How can supply chains recover from the Covid-19 bullwhip?

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 business 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 lockdowns of their customers, have seen their inventories gradually build up. Their replenishments, especially those with long lead times, 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 scarce products. This hoarding effect distorts the demand patterns, creating the same bullwhip effect. When amplified orders exceed real consumption, inventories will build up. The resulting stockpiling 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 lockdowns, or from (de-)stocking phenomena downstream the supply chain. The drop in market demand has not been the same in all industrial sectors (see figure). The appropriate response depends on quickly identifying the source of the observed dynamics.

This live ‘Supply Chain Recovery Map’ provides insight into the current economic recovery per sector, based on 3.000 factories and warehouses in Europe, as well as their transport flows.

 
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 destabilise 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 short lead 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 non-stationary 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, as 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
Vlerick Business School and KU Leuven

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