Increasing inventory levels will never solve current supply chain disruptions
Sometimes you read during the last months, that dramatically optimized supply chains with Just-in-Time (JIT) deliveries and “warehouses on wheels” are one of the major reasons why supply chains still are affected from COVID-19 pandemic although most businesses around the world already are in recovery mode and are struggling heavily to fulfill their customer’s demands. But that’s wrong: JIT isn’t destabilizing supply chains — it’s doing exactly the opposite.
Looking at the problem from the outside, it seems easy. The Automotive industry and many other producing companies optimized their logistics processes more and more and took all stock out of their factories — obviously to save money and increase efficiency. Many people may understand this as a steady weakening of the corresponding supply chains that wouldn’t have been broken if enough stock would have been at every single player’s location. And yes, that also was my first thought: Will this be the re-invention of higher stock levels?
And here’s the truth: Increasing inventories are currently making it worse! Let’s have a closer look that is quite closely going along with the brilliant article that MIT professor Yossi Sheffi published in the university’s MIT Sloan Management Review[1].
What happened during 2020 with the global supply chains?
In 2020, demands got quite volatile for many industries. While some industries (e.g. carmakers) where heavily suffering from closed dealerships and reduced mobility needs around the world, other industries (who also where suffering from closed production sites) had to handle a massive increase to cover the client’s demand for home electronics, home office products and many more goods that helped customers around the world to work from remote and spend the time during lockdowns.
For the corresponding supply, times immediately got hard as lockdowns of factories began in spring 2020. Containers couldn’t be delivered to closed factories, harbors where closed, complete ships stopped due to quarantine of their crew, buyers stopped their orders etc. Global supply chains were disrupted all over the world.
When they tried to recover, demand increased without having the supply chain capacities available. Huge traffic jams were at some harbors, empty containers not available for weeks and the cost of global transportation exploded for the rare possibilities that were available. A container transport from Asia to Europe or to the US meanwhile costs nearly ten times of 2019’s price. This again affected the demands, as buyers in many industries still didn’t place their orders, waiting for lower costs, as long as possible. Maybe one reason, why some shelfs are empty when you want to buy furniture or other bigger goods, where the cost of logistics counts more.
Just-in-Time is about quality first, not cost efficiency
Now let’s come to Just-in-Time (JIT) deliveries and their effects. JIT is one of the core principles of Toyota’s production philosophy that was shared with the global production industries in the early 1990s. The major reason behind this totally new approach of thinking production, quality and logistics was to build products with less defects. It’s about quality and about building a reactive enterprise that easily can react to shifting demands, new products and deliver a bigger product variance. Is it also reducing cost when not needing higher inventory levels — for sure, but mainly it is about reducing “waste” as the Toyota production system principles did call it and what probably everyone in production and logistics had to learn since that time.
The intention was to quickly identify defect products within a supply chain and be able to quickly react to changes and improvements without having a bigger stock available that is suffering from the same problem or is still an older product to be used while a new version already is available.
The Bullwhip-Effect of increasing inventory levels
Abandoning JIT and coming back to higher inventory levels is a naturally first reaction on the current supply chain disruptions. But will that really help? No, not at all. It is the comeback of the bullwhip effect in 2021. This effect, also known as the Forrester effect has been recognized already in the early 1960s[2] and is created by a distortion in the demand information.
Beneath the fact, that current demands in general are very high after the 2020’s lower levels (e.g. with car-makers still heavily trying to come back to former sales quantities), that’s one of the aspects that you can see now, affecting supply chains: Companies see higher demand by their customers and want to be sure to cover it with having enough stock of the needed parts. They order even more parts at their suppliers than they need, assuming that the client’s higher demands will remain stable. This goes on with the supplier’s supplier and so on. The first problem is that his leads to bigger and bigger demands across the supply chain making it very hard for companies to deliver rare goods to the right clients.
The main problem with the bullwhip effect is, that demands are volatile and probably won’t keep up high if inventories are full again and the bow wave of the parked demands is processed.
Conclusion
The situation within many logistics departments across the world is horrible these days. Volatile demands, exploding cost and lots of issues to keep the supply chains running. On top of that, probably most of the people around the world are aware of this situation which — even if the teams manage to fulfill demands — often leads to more and more reporting efforts to explain rising cost and to show what has been done to safeguard shipments and ensure a continuous supply.
Nevertheless, the solution for any company must not be higher stock levels. Safety stocks are valid for solving short-term fluctuations and local disruptions. Every extra inventory only is blocked money (being a financial liability) and maybe even environmental waste if demands for a product slump or shorter and shorter product cycles bring new versions into the markets before the stock is processed.
The solution is far more complex: We have to talk about reducing dependencies in the supply networks, more local supplies instead of global chains and using digitalization to increase transparency across all players in the network.
[1] https://sloanreview.mit.edu/article/what-everyone-gets-wrong-about-the-never-ending-covid-19-supply-chain-crisis/ (25.10.2021)
[2] Forrester, Jay Wright (1961). Industrial Dynamics. MIT Press.
