02/21/2013 07:13 pm ET | Updated Apr 23, 2013

The Horse-burger Debacle: No Pain, No Gain for Tesco

The recent scandal with Tesco's burgers has reignited a discussion about who, along the value chain, should bear the brunt of responsibility for a product. Much has been said about the moral dimension; there's been quite a bit of discussion about the legal issues of liabilities and representations; but much less has been said about the underlying strategic issues, where the burden of the certification and the liability that comes with it is a major blessing in disguise.

We live in a world of complicated, global value chains, with a myriad of participants in increasingly interdependent ecosystems. Simple, vertically integrated structures, responsible for all parts of the value chain are becoming a thing of the past. For more and more products -- from simple ones like a cup of coffee to complex devices like smartphones and tablets -- you find a bewildering plethora of firms (let's call them ecosystem participants) coming together to give something to the final customer.

In these complicated ecosystems the question of who guarantees quality is absolutely pivotal. And, interestingly, it isn't determined by fate or technology alone. Let's take a simple product -- wine -- and consider who guarantees quality. For a good bottle of Bordeaux, what name would you think of? Perhaps Château Margaux, Petrus, or Lafite-Rothschild. For Port, the names might include Churchill, Warre, Sandeman, Taylor. Odd, isn't it? For Bordeaux it's French, yet for Portuguese Port, the names are English... Why so? It's a fascinating story. It turns out that in Port, the quality is certified by shippers -- who often don't own any of the vineyards. In Bordeaux, it's the producers. In the Cotes-du-Rhone area, it's the commerçants -- those who buy and oversee vinification. And, increasingly, supermarkets, further down the distribution chain, are also starting to be seen as guarantors of quality .

The question of who certifies quality is closely associated with the question of which part of the value chain becomes the most sticky, the most valuable, the most relevant for the ability to capture value. It's not just wines, with their fascinating tales of branding wars and squabbles for power along the value chain in post-Napoleonic Europe. If you look around you, you'll see firms in many an industry trying to move up the visibility and certification chain, changing their role from a simple provider of intermediate services to a guarantor of quality with links to the final customer. Following the example of Microsoft and Intel, which managed to eclipse industry giants like IBM and Compaq, and shift the value to their own part of the sector, firms like SAP are currently engaged in an effort to reinvent themselves and change their connections along the value chain, becoming ever more visible, ever less replaceable.

Food distribution has been a setting for such changes for quite some time. The growth of mega-retailers like Tesco, Sainsbury, ASDA, Lidl or Carrefour in Europe, or K-Mart and then Wal-Mart in the US has not only crushed wholesalers, but allowed retailers to gain increasing power over FMCGs and their producers. The growth of white labeling, where the retailer sells products under its own brand, has increased retailer margins, as well as their strategic control; and this happened as retailers gained acceptance from the public and decided to leverage and monetize it. Yet with these privileges come the risks of dealing with failures in quality standards. In other words, Tesco's success means it should be happy to take full responsibility for the horsemeat fiasco because it is this very responsibility that gives it healthy margins.

The question of how the legal liability is divided between players in a sector is a related topic. If a product or service is fairly integral (like a car) then one player assumes responsibility, even if some of its suppliers are liable for the fault. Consider, for instance, the Firestone / Ford Explorer debacle. When Ford Explorers started turning over because of an unexpected interaction with Firestone's tire design, it was Ford, not Firestone, which was liable. More recently, when the Chevy Volt's batteries started catching fire, it was Volt's manufacturer, GM, not the battery maker, who had to face the criticism.

Interestingly, the very fact that automobile manufacturers hold legal liability has been an instrumental tool in their ability to control the sector. While the pain of legal liability is a huge issue, and one that many automobile executives would happily dispense with, my research with John Paul MacDuffie of Wharton on why value didn't migrate in cars (from OEM to suppliers) as it did migrate in computers suggests that legal liability is a major benefit in disguise.

The irony is that executives often fail to see the huge strategic leverage that their role as certifiers of quality provides them; they only see the short-term pain of legal liability and company value destruction. IBM executives didn't think hard enough about the value that they might have dissipated when they standardized their sector. A clever lawyer might think they've scored a great coup for their firm if they managed to push away legal liability. Yet this very shift, convenient in the short term, would be the undoing of a firms' strategic strength.

The moral of the story? Tesco should accept the short-term pains that go with certifying quality and managing the customer experience, and focus instead on restoring its customers' confidence. Its suppliers, on the other hand, might want to strengthen their hand by pointing out that the differences are in individual producers, who should be the ones responsible for certifying the quality in the eyes of the customer. They might even want to take the short-term legal hit -- as this might be used to ultimately control the fate of the industry. For them, as in any other industry participant, the old adage rings true: No pain, no gain.