PRODUCTION & LOGISTICS

How to recover from the covid-19 bullwhip?

The covid-19 spring was interesting from a supply chain perspective. We switched our courses Production & Logistics Management overnight to online teaching with notably more students in our online class compared to the auditorium in the Dekenstraat and – remarkably in times of social distancing – less “distance”between professors and students due to a lower barrier to raise questions. But it also provided a unique opportunity to relate our supply chain theories to today’s context and valorize our research models. Never waste a good crisis.

As we slowly resume from the unprecedented lockdown, the one-million-dollar question remains how the recovery will look like. One thing is for sure: we face a bumpy road ahead. Those who have played the famous beer distribution game, recall that even a small but sudden change in consumer demand may lead to large demand variations upstream. This bullwhip effect is observed in today’s supply chains and it seems we will be playing the beer game for real in the months to come. Companies that have witnessed serious demand drops, either due to reduced market demands or due to production lock downs of their customers, have seen their inventories gradually build up. Their replenishments, especially those with long leadtimes, kept coming in as they have been placed in tempore non suspecto. As long as this inventory build-up lasts, it creates near-zero orders for their suppliers upstream in the supply chain. However, when these inventories start declining again due to recovered demand, the upstream suppliers will have to be prepared to cope with a sudden increase in their demands. When they are not prepared, shortages may occur upstream in the supply chain later this Fall, disrupting our supply chains. We have observed a similar effect in the quarters following the financial crisis early 2009.

In some sectors, such as for instance certain healthcare supplies or consumables like toilet paper, demand has increased. Also those companies that were capacity constrained due to the production lockdown may have witnessed increased demands.To avoid the risk of a supply shortage, their customers may have artificially increased orders in order to claim more of the scarceproducts. This hoarding effect distorts the demand patterns, creating the same bullwhip effect. When amplified orders exceed real consumption, inventories will build up. The resulting stock piling will then again be followed by a destocking, etc. To predict how a company will recover from the covid-19 bullwhip, it is therefore imperative to understand the inventory dynamics along the supply chain. We commend the use of digital control towers to increase supply chain visibility. Monitoring or sharing real-time information along the supply chain will be informative to understand whether fluctuating customer orders and inventories originate from long-lasting changes in market demand, from temporary fluctuations caused by lockdows, or from (de-)stocking phenomena downstream the supply chain. The Figure below shows that the drop in market demand has not been the same in all industrial sectors. The appropriate response depends on quickly identifying the source of the observed dynamics.

Moreover, although it is tempting to free up cash these days, we caution against excessive inventory reductions. Any overreactions are to be avoided, as it will destabilize supply chains even more. Instead, given that the lead-time to prepare your supply chain for any change is long, we encourage you to rethink your global supply chain strategy. Dual sourcing strategies, where part of the supply is nearshored, provide an accurate response to demand fluctuations. It does not involve a complete re-shoring of demand, but a small, local, fast response that supplements a large offshore supply. The shortlead time of nearshored supply allows for tighter control of inventory levels, off-setting the potentially higher production costs, and stabilizes supply chains. This local speed supply becomes substantially more valuable under nonstationary demand.

We don’t have a crystal ball and cannot predict the precise recovery for each individual company. The inventory dynamics downstream in the supply chain will determine how the recovery will look like. At the same time it is vital to keep an eye to our upstream supply companies - they should remain resilient to the large swings in demand. If they collapse, it will create supply shortages and prevent us from fully taking advantage of the market recovery when demand picks up again.

Robert Boute and Maxi Udenio Professors Supply Chain Management Research Center for Operations Management