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September 7, 2006

Supply Chain

Distortions are amplified up and down the supply chain. While you can't stop it, you can try to contain it.

Many business school students first learn the vagaries of the supply chain through a computer exercise developed at MIT known as “the beer game.”

Students, acting as retailers, distributors, wholesalers and brewers, place and receive fictional orders for cases of beer. The would-be managers tend to overreact to changes in order quantities, amplifying the effects as orders move up the chain. By the time the orders reach the brewers, they often bear little resemblance to the needs of the consumer market.

It’s an interesting simulation, but managers who deal with the bullwhip effect in the real world know it is no game. Distortions in the supply chain, and the ensuing effects on everything from inventory to pricing, can leave many managers feeling like they could use a beer.

For as long as there have been middlemen buying and selling goods, the bullwhip effect has created nightmares. Typically, a spurt in demand or perceived tightening of supplies causes a buyer to increase an order to build safety stock. That supplier increases his or her own order with enough to fill commitments, plus even more safety stock. This wave is amplified up the chain, so a small move can cause a big reaction, like the flick of a wrist causing the end of the whip to jump. The problem can be just as bad in a weakening market, as buyers cut orders for fear of being stuck with excess inventory.
Such imbalances add cost, waste and inefficiency, but the metals industry generally treats this commercial storm like it treats the weather—it’s bad, but there’s nothing you can do about it.

Of course, there is something you can do about it. You can come in out of the rain. Information-sharing and inventory management can mitigate the bullwhip effect, yet metals suppliers continue to guard commercial information closely on the premise that their insights and market intelligence give them a competitive edge.

“There is no movement to look across the supply chain to bring all the parties together to work on this,” says Michael Hilbrich, vice president of industry marketing at i2 Technologies Inc., a Dallas-based supply chain software and consulting com-pany. Instead, mills and service centers closely guard their market intelligence. “You have to remove the information silos,” Hilbrich says. “We are a long way off from that.”

DELIBERATELY INEFFICIENT
The downturn that ravaged the industry between 2000 and 2003 created massive bullwhips. “People get so scared that they are going to get caught with too much inventory or not enough supply [in an upturn] that they forget what they learned about the bullwhip,” says Hau Lee, a professor at the Stanford Graduate School of Business and co-author of a 1995 paper that documented the bullwhip effect.

Another problem is that companies that purchase large quantities of metals—automakers and other large OEMs—haven’t had sufficient incentive to push for efficiency in the supply chain. Many, like the automakers, have had their own problems to deal with, and none have the market power that a behemoth like Wal-Mart Stores Inc. can exert to marshal the players to work together.

Metals buyers still have a lot of buying power and choice when it comes to mills and supply centers. “They’ve said, ‘It’s your problem; deal with it,’” Hilbrich says. “To solve a problem like this, you have to want to.”

In fact, the industry’s fragmentation enables consumers to play suppliers off one another, which keeps margins depressed.

In turn, mills have a history of abusing service center relationships to foist off excess supplies. “Whatever steel is left over, all the mills are battling to ship to the distribution channel with it,” says Frank Ruane, director of corporate purchasing at Olympic Steel in Bedford Heights, Ohio.

The very structure of the metals sector makes addressing the bullwhip effect a tricky proposition. Mills act as suppliers to service centers and simultaneously as competitors, as they supply many service centers trying to sell to the same consumer. That makes it difficult to create partnerships and share information.

“We have an inefficient supply chain on purpose,” Ruane says.

RETAIL NIRVANA
The retail and consumer product sectors have set the standard in supply chain management largely because there are large, powerful players, such as Wal-Mart and The Home Depot Inc. They can insist that market players communicate and forecast jointly to minimize the bullwhip effect, Lee says. These efforts haven’t materialized as much in industrial sectors, which remain more fragmented.

“The goal is to reduce the nervousness up the chain that results from misinformation,” Lee says. With collaborative forecasting, companies compare notes on their future expectations. This allows one company to factor information from another into its own projections.

Some industrial companies aren’t waiting for industry giants to tackle the problem. Gibralter Industries, a processor and distributor for products used in building, transport and industrial applications based in Buffalo, New York, has tried to develop relationships with suppliers that build a level of trust, says John Wagner, corporate vice president of supply chain management. “If you are in and out of the market and playing suppliers off one another, you’re going to be on the outside looking in during a tight market,” he says.

Wagner says minimizing the bullwhip often is just doing small, common-sense things. “We communicate more; we ask more questions,” he says. When orders come in that seem out of the ordinary, the company wants to know what’s behind them.

When Wagner joined the company in 2004, some members of the purchasing department didn’t even talk regularly to sales. “Now, they share data at regular meetings,” he says. Gibraltar compiles 30- and 60-day rolling forecasts, created by teams from different departments, and includes data outside of the company’s own orders such as changes in steel prices and in the housing and construction markets that drive demand for Gibralter’s products. That data shapes purchasing and inventory decisions. “It’s another layer of intelligence that lets us test our assumptions and improve our forecasts,” Wagner says.

Technology also is available to minimize the bullwhip effect. Radio Frequency Identification has the potential to help counteract supply chain inefficiency, because it can pass more information in real time to anyone with a receiver, allowing suppliers to see two and three levels down the chain.

“It allows a tremendous amount of visibility into where inventory is,” says Panos Kouvelis, a professor of operations and manufacturing at the Olin School of Business at Washington University in St. Louis. In some instances, suppliers have linked their Enterprise Resource Planning systems to share information that used to be proprietary. Gibralter’s Wagner says his company hopes to create links down the supply chain so that it can view sales and inventory data in real time.

The Internet also offers limitless chances for information sharing and collaboration because of its ease of access, good security measures and the real-time nature of the technology, Kouvelis says.

A BETTER VIEW
There are other ways to gain more information into the true nature of the market—or perhaps more importantly to minimize the misinformation that feeds the bullwhip. For example, vendor-managed inventory programs can help minimize supply chain distortions. Suppliers work on-site at their customers’ warehouses, ensuring that parts and materials are fully stocked. The supplier usually generates purchase orders and has access to greater inventory data. Programs range from simple restocking to more complex arrangements where the vendor controls the inventory.

“That is something we’ve seen in many industries, regardless of the level of fragmentation or the existence of power players,” Kouvelis says. With this improved view into what actually is happening at customers’ sites, suppliers can better judge their own inventory needs. At Wal-Mart, vendors work on site at the company’s warehouses or, in some cases, even stock Wal-Mart shelves, giving them greater insight into sales trends.

Another technique is to reduce long lag times that feed the bullwhip, because the longer the time between orders, the greater the chance of distortion. If a customer placed an order every day, he or she would track actual demand. But if orders only can be filled every week or two weeks, they become based on expectations, and thus the need arises to build safety stock.

Similarly, volume discounts can create problems if the supplier stocks up on raw materials as the market weakens. As inventory grows, the customer places a smaller order the next time, and the supplier is stuck with excess inventory. Kouvelis recommends that companies offer discounts based on orders over a long period of time instead of single orders. “Use smart discounts instead of bulk discounts. It will streamline demand and lessen the bullwhip,” he says.

As an industry, Wagner says, metals companies are improving inventory management, which will go a long way toward reducing the bullwhip effect. The biggest cure for the bullwhip is sharing information along the supply chain. When suppliers have more information about why buyers are placing the orders, they can make better decisions.

But old mindsets don’t change easily. Managers are used to fluctuations in inventory and consider it a cost of doing business. Information is not easily shared. “Creating a pipeline that is visible to all
participants is the key,” Hilbrich says. “But we are a long way off from that.”

TAMING THE BULLWHIP

SOME SOLUTIONS FOR MINIMIZING SUPPLY CHAIN INEFFICIENCY.

CAUSES COUNTERMEASURES
Complex inventory Too much variability in the number and types of products creates inventory problems. Slow sellers make it harder to forecast demand. Reduce the number of products by eliminating slow sellers. Reduced overlap in products should give clearer information about demand for them.
Volume discounts Variations in pricing creates incentives to place big orders. When customers order more than they need to take advantage of a sale, they can have large swings in inventory. Change volume discounts from one-time to cumulative. Reward customers with annual targets, or give discounts on quick payment instead of bulk orders.
Long lead times If a supplier can only fill orders every so often, customers are forced to guess at future demand or protect against shortages with safety stock. Reduce set-up times to move products to customers faster and lessen need for safety stock or shortages.

Low visibility into customer’s sales Why buyers are placing orders is as important as what and how many. Not knowing why creates opportunities to misread the market and order too much or too little.

Increase communication with customers and suppliers. Software can help. Vendor-managed inventory also can increase visibility.

High transportation costs encourage less-frequent orders Customers may wait to place an order until they need enough to cover the cost of shipping, or to avoid the premium put on small orders.

A third-party logistics company to lower the cost of shipping a small order encourages more-frequent orders and more visibility into the market.

Gaming the system Customers may lie to get what they want. During a shortage, customers may order double, thinking only 50% will be filled and they will get what they want. But the supplier now thinks the true market has doubled and ramps up more.

Ration based on history of orders, not current orders. Offer incentives to delay orders during peak times.