The Economics of Non-Compliance in Food Industry

Authors:
  1. Muhammad Salman Chukkan, Technical Officer, FSSAI-Ahmedabad
  2. Jibin Balu M T, Technical Officer, FSSAI-Ahmedabad
  3. Rushda Hussain, R&D Executive (Ready To Drink), Tata Consumer Product Limited, Bangalore.

Non-Compliance can be defined as the intentional or unintentional gesture of disregarding the Act, Rules, Regulation or any advisories from a competent authority or Government who acts as the watchdog of a particular Industry or Sector. All the sets of Act, Rules or Regulations are essentially developed to protect the interest of a nation, its citizens and other businesses. The true cost of Non-Compliance will be discussed in this article.

Non-Compliance happens in businesses because of various factors, like inadequacy of money, interest, knowledge, time etc. Based on the differences in factors, the business with non-compliances can be classified into three types, i.e ‘Amoral Calculators’, ‘Political Citizen’ & ‘Organizational Incompetence’ as described by Kagan & Scholtz in the article ‘The Criminology of the Corporation and Regulatory Enforcement Strategies’. All three types of businesses are well available in the Indian scenario.

  1. Amoral Calculator: A business entirely looking for profits, even when it is functioning on an evident non-compliance. Such kind of businesses considers the cost of compliance as a waste of money. For example, A Packaged Drinking Water is sold in the market without a valid BIS License.
  2. Political Citizen:  These are the group of businesses that evades compliance with connections and networks in higher authorities. For example, Businesses that completely rely on malignant practices like bribery.
  3. Organizational Incompetency: These types of businesses are incompetent to understand and implement any aspects of Act, Regulations, Rules etc. For example Businesses without technically qualified personnel to support the organization in terms of regulatory aspects.

To understand the true meaning of Cost of Non-Compliance (CNC), one should understand what is the Cost of Compliance (CoC). CoC is the total cost incurred by a firm to adhere to be compliant with all requirements which are mandated by a government or an authority. The components of CoC are Initial Compliance Cost, Cost of Maintenance, and Cost of Conformance..


TermDefinition
Initial Compliance CostThis is the cost incurred to set a compliance ecosystem in the firm. This cost includes the cost of expertise, training etc.
Cost of MaintenanceThis is the cost incurred to sustain the existing compliance requirements. This cost includes Annual License fees, Testing fees etc.
Cost of ConformanceThis is the cost incurred to adjust with the upcoming regulations or trends.
Table 1: Components of Cost of Compliance

Cost of Compliance = Initial Compliance Cost + Maintenance Cost + Conformance Cost

Cost of Non-Compliance is the total cost incurred by disregarding the Act or Regulations or Rules set up by the government or an authority in-charge.CNC is often mistaken by businesses as the cost incurred for fines or penalties. But CNC is much more than just fines/penalty. It is worthy to note that CNC has an Iceberg effect, which means that the fines & penalties are just the visible cost. There are other hidden costs which account to 86.66 % of CNC. It is a harsh irony that no one accounts for this hidden cost.

If a non-compliance delivers an unsafe item (food) into the market, the food is supposed to be recalled. As per the study conducted by the Food Marketing Institute and the Grocery Manufacturers Association (GMA) in the US, the direct cost of food recall is 10 Million USD. This cost is also not being considered by businesses.

Iceberg Effect of Cost of Non Compliance (Source:Swissre.com)
Hidden CostExplained
Business disruptionThis is the cost incurred due to the stoppage of business due to the action taken by the authority. This is generally 33.34% of the CNC.
Revenue LossThis is the cost incurred due to the loss in sales due to the regulatory action taken by the authority. This is generally 26.67% of the CNC.
Productivity LossThis is the cost incurred due to non-usage of Machinery, Human resources, Raw Materials and Packaging materials.This generally takes upto around 24.67% of the CNC.
Reputational DamageThis is the cost incurred due to the loss in the brand image in the public. The extent of damage in brand image will depend on the non-compliance. As per the recent study conducted by Deloitte, it was found that 87% of the executives in industries consider non-compliance to tarnish the brand image.
Table: Hidden cost of Non Compliance explained
Understanding Costs of Non-Compliance and Compliance (Source:https://www.spectroscopyonline.com/)

Above figure is a great tool to understand the CNC and the risk associated with it. The left hand axis is CNC and the right hand axis is CoC. From the figure it is much evident that CNC is way higher than CoC. This figure also suggests that when compliance is in place the cost gets reduced drastically in logarithmic fashion. Thus it is pretty evident that complying at first place is better than non-compliance.

Case Study:

Let’s say there is a firm XZY, which manufactures Packaged Drinking Water.  The firm is publicly listed in the stock market. It is also to be noted that the firm is having an extensive supply chain from Kashmir to Kanyakumari and Gujarat to Mizoram.

 As per the FSS(Food Products Standards and Food Additives) Regulation, 2011 and Food Safety and Standards (Prohibition and Restriction of Sales) Regulation, 2011, Packaged Drinking Water should not be sold without a BIS License and the water shall be complying with the IS 14543 Standards. Suppose, the firm has not renewed the BIS License and the product is also not complying with the required standard. The label has the following claims as ‘This water originates from foothills of Mountain X and it can cure Cancer’. One day, a consumer died after consuming Packaged Drinking Water of firm XZY. The Food Safety Department took the sample and sent it for analysis. It was found that the sample contained E coli O:157 in it. Also, there are violations as per Food Safety and Standards (Labeling and Display) Regulations, 2020 and Legal Meterology (Packaged Commodities) Rules. This means that the firm is in complete turmoil.

Now let’s work out the CoC and CNC.

Cost of Compliance
SI.NoParticularsCost associated
1BIS Renewal Fee0.2 Lakh
2Testing and TrainingFees10 Lakhs
3Preventive Maintenance1 Lakh
4Cost of Conformance10 Lakhs
5Calibration charges1 Lakh
6Initial Compliance Cost35 Lakhs
7Miscellaneous Costs10 Lakhs
8Cost of Maintenance10 Lakhs
9Expertise Cost10 Lakhs
Total           Assumed as 1 Cr
Table : Cost of Compliance as per the case study
Cost of Non Compliance
ParticularsCost associated 
Compensation to the Kins of dead person    6.6 CR 
Penalty 
Fees for legal experts 
Recall5 Cr 
Business Disruption17 Cr 
Revenue Loss13 Cr 
Productivity Loss12 Cr 
Total53.6 Crores
Table: Cost of Non-Compliance as per the case study

The case study is just a vague calculation of CoC and CNC. This exercise suggests that the CNC is approximately 50 times the CoC. So, for a Food Business Operator, it is a wiser approach to comply with all the regulations governed by the Food Authority. This also suggests that Non-Compliance can be particularly deadly for MSME sector than the large conglomerate firms- as large firms have the financial as well as other resources to deal with such kind of issues.

            It is important to note that consumer awareness is a prime focus area of all regulatory bodies as consumers play an important role in the Food Safety Ecosystem. In order to achieve more participation from consumers, various regulatory bodies have introduced campaigns, mobile applications, toll-free numbers etc. In a 2018 study by Gomathi et al, it was found that there has been an increase in the level of awareness among consumers for prepacked food products. It is also important to notice that regulatory enforcement is increasing year by year. For instance; there has been a 78% increase in the penalty imposed by FSSAI in the year 2019-20 when compared to the year 2018-19.

To reiterate the popular adage by the Dutch Philosopher Desiderius Erasmus i.e, ‘Prevention is better than cure’; adequate sensitization of FBOs which subsequently inculcates a conscious and continous practise of complying with all the requisites at the first hand is the right way forward to minimise occurrence of non-compliances rather than controlling the damage incurred. Thus, complying with requirements is the wiser decision to save from closedown of the business.

(Note: All the calculations are based on the data available on the internet with respect to the food and allied industries in the developed economies, this data may not truly represent to the Indian scenario. This case study is fictitious, any resemblences to an incident is purely coincidental and meant for educational purpose only. It is also to be noted that this is not detailed academic work.)

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