Justification for an Internal Control

Justification for an Internal Control System

To the CEO of the Crafty Foods Company:

Re: internal vs. external controls

A recent spate of recalls in the food industry has caused many corporations to be on edge regarding the potential financial losses that could incur if a product is found to be contaminated. Our company is well-known for its sound external controls regarding risk mitigation. For example, we are insured against potential losses of shipments due to unforeseen weather circumstances, including the events transpiring in the gulf. We also adopt a so-called 'portfolio' based strategy of risk management. Regarding our popular Kids Chicken Nuggets, we use multiple suppliers of poultry to ensure that if one source is deemed unsafe, dramatically increases in price, or becomes unavailable, we will still have access to the needed input materials of white chicken meat.

However, the problem with any external approach of risk management is that it assumes that things will go wrong, and merely provides a way of mitigating the risk, rather than avoiding risks altogether. Regarding insurance, quite often even a strong insurance policy such as ours will not provide enough money to pay for the losses after a disaster. And not all potential hazards are covered by insurance policies. For example, a house insured for fire and flood damage might be hit by golf ball-sized hail during a freak storm. Using salmonella-tainted peanut butter by accident could result in a costly lawsuit and if our workers are found to have deviated from standard operating procedures, insurance many not cover the damages we have to pay. Or a worker might be injured in one of our processing plants in a manner also not covered by our standard insurance policies. Moreover, even if insurance does cover some of the losses, there are other, intangible losses that cannot be easily quantified. The loss of public trust and goodwill can impact sales in a devastating manner, and have repercussions for decades. Better for such events not to happen at all, than to take comfort in insurance coverage.

An instructive example of the loss -- and regaining -- of positive PR can be seen in such examples as the Mars Corporation, which immediately embarked upon a risk avoidance strategy by doing away with its red-colored chocolate M&Ms in the 1970s, until an acceptable and safe alternative could be derived. The hassle of proving that the dye might be safe was simply too costly and too much of a headache. Forecasting and planning for risk is the best way to avoid losses, rather than passively accepting the inevitability of such losses in the 'insurance' mindset. For example, when a corporation has 'the' hot new toy at Christmastime, rather than assuming the toy will always be as popular, it often creates artificial scarcity before the holidays, and then afterwards it plans a new type of publicity campaign to continue to sell the toy at robust levels, but without expecting the same level of buying frenzy will continue into the next year. Planning for the future is the best way to guard against losses and bad decisions.

Mitigating risk by 'spreading' risk around is also problematic as a strategy, because it can simply result in embarking upon more risky ventures in a half-hearted way, and dilute rather than avoid risk. For example, regarding our line of chicken nuggets, what if consumer demand begins to suddenly abate because of the health concerns about processed poultry-based fried nuggets? Having alternative suppliers will not guard against this type or risk. Continually monitoring market trends is a better way to anticipate the possibility that vegetable-based or baked nuggets might rise in popularity. Secondly, having alternative sources, in case one supplier is found to be contaminated, will not solve the problem of the consumer fears that might occur if our product line is found to be tainted. All of our products might suffer losses. Better to have strict monitoring of quality, than try to use many suppliers in the hope that only a few will provide a tainted product.