The effect of slack, diversification, and time to recall on stock market reaction to toy recalls
My team and I have just had our research accepted into the International Journal of Production Economics after several rigorous reviews and revisions – published as Wood, Wang, Olesen, and Reiners (2017). The article is titled: The effect of slack, diversification, and time to recall on stock market reaction to toy recalls
In this work, we used event study methodology, which has been used in the Operations Management literature to study demand-supply mismatches (Hendricks & Singhal, 2009), medical device recalls (Thirumalai & Sinha, 2011), product introduction delays (Hendricks & Singhal, 2008), and food recalls (Salin & Hooker, 2001) among other topics. The calculations gave us an abnormal return value for each event that we then used in a cross-sectional regression to test a series of hypotheses that relate to the operational decisions that managers can make. Specifically, we were looking at geographic and business diversification; financial, inventory, and capacity slack; how long a product is on the market for before it is recalled; and whether reactions to the recalls change appreciably over time.
Past toy recalls have led to an increase in consumer concerns while toy manufacturers and retailers increasingly outsource and create longer supply chains, making it more challenging for them to ensure toy safety. This article examines firms making toy recall announcements to assess the impact operational characteristics have on the negative stock market reaction to the announcement. 135 toy recall announcements in the U.S. from 1979 to 2016 were analyzed using event study and cross-sectional regression. While a toy recall announcement results in a negative stock market reaction, our results show that greater levels of business diversification, inventory slack, and a longer time to recall are all associated with a less negative stock market reaction. In contrast, greater capacity slack is associated with a more negative stock market reaction. We find no evidence that geographic diversification or financial slack influences the stock market reaction, nor have reactions changed appreciably over time. This article contributes to the product harm and product recall literature by focusing on these operational elements. Managers should be aware of the benefits of greater slack and business diversification while planning their business, and the impact of a longer time to recall.
Hendricks, K. B., & Singhal, V. R. (2009). Demand-supply mismatches and stock market reaction: Evidence from excess inventory announcements. Manufacturing & Service Operations Management, 11(3), 509–524. https://doi.org/10.1287/msom.1080.0237
Thirumalai, S., & Sinha, K. K. (2011). Product recalls in the medical device industry: An empirical exploration of the sources and financial consequences. Management Science, 57(2), 376–392. https://doi.org/10.1287/mnsc.1100.1267
Another fun week and we were running the Littlefield Labs simulation in two of our operations management classes. First, in the Postgraduate Diploma class on Supply Chain Management, with a focus just on management of capacity with a scenario focused on queuing and leadtimes. Second, I run a scenario with my Global Operations Management class (in the Business Masters programme), focused on capacity management and the use of appropriate contracts given operational performance. It’s a great group of talented students so I’ve given them a reasonably challenging situation to keep them busy in the session. We run the in-class session over a 120-minute team-based learning (TBL) session, giving us plenty of time to get into the simulation. All the best to the students – it should keep them busy and entertained over the session!
What is capacity? Is this important? Why would we care in our business?
Capacity – the ability to meet demand, receive guests, produce products; expressed as an amount per time period. A hotel has a certain capacity of guests they can serve each night. A manufacturing has the capacity to make a certain number of products per week.
Is this important? Yes. We need to have a good idea of our capacity for planning purposes. But – what is capacity? How easy is it to measure? If we have a small restaurant, with four tables each able to seat four individuals – will we always have 16 people sitting and buying food? No – sometimes we’ll have a couple at a table or a group of three, and we are not making full use of our capacity. If we run a production facility and a machine breaks down, capacity is ‘lost’ and unavailable.
How much capacity do we plan for? In manufacturing the question is addressed strategically, then through sales and operations planning (S&OP), then balanced in the short-term through adding staff or running extra shifts.
Service firms have a slightly more difficult job. Demand can vary significantly. How much capacity should we plan for?
Capacity costs MONEY. Is it going to be sensible for a service firm to plan capacity to meet the maximum demand? Probably not. Many service firms use some form of ‘demand management’ to influence demand patterns and ‘shift’ demand from a busy period to a quieter period (promotions, special discounts). If we planned for peak demand much of the time we have paid for capacity that will never be used. However, some service organisations may still plan to meet peak demand where there is a crucial reason to do so. Hospitals are an example; they need to be able to serve large numbers of sick or injured people during epidemics or disasters.
Excess capacity consumes resources that could be better used elsewhere in the business. Fixing suitable levels of capacity can be tricky but can provide a firm with a long-term advantage (suggesting, of course, that examination of competitor actions may also be crucial).