By: Henry F. Camp
IDEA exists to accelerate world prosperity.
Investment in continuous improvement is supported in an environment of steady reliable growth. One of the biggest impediments to steady reliable growth is recession. Recessions are a leading cause of uncertainty. Uncertainty is an obstacle to investment. So, for IDEA to achieve its goal, recessions must be avoided.
Demand for goods is affected by consumer confidence. Stuff happens in our world beyond our control. Japan has just experienced a major earthquake. Drought, floods, hot and cold weather affect growing seasons and our food supply. Wars are a continuing part of the human condition. There are many things that cause consumer confidence to wane.
However, recessions and depressions cause more severe damage than just a temporary dip in consumer demand because of a “bullwhip effect” caused by changes in inventory levels. It is this “bullwhip effect” that costs so many jobs and drags down the economy, often for years.
Imagine a retailer selling some commodity to consumers. The product is manufactured in China and supplied to the retailer by an importer. Something happens that shakes consumer confidence. People buy a little less of the commodity; let’s say 3% less, in terms of units sold. The retailer notices that consumers bought less than forecasted. The retailer wants to reduce its exposure to high inventory levels which could force more discounting than planned. Discounting means even less revenue, on top of the 3% drop in sales to customers. The retailer has just become pessimistic about their inventory investment, so they only order what they are low on to quickly reduce their inventory position.
The importer heard about the drop in consumer demand from a hysterical media. (It behooves media companies to find reasons for hysteria, because problems sell.) The importer has seen orders from retailers drop by 20% and braces for a recession. They immediately decide that their inventory must be reduced. Importers have far lower margins than retailers, so they can ill afford to be the ones stuck holding stock the world no longer wants. Therefore, they only order what they are low on from their manufacturers, until inventories to drop. They plan to resume buying what is selling, once inventory turns improve to the new target.
Suddenly, at production facilities in China, new orders have dropped by 50%. They plan for massive layoffs as soon as their current production backlogs are produced. They stop purchasing raw materials from their suppliers, as much as possible.
The raw materials suppliers see an 80% drop in orders. They close their mines, stop cutting their forests and close their factories.
That is the “bullwhip” effect. People who are laid off buy less. The viscous cycle continues until there is so little inventory in the supply chain that too many good orders can not be filled. Links in the chain realize that they are missing orders for lack of stock. They buy a little more than they sold and the economy starts to pick up. It takes time before the shuttered raw material suppliers reopen – delaying the recovery. Prices rise. The news tells us we are out of the recession but we will still feel pretty poor for too long.
What causes a recession or a depression is not the direct loss of 3% of sales due to consumer uncertainty. That is only the trigger. Rather, it is the supply chain’s dramatic reaction to a 3% loss in sales. Viable companies can withstand a 3% loss in sales without draconian cutting of costs or investment. Almost no company is positioned to survive when sales drop 80%.
IDEA’s clients are positioned to block the “bullwhip effect” that causes of recessions and depressions. Our clients keep the right inventory – enough to keep from running out without surpluses. Using our demand pull based inventory system, there is no excess inventory to cut. Cutting IDEA’s inventory buffers directly results in more shortages and less sales – the opposite of what a company that is facing a 3% drop in sales needs. So, a supply chain that uses Elucidate is able to continuously improve and protect the broader economy.
Dear reader, do your duty to your community. Do your duty to your customers. Do your duty to your employees. Do your duty to yourself. Help us change the world, supply chains and companies, one by one, until the tipping point is reached. We need innovative decision makers who want to get ahead and make a difference.