HOW THE SUPPLY CHAIN WENT OFF THE RAILS

Seems like “Supply Chain” and “Inflation” occupy more headlines today than they have in decades. Why is that? How did the supply chain get wrecked so thoroughly?

The clues appear in the most unlikely of sources, a beer game at MIT.

Business Schools love simulations and grad students love beer, so it was inevitable that The Beer Game – a production-distribution simulation to teach students about the dynamics of a full supply chain – would become popular at MIT’s Sloan School of Management and beyond.

The lessons of the game point to how the supply chain went off the rails for so many industries. It also points to the need for far greater transparency in the supply chain, better communication, and ultimately to a Vendor Managed Inventory (VMI) solution.

The Game

The simulation is deceptively simple, but the end result leaves students angry at their colleagues and even more angry at “the customer”.?

The game starts by dividing students into 4 teams representing the RETAILER, The WHOLESALER, the DISTRIBUTOR, and the MANUFACTURER. The objective of the game is to minimize total team costs. Inventory holding costs are assessed along with backlog cost, to capture both the lost revenue and the ill will that a stock out causes among customers.

Here's the catch... although this "catch" represents the reality in most industries. Each team knows only what the purchase orders they receive. Nobody sees the whole chain, just their part of it. You get where this is going.

If this sounds a bit devilish, here’s one gift the organizers provide in the simulation, which runs about 30 “weeks” (each round represents a week). They set the initial Inventory levels for everyone at 12 cases, and initialize Retail Sales at 4 cases a week. That sales level remains identical – 4 cases a week – for the first three weeks. Steady state (life should be this easy).

But beginning with Week 4 the players are allowed to order any quantity they wish, and are told that customer demand may vary; and one of their jobs is to forecast demand.

Forecasting demand is at the heart of any business or service, so this is where things get real.

You might expect the organizers to have fun wildly gyrating demand. No so. They bring the Retail Sales demand up from 4 cases a week to 8 cases a week – and hold that new level constant for the duration of the game. The supply chain just needs to accommodate this new level of demand, and that wouldn't be hard if there was visibility into the entire supply chain, but just like in reality, each group sees only their part.

The game is actually even simpler compared to real life. There are no machine breakdowns or other random events, no labor problems, no capacity limits or financial constraints.

Yet even with a steady state the results are appalling.

The Results

The average team cost (remember they are charged for holding and backlog costs) is $2000 while the optimal cost (the best they could do in theory) is $200. So on average, the cost is 10 times greater than optimal. And this is MIT.

Beyond the poor economic performance, the dynamics up and down the supply chain are just as embarrassing. I say embarrassing because when the students are told what the real demand was they realize just how simple and efficient the supply chain could have been.

After the game the organizers ask the players to sketch their best estimate of the pattern of customer demand. The vast majority invariably draw a fluctuating pattern for customer demand, rising from the initial rate of 4 to a peak around 20 cases per week -- then plunging. While in reality customer demand remained steady at 8 cases per week.

When they find out the truth, they are uniformly astonished, and again, this is MIT.

"From my vantage point the demand surge wiped out my stock and forced me to run a backlog. Then just as I got to the point where I could handle the demand it looked like you tricked us and made the customers drop the product, so I got stuck with all this excess inventory."

If you’ve been reading financial news lately you know this is pretty much how a major retail chain explained a recent earnings miss.

Eventually the players realize their own actions created the whipsaw gyrations in inventory levels, and they hadn't accounted well for what their actions meant to others in the supply chain.

Let's take a closer look at that:

• Customer demand goes up unexpectedly, causing Retail inventories to fall.
• Since Retailers know that orders and manufacturing take time to be processed, they address this by placing large orders.
• The large orders result in a stock out for the wholesaler.
• Retailers don't receive the quantities they ordered, and grow increasingly anxious as their backlog worsens; leading them to order still more, even though the supply pipeline contains more than enough.
• The result is even a small step in demand from four to eight cases a week gets amplified and distorted as it is passed to the wholesaler, who reacting in kind, further amplifies the signal as it goes up the chain to the factory.
• Eventually, of course, the beer is brewed. The players cut orders as inventory builds up, but too late - the beer in the supply line continues to arrive.

Observations

Under pressure, people focus on managing their own piece of the system, trying to keep their own costs low. But as the simulation shows time and time again, as we try to control our own little piece of the supply chain, we cause ripple effects and it eventually returns to vex us as well.

Rather than seeing this clearly, we instead blame our customer for ordering erratically, and our supplier for delivering late.

Focusing on external events leads people to try to perfect their own self-focused forecasts rather than redesigning the system to be robust in the face of fluctuating demand. That just reinforces the belief that we are helpless cogs in an overwhelmingly complex machine.

The Case for VMI

The obvious answer is to improve visibility and communication across the supply chain, and cloud technology makes that possible. Yet there is a step even beyond that.

Vendor Managed Inventory (VMI) was designed to look at the system as a whole and provide the type of transparency needed to bring inventory levels down across the supply chain, while minimizing the chance of stock outs.

The basic concept of VMI is that suppliers (vendors) are accountable for a customer’s inventory and restocking. With this approach, the decisions about timing and level of customer’s replenishment are determined by the supplier who is supposed to have visibility into the customers’ needs, in order to avoid stock-outs.

If you'd like to relate some of your supply chain experience that reflects some of the lessons learned from The Beer Game please comment below. Or if you're interested in learning a but more about VMI you might want to check out the article Vendor Managed Inventory: Building the Modern Supply Chain.

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