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What now for supply chains?  Inflation, e-commerce and over-stocking are all driving change

Published 17 March 2022 in Supply chain • 4 min read • Audio availableAudio available

Economic growth is being driven in part by supply chain dynamics. The confluences of forces might bring about a new paradigm in supply chain inventory management and perception of excellence, argue Ralf W. Seifert and Richard Markoff.

 

Inventories are front of mind

Quarterly US GDP would not normally be considered a matter for supply chain professionals, but we are in strange times. US GDP grew at an annualized rate of 6.9%, a robust figure that is being attributed in large part to inventory growth, as companies look to restore stock levels depleted by the global shipping crisis. It’s worthwhile to take this moment to consider the implications this, and other dynamics, may have on working capital levels and supply chain management as a whole in the coming months.

The Inventory Bounce

Reconstituting inventories right now may have surprising impacts on the long, and still sluggish, global supply chains. The restocking is in fact a form of “inventory bounce”. The increased production that enabled the increase in inventory levels in turn surely increased demand from upstream supplies, their upstream suppliers, and so on. The demand signals moving up the stream may be very difficult to identify and distinguish from genuine increases in demand. The risk for confusion is higher knowing that demand for goods is at an all-time high, as consumers spend less on services during the COVID-19 omicron wave.

This is a classic root cause for the bullwhip effect: the obscuring of true demand signals with changes in inventory holding policy. Surely not helping is the light being shone on just-in-time supply chains. Some companies may be looking to increase their baseline safety stock levels after the painful experience of the last few months of shortages, making for a complex blend of inventory restocking, inventory resizing and high demand all occurring in parallel.

If all of this weren’t enough, there is another very understandable phenomena adding to risk of demand distortions that lead to bullwhip effects. With so many shortages over the past few months, it is not surprising that many companies have engaged in “shortage gaming”, asking for more than they need in order to secure more inventory, production capacity or even container space. The crisis in Ukraine can only serve to further cloud the picture.

Warehouse operer
“With so many shortages over the past few months it is not surprising that many companies have engaged in ‘shortage gaming’, asking for more than they need in order to secure more inventory, production capacity or even container space.”

Inventories and Inflation

There are other macro-economic forces currently at work to further confound supply chain visibility and drive up inventory levels.

The U.S. inflation rate just had its highest year-on-year increase in 40 years.  Why is this important for supply chain managers?  Well, for those that like to get into the weeds, it can hopelessly distort calculating inventory turns, but there is a more strategic concern.  In a high inflation environment, it can make more sense to build inventory now, knowing that it can be sold for more over a short period of time as its price increases rapidly.  In a sense inventory can be seen as appreciating rather than depreciating in times of high inflation, a dynamic observed in the past in BRIC countries undergoing very high inflation. 

By squinting just a little, this looks a lot like a price speculation distortion, another classic root cause of bullwhip effects.

A hidden impact of Covid

All of these root causes help explain the inventory increase driving GDP growth. And the result is starting to be felt. Warehouses across the US are virtually full, with free capacity of less than 4%, and this despite having more warehouses than ever before.

Though inventory restocking and the adjacent demand distortions are certainly factors, there is one last element to consider: the exploding share of e-commerce during the pandemic and its accompanying consumer expectations. E-commerce now accounts for about 20% of global retail sales, and consumers are demanding ever-faster deliveries.

More e-commerce with shorter transportation times inevitably leads to more warehouses that are closer to more consumers. And the growth of these inventory positions mechanically leads to more overall inventory, through a well-worn but well-proven heuristic called the square root rule. So even if there were none of the supply chain distortions we have seen recently, inventory and warehouses would still be increasing.

A new era in supply chain excellence

There was time a few years ago where keeping inventories low was a sign of an efficient, well-managed supply chain. The best companies attacked bottlenecks and constraints and lowered inventory across the chain. As supply chains struggle with the impact of the events in Ukraine and the aftermath of COVID-19, it is not clear when or if that time will return. After all, inventories are not merely another cost, they do serve a purpose.

Issue 5

Current Issue

Inventory of change

The disruption of production from smartphones to furniture wrought by the COVID-19 pandemic has brought home the importance of global supply chains to every customer. But what have been the fundamental shifts and advancements in supply chain management over the period? Inflation, e-commerce and geopolitcal conflict are all driving change. In Issue V of I by IMD, we explore what is next for supply.

Explore issue VMore about Supply chain

Authors

Ralf Seifert - IMD Professor

Ralf W. Seifert

Professor of Operations Management at IMD

Ralf W. Seifert is Professor of Operations Management at IMD and co-authoredThe Digital Supply Chain Challenge: Breaking Through. At IMD, he directs the  Digital Supply Chain Management program, which addresses both traditional supply chain strategy and implementation issues as well as digitalization trends and new technologies.

Richard Markoff

Richard Markoff

Supply chain researcher, consultant, coach and lecturer

Richard Markoff is a supply chain researcher, consultant, coach, and lecturer. He has worked in supply chain for L’Oréal for 22 years, in Canada, the US and France, spanning the entire value chain from manufacturing to customer collaboration. He is also Co-Founder and Operating Partner of the Venture Capital firm Innovobot.

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