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Beware the Bullwhip Effect

November 26, 2021

What is the "bullwhip effect" and what sort of risk does it pose to businesses in regards to current demand trends? Catch our newest TrendsTalk episode with ITR Senior Forecaster Connor Lokar to learn more.

 

 

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Transcript by Rev


Hello, everyone, Connor Lokar here, Senior Forecaster at ITR Economics. Checking in for our latest and greatest TrendsTalk. Today, we're talking about the bullwhip effect and the company-borne risk that that could carry for some folks as we head into 2022.

So, what I'm talking about there is the fluctuations in demand signaling and some of the inefficiencies that that can create in supply chains. Obviously, right now, we are in a severely red hot demand environment right now. We're bottom of the funnel base of the channel at the retail consumption level, and we're seeing that trickling upstream in the form of strain for distributors that cannot get product from their manufacturers, manufacturers that cannot get their inputs and raw materials to satisfy this demand. And everyone finds themselves in a similar situation right now, where everyone's chasing, everyone is overwhelmed.

Lead times are getting longer, pricing is going up, AR shipments are falling behind inbound orders, our backlogs are getting longer... Which, most years, that's a pretty good problem to have, though this year it's... Probably feels more stressful than helpful at this point, but that's not going to perpetuate indefinitely.

As folks sit here in budget and planning season for next year, folks are going to continue to chase this demand into next year. But the reality is, is that the demand pressure that we are currently sustaining right now is going to change. It is going to shift. It is going to decelerate and cool off as we move into 2022.

And this can, and likely will, create some risk and problems for folks that do not see this coming. I've read number of articles recently where various supply chain commentary basically says supply chains are, in a word, screwed for one, to three, to five years, some sort of indefinite hurdle where the supply side is not going to be able to catch up. And I think the mistake that a lot of that commentary is making is assuming static demand pressure in line with just the unprecedented, in many cases, inorganically induced demand situation we find ourselves in here, and have found ourselves in for 2021, in terms of the overwhelming pent up demand being unleashed.

Of course, more than $6 trillion in fiscal stimulus support being applied. Inventories that were drawn down, probably appropriately early on in the pandemic last year, that left the cupboards bare for when demand did come back. It took a very unique set of factors to get us here, and those unique circumstances are starting to fade.

I want to share a story with you that a client shared with me earlier this fall at a keynote presentation. And this gentleman, his business, they were a manufacturer. They were in plastic product molding, molding for plastic-borne consumables. Things like kayaks, coolers, and one of their products was gas cans, seven gallon gas cans.

And he told me a story that I thought was interesting. So back in the closing stages of 1999, leading up to the Y2K scare, as some folks were terrified that the world as we knew it was going to end, there were going to be computer system breakdowns, infrastructure failures as we transitioned into the new millennium, and it led to panic buying. Not all that dissimilar to panic buying of different items that we saw last spring in March/April, 2020. But for their particular product mix, it was seven gallon gas tanks. Folks were buying generators in case the grid went down. It was full doomsday prep scenario.

And ultimately, it was fantastic for this manufacturer. They moved multiple years worth of gas cans in a short period, and they drove an associated response at the manufacturing level to make more, to chase that demand, to build up that product inventory. And of course what happened was nothing. The world did not end. Armageddon did not come.

And this manufacturer said that because of the inventory build up that they drove, they did not have to manufacture another gas can until 2005. They basically had built up five years worth of normal year demand in their inventory process in a several month period, in the lead up to 1999, that left them over overly flush with product. So I think that that story...

I thought it was a great story, and he told it better than I do, but I think it's very interesting. Now, granted, ITR's outlook, in terms of demand deceleration next year, is nothing nearly as fatalistic as that, where folks, even manufacturers or potentially distributors, are going to be caught with multiple years worth of inventory that they cannot move. But I think that there are lessons to be drawn there as folks think about their stocking positions in their inventory positioning as they move into 2022, and making sure not to overestimate their demand, particularly as moving into the second half of next year.

Because there's going to be this tendency where folks have been chasing... We've all been chasing for the last several quarters and really making no headway. And what's going to start to transition and happen as we move into 2022, as this demand starts to decelerate, all of a sudden lead times are going to start to get a little bit shorter. Input pricing is going to start to plateau. In some cases, it's going to come down. And there's going to be this tendency and temptation to say, "Finally."

Finally, we can catch up, and over build, and lean just a little bit too far out over our skis, and potentially get ourselves out of position. Stocking up, building up, on record priced inventory, tying up a ton of working capital, just in time for our, right now, overwhelming order boards to become much more manageable and perhaps in some individual company cases, somewhat anemic relative to potential inventory builds that could be happening during that time as we head in that direction.

So, we want to make sure, here at ITR and for the ITR client base, that we're staying sober with our approach, understanding. And we've talked in several blogs and TrendsTalks talks to this point of making sure that we're not straight-lining our forecast. And also really, at the strategic and operational level, making sure that we're really carrying that through, that we're not putting ourselves in a position where we're going to be pulled into some of pricing knife fight, massive discounting, taking losses to move product that we had over accumulated, assuming that our order activity in the fourth quarter of 2022 is going to look as robust as it does in the fourth quarter of 2021.

So, there it is. That's my story, the bullwhip effect. Keep an eye out for it. Make sure that we are staying rational in our planning, not straight-lining our forecast, and keeping an eye on our inventory position as we head into the second half of next year. So with that, Connor Lokar, Senior Forecaster for ITR, signing off. Thank you for joining.

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Since 1948, we have provided business leaders with economic information, insight, analysis, and strategy. ITR Economics is the oldest privately held, continuously operating economic research and consulting firm in the US. With a knowledge base that spans six decades, we have an uncommon understanding of long-term economic trends as well as best practices ahead of changing market conditions. Our reputation is built on accurate, independent, and objective analysis.