be very expensive to fix.” Bowen and Kennedy (2010) discuss in detail the total costs of the recall. Therefore, if Toyota would have taken the results of the test that concluded “not acceptable for production” by engineers seriously, and identified the problem and fixed it in 2001, the total direct cost would have been about $100 per vehicle. Of course, in 2001 significantly fewer defective automobiles would have been sold. The total direct cost for fixing the defective sudden acceleration for 8.1 million cars in 2010 would have been $810 million. The most conservative estimate for fixing these vehicles is $2 billion, which is the total direct cost for the unethical operational decision. And of course there are significant indirect costs to its reputation that are not easy to calculate.

Appendix 4: Case Study: GM in 2014

GM noticed the ignition switch problem in some of its car models as early as 2003. To fix the problem, the company needed to recall these defective cars, which might cost the company 57 cents per car—or about $100 million in total if the recall happened in 2007 (Krisher and Durbin 2014). An engineering manager at GM rejected the fix proposal because it was “too expensive and would take too long” (Higgins 2014). Instead, in 2006, the manager approved a plan proposed by Delphi, the company that makes the switch, for a redesigned ignition switch, but did not create a new part number for this change. “Changing the fit, form or function of a part without making a part number change is a cardinal sin,” as an expert asserted, because it caused years of delay in tracing the defect on GM’s cars (Colias and Bunkley 2014). The design change had been unnoticed until April 2013 when an outside expert hired by GM finally figured out the problem.

When the ignition switch problem was found in 2006, GM could have made an ethical decision by acknowledging the problem and recalling all defective cars. The direct total cost of the ethical decision would have been at most $100 million. Unfortunately, GM chose to follow an unethical decision-making track, which was to hide the information and quietly make corrective modifications to their defective products. Such a decision exacerbated instead of fixed the problem and led to the mass recalls in 2014 and at least $1.2 billion in total direct cost.