Through our collaborative forecast processes we’ve seen a certain amount of conservatism by the OEMs in forecasting parts sales for 2010. The recession’s paradox of thrift took a big chunk out of sales in 2009, but, now with recovery, what about a resounding rebound? Nobody’s looked very hard at the “bullwhip” effect on 2010 sales. This phenomenon, alone, could have as profound an impact as did the recession’s paradox of thrift. We’ve heard that the bullwhip effect could increase enterprise manufacturing sales by 65%, based on negligible increases in end-customer sales. It could lift sales, alienate customers, shift market shares, or most probably do all of this in the most unsatisfactory fashion for the OEMs.
What do brake rotors have in common with disposable diapers? Easy. The bullwhip effect – P&G surfaced this phenomenon in 1990 with supply chain problems seen in its diaper product lines. I was at Colgate-Palmolive as we tried to compete with P&G – they simply dominated in this space.
The bullwhip effect is all about demand magnification throughout the supply chain, caused by a series of independent (and somewhat myopic) reactions of value-chain partners buying inventory in reaction to sales events. As we recover from last year’s recession, consumers will start to buy more … from severely depleted value chain inventories. Delayed maintenance and repair will transition to upticks in dealer businesses, and independent installer business. Who gets what depends on who has what. The surviving retailers out there will have to compete for this uptick in demand and will want to replenish their inventories, both for what is selling and what they think might sell. Distributors will respond to this with orders on their suppliers. How will they react? They will react from the same nexus of fear … fear that they will lose sales and, worse yet, customer purchase loyalty. So, they, too, will have to replenish (probably over-replenish) for what is selling and what their wizards think will sell. And so on as we move along the supply chain. MIT and others have studied this to death. Bottom line is that a link chain of these sorts of reactions will rebuild inventories and enterprise sales … far beyond what actual demand might be. Just as we all were slaves to the Keynesian Paradox of Thrift in 2009, we will be slaves to 2010’s bullwhip. But the big questions are not only how loud the crack will be, but also, who will get cracked?
Let’s walk through this.
Think about a typical customer. Recessionary market research shows that one immediate reaction to the horrific recession was to delay maintenance and repair, drive less, and conserve cash. Customers across all segments showed extreme buying conservation that was magnified by a depression-era attitude of thrift. Now, the interesting thing here is that we saw more survivors than we ever expected in our dealer and supplier groups. How did they survive? Well, they did the same thing John and Mary Doe did; they bought less and lived off, as best they could, depleted inventories. Backorders were not so good, but we all had bigger things to worry about. What about the guys in the middle of all this? The OEMs? In 2009 cash was king; inventory = cash flow. We all did the same things: cut back. All that was okay in 2009, because we had to survive and sales were in a free fall – if nobody is buying anything, then why do we need so much? What did we all hold on to? We kept our mission statements that said the customer was king and that we were all customer centric organizations. Pretty much paranoid about it. So, we worried about dips in loyalty – customer and dealer – but, it looked like we were all in the same sinking boat. So, we were okay.
Just read the papers and you can see that customers are crawling out of their conservation caves and starting to drive and buy more. So, these M&R delay cycles will be reduced and the absolute demand for M&R will increase. Heavy Truck will see the same thing. Ag, kinda. Construction is on a different periodicity with some different problems and non-problems. One thing’s for sure, customers will be out to buy more service in 2010 from retailers with depleted inventories. If parts delays result in service delays, customers will shop for alternatives. We all do this. And, we all know that once a customer strays, it is exceedingly difficult to get them back. Good dealers know this, too.
The OEMs must be asking themselves if they will hear those siren songs of a loud whip crack. There really are two issues: (1) how loud will the crack be?, and (2) will they feel it or will others benefit from it?
How loud will the crack be? One problem is with access to money – money to buy whole goods for sales lots and money to buy parts inventory. Money supply at the regional banks is still very tight and OEM financing is like getting water out of a dry well. The money supply will increase, but at a slower pace than we’d like to see. So, when customers return and ignite the service and parts bullwhip, dealers are less likely than ever to respond with orders that represent inventory expansion. Another “crack muffler” is how well, and effectively, the OEMs have integrated their supply chains. OEMs with few echelons of distribution will have less of a magnification of the link-chain reaction to sales events. Vendor-managed inventory (including ship-direct) and well-executed RIM strategies will also soften the whip crack for the parts they represent. OEMs with high backorder rates and sub-standard supplier responsiveness will find it difficult to improve in these metrics without contributing to the crack of the whip. Similarly, if your inventory management and forecasting systems are old and squeaky, and you’ve reduced staff support in this area, it is time to look for another job. Since this “magnification” represents OEMs buying more inventory, that’s probably not going to happen in 2010. So, certain, let’s call them “unsatisfactory,” levels of service are bound to persist throughout 2010.
So, who benefits from the whip crack? Darwinian evolution has left us with a pretty smart group of dealers. In the absence of improvement from the OEMs, they will simply increase their purchases from the independent aftermarket, because then they can “kan ban” production in their service department with parts deliveries every 45 minutes. This makes sense – the independent aftermarket’s supply chains generally emerged much healthier than the OEM’s after 2009’s market collapse. Think of the “whip crack” as resulting in a certain amount of parts sales from either magnified inventory replacement or market share shifts. The whip is certain to crack. Some OEMs will change and benefit. Others will suffer from lower dealer purchase loyalty and market share shifts.
The bullwhip is just as inevitable as the thrift paradox. The big question is who wins and loses from the crack of the whip. You will know you have trouble if your backorders are at all-time highs – this means that your suppliers have cut back capacity and operating costs. If your supplier on-time performance is low, then you know that you are at the back of the food chain when the kitchen warms up. In fact, if there’s any truth to the science of the bullwhip effect, inevitable replenishment order magnifications will place significant order increases on first/second/third tier suppliers. This, coupled with tightened supplier capacity and diminished labor forces, means that things can only get worse. If RIM compliance is an issue or your RIM parts represent a narrow range this is a danger signal. Well-running ship-direct strategies are winners. Look at your average dealer inventories. If they made significant cutbacks, then they will be unprepared for the recovery. Now, I don’t want you to worry about them – they know how to survive. They will take care of their customers; if you don’t step up, it just won’t be by using the stuff OEMs sell them. They will apply Toyota Production principles, just like the OEMs do, and get it from suppliers who can get parts to them just in time for the service event.
If it all looks bad, what do you do? (1) Really focus on RIM performance and compliance, and (2) you will need to change your terms and conditions to be much more favorable than the aftermarket, especially payment terms. If you can’t do this, you should talk to your Fidelity rep and buy aftermarket stocks for your 401K.