ROHS compliance strategies: there are several ways to ensure that you're in compliance with the EU's hazardous material rules. The trick is determining which is the best for your company.

In July 2006, the way electronic equipment manufacturing companies operate in the European Union will change forever. At that time, the Restriction of Hazardous Substances (RoHS) Directive goes into effect. The regulations, designed to limit the use of lead (Pb), mercury (Hg), cadmium (Cd), hexavalent chromium (Cr+6), polybrominated biphenyl (PBB) and polybrominated diphenyl ether (PBDE) in electronic and electrical products, promise to impact manufacturing, distribution and marketing practices worldwide.

RoHS affects a wide array of products including computers, consumer electronics, telecommunications equipment, many major appliances and a large group of other devices with computer processors and/or electrical wiring components. While the RoHS Directive originated in the EU, it will have a tremendous impact on organizations worldwide. Figures from Eurostat, the Statistical Office of the European Communities, indicate the value of imported products subject to these regulations to be more than 140 billion euros annually.

The new EU regulations present clear choices for compliance strategies. Each offers specific cost/risk tradeoffs that companies must seriously consider before forming their policies.

Worst-Case Scenarios

Assume a mid-sized German electronics company is marketing a new children's PDA to secondary school students in the United Kingdom. The company discovers that the devices have cadmium in excess of the levels specified in the Rolls Directive. The cadmium discovery occurs after the product has been on the market for one month, with 100,000 units in stores and an additional 100,000 moving through the fulfillment pipeline.

The German company will face penalties under RoHS that can include serious fines. Beyond this, the company could be dealing with potential class-action lawsuits from lawyers representing the 100,000 buyers of the product. Beyond the potential criminal and civil implications, the company may be dealing with serious damage to its brand image as a result of the recall. This impact may spread across related products in its portfolio. Repairing its brand may also require a major investment in public relations and advertising.

In the event of such a compliance failure, the electronics company must first be able to certify that existing supply-chain partners meet the regulations. If that isn't possible, the German company will have to identify and switch to new suppliers that can meet RoHS requirements. Either way, to resolve these issues company managers will need to spend considerable time traveling to and working with existing or new partners in Eastern Europe, North America or Asia.

But even before the costly supplier issue is resolved, the German company has other expensive issues it must deal with immediately. First, logistics must be arranged for the return of the 100,000 units already in the public realm, including those in stores and in the hands of consumers. Next, the company must choose to either fix the 200,000 non-compliant units, or destroy them in a manner that complies with local regulations. Destroying such products represents an enormous financial commitment for the organization.

The company's sales organization faces serious repercussions as a result of the PDA recall. In this scenario, all back-to-school sales of the PDA have been lost, resulting in long-term damage to the relationship between the sales team and retailer buyers. If this relationship is not repaired, it is possible that retailers will permanently pull the manufacturer's products from store shelves.

Beyond the sales impact, the value of the company itself will likely take a hit. The German company is publicly traded. Product recalls that impact sales and earnings affect investor perceptions of long-term profitability and ultimately share price. The company will likely need an active program of investor relations and financial communications to help restore that value.

Comply, Or Else

In reviewing early restricted substances compliance efforts, four corporate strategies for meeting the new regulations are emerging. Each has its own distinct set of pros and cons:

Delegation of responsibility down the supply chain. In this model, manufacturers require supply chain partners to demonstrate compliance with all relevant regulations and assume responsibility via contract for compliance wherever possible (via paper trails).

Pros: This approach has the advantage of low cost. Should there be a compliance failure, the suppliers may be responsible for all legal and recall repercussions to the extent that they relate to civil or non-criminal regulatory liability and are allowable under their contract relevant laws. In addition, manufacturers can tailor the agreement in anticipation of future regulations, thus reducing future costs.

Cons: While this method may absolve manufacturers of some legal responsibility, it hardly provides them a safe haven. First, it assumes relatively weak enforcement by the EU that is not justified by the facts. Additionally, consumers, government attorneys, retailers and others will likely still pursue the OEM. Finally, governmental regulators could potentially see this behavior as a reason to open additional aspects of a company's operations to further scrutiny.

This approach does nothing to solve the marketing, public relations sales and investor impact of a compliance failure. Further, since this model provides no ongoing monitoring, materials substitution or even small product design changes can open the door for more compliance problems. Under this model, a company also faces considerable costs related to managing the paper trail.

Accepting suppliers certified by other OEMs. In this model, manufacturers demand that suppliers meet the requirements of another OEM with an established compliance program.

Pros: This approach is likely to be the least expensive for manufacturers and may provide some initial assurance that suppliers meet requirements set forth by a certifying OEM.

Cons: This method exposes manufacturers to greater risks on a number of fronts. More importantly, it is not clear whether this approach, by itself, will meet the Rolls Directive requirements. Manufacturers do not know if there are issues with a particular supplier, only that it participates in another OEM's program. Also, this approach provides no ongoing surveillance. As a result, manufacturers may not be notified in the event that the status of the component or supplier has changed.

In the event of a compliance failure under this regimen, the manufacturer will be responsible for all legal, financial, marketing and operational repercussions of the event.

Building an in-house compliance organization. In this model, a manufacturer takes on the direct responsibility for monitoring the compliance of its supply chain partners. The manufacturer will provide all resources and procedures needed to test and document ongoing compliance.

Pros: By managing the entire process themselves, manufacturers have a high degree of control over compliance with the RoHS Directive. Regulatory authorities will view manufacturers as being proactive, cooperative and acting in the spirit of the legislation.

Cons: For most manufacturers, this type of compliance effort is well beyond their core competencies. The direct costs of building complete testing, compliance and surveillance departments from the ground up--just to monitor their own product lines--would be prohibitive.

Using third parties to assist with compliance. With this approach, manufacturers engage a third-party partner to test and monitor products throughout the supply chain. The third party works with an OEM's supply chain partners to test homogeneous products and provide ongoing surveillance of processes to help the OEM declare compliance.

Pros: Because this system provides economies of scale within a large organization, a manufacturer can afford processes that offer the highest degree of confidence. This approach has much lower direct and opportunity costs. In addition, a manufacturer can benefit if the third party brings an established level of credibility to the compliance efforts.

Cons: While this approach costs much less than an in-house effort, it does involve some ongoing expenses. To be effective, it also requires manufacturers to find a partner with the research and testing capabilities, organizational breadth and international scope to stay abreast of evolving requirements and proposed regulations.

Decisions, Decisions

The implications of non-compliance with restricted substance regulations can be crippling to every aspect of a manufacturing organization. It is imperative for these companies to address compliance as a top priority before problems arise.

The choices for manufacturers seeking compliance are divided between those that delegate responsibility to others, those that bring full responsibility inside the organization and those that engage third parties. Delegation saves on costs, but may bring a high level of risk to the organization.

In contrast, self-managed compliance or working with experienced third parties may help organizations manage risk more effectively, but comes with ongoing direct and indirect costs. In the end, each manufacturer must weigh each of these factors, taking into account its current position, future prospects and ultimate place in the world community to determine the proper course.

MAXIME ELBAZ is general manager of the Underwriters Laboratories Inc. Restricted Substances Strategic Business Unit; [e-mail].