Building Future Proof Supply Chains

Container Prices are on a freefall, does that mean it is time to celebrate?

Well, not yet!

Allow me to introduce you to the term Reverse Bullwhip effect,

We all know Bull whip effect, but have you heard reverse Bull Whip Effect!

In the last decade, where we never saw a disruption which reduced the demand, we only talked about Bullwhip effect. A Bull Whip Effect is when small changes in the customer demand creates large fluctuations as we go upstream in the supply chain.

But what happens when the impact of decisions that the upstream supply chain nodes take, starts to travel downstream and affect the ability to meet service level targets?

This is called Reverse Bull Whip effect[1]. This terminology is seldom explored in literature or talked about in industry and the reason is understandable. We never really experienced what we are experiencing today!

The 3 year long Pandemic and the ongoing geo-political constraints suddenly made suppliers as predictable as this week's Lotto numbers. Supplier deliveries are becoming uncertain. Even if suppliers manage to create a large shipment to react to the demand increase we saw in the last years, we are now sitting on excess inventory as economy slowdown kicks in. The unpredictability in deliveries and the slowdown in demand together are making matters worse. [2] In addition to this, the increase in costs due 2 yrs of transportation premiums, coupled with disappearance of "Cheap Money" from the financial Markets have already created inflationary pressures on the nodes of supply chain close to end-consumer. In other words, Transportation Prices were only one factor affecting the supply chain and by the time it eased, we are looking at many more which may or may not have been caused by the transportation disruptions.

So what does it mean for the business?

Unwanted Inventory Levels

The Bull whip effect and the Reverse Bull whip effect creates inventory shortages and unwanted buffers in the entire network. This further impacts the ability to meet service levels and results in top line impact while eroding bottomline due to costs.

Incorrect Calculations in Planning Solutions

Due to the changes in the delivery pattern, the MRP calculations for the PO Proposals or Inter Warehouse Transfers become inaccurate. The lead times maintained in the system are different than what the actual world will be. This results in incorrect Promise dates to customers, expedite costs, delays in meeting customer demand and even order cancellations.

Increasing Costs and Impact on Revenue.

The impact of inventory levels and incorrect inventory levels certainly have an impact on costs and revenue. The impact on revenue is due to lost sales and dampening of demand due to increased prices. Similarly the impact on costs is due to expedites, unnecessary storage of inventory and associated costs. This gets further amplified as the both revenue and costs start to have a feedback loop.

What's the Remedy?

The first step that supply chain leaders should take is build resiliency in the supply chain. This involves de-risking suppliers along with near-shoring of procurement wherever possible. In addition to this, supply chain practitioners need to use mathematical models to maintain the right safety stock levels in the supply chain.

However this will only solve part of the problem. The safety stock is an assumption of what the distribution of demand signal at the node could be. And the objective is to be able to meet X% of the demand on time in full. Where X corresponds to the target service level. However, in reality the actual distribution of demand could be quite different and the company may not be able to meet even the target service level. This is where organizations need the ability to predict the projected service levels. It is easy to predict the service level within the ordering lead time, however organisations have enough data to predict the service levels and stock out probabilities beyond the ordering lead times. Using this to fix the gaps pro-actively can help organisations react better.

In fact the same data is also indicating the variations in the shipment behavior of the supplier or supplying entities. This is applicable for not just outside trading partners, but also for the inter-organisation material movements. Using the information to improve the master data that runs planning and collaboration.

Conclusion

We have to accept the new reality of a supply chain in flux. Suppliers will move their manufacturing facilities as a result of Cost pressure, Geo-politics as well as Climate Change. BASF is already considering permanent cost cutting of European operations [3] while EU is planning a response to the Inflation Reduction Act by The United States, in order to avoid businesses shifting to the US[4]. It will make it difficult for companies to react to changes quickly. Organizations need to invest in building transparency, resiliency and agility in these changing times, which will include investments in change management as well as technology. While this will pass-on the costs to consumer, we can rely on the region specific Central banks and governments to ease the blow. However, one thing is for sure, the supply chains will become future ready.

citations

[1] https://www.proquest.com/openview/447589c2331e1ba0af33289888edc288/1?pq-origsite=gscholar&cbl=2031962

[2] https://www.automotiveworld.com/news-releases/chip-shortage-in-automotive-and-industrials-despite-lower-demand-for-semiconductors/

[3] https://www.reuters.com/markets/europe/basf-says-european-operations-need-be-cut-size-permanently-2022-10-26/

[4] https://www.reuters.com/markets/us/us-eu-address-inflation-reduction-act-fears-constructively-draft-2022-12-02/