The Anti-Lean Global Supply Chain
Updated: Jan 20
If there is excess inventory everywhere, why are we still having supply chain problems?
Yogi Berra, one of the greatest baseball catchers of all time and erstwhile philosopher, was once asked if he ate at a popular New York restaurant. His answer: “Naw, nobody goes there anymore, it’s too crowded.” Huh? This is simply one of a long string of what are called Yogi-isms, which have become the story of legend to the point where Yogi is considered by some to be a Zen Master. There are even multiple books that compile the wisdom of Yogi and his numerous musings on various topics.
One of the defining characteristics of a Yogi-ism is two contradictory thoughts that are simultaneously paradoxical and true. Yogi had an eighth-grade education but was obviously naturally intelligent along with being sly as a fox. He is considered by many to be the best baseball catcher of all time. If winning is the measure of greatness, then he lands on top.
Like a Yogi-ism, today’s supply chains have two contradictory facts that are simultaneously paradoxical and true: excess inventory and shortages. An October Wall St Journal article captures this problem (Choked-Up Yards and Trailer Shortages Box in America’s Truckers; subscription required). This article profiles the challenges of a truck driver in picking up and delivering his loads to a retailer. The article highlights several problems, including:
Trailers not available because they were still sitting with empty containers or were being used to temporarily hold inventory
Containers of inventory stacked on top of inventory that needs to be shipped to a customer
The article profiles several other problems (lack of coordination; lack of documentation), but the two above issues highlight what happens to a supply chain system when there is too much inventory. The inventory for real demand is available, but it is being blocked by inventory for which there is not currently real demand.
This is emblematic of a classic push system in which product is produced and pushed into the supply chain regardless of whether or not there is real demand. But it is not the factories that are creating the orders; it starts at the very end of the supply chain at the retailer and makes it way backwards. Retailers over ordered thinking “if you build it, they will come.” This, along with various other bullwhip driving behaviors caused a massive inventory bubble to get pushed through significant parts of the consumer goods supply chain.
There is also a fair amount of game theory in the overall system, as rational actors (competitors) seek to maximize individual gains, which under certain conditions, results in the overall system significantly underperforming. There is a tendency to think of the overall system as a single supply chain, but is in fact thousands of intersecting supply chains driven by different actors, many of which compete with each other. And, as Bob Crandall, former CEO of American Airlines, once said regarding pricing in the airline industry: “This industry is always in the grip of its dumbest competitors.” For more details on the application of game theory to this and other supply chain problems, see Human Behavior and Aggregate Supply Chain Performance.
How does this line of thinking apply here? When you have many independently operating, often competing actors ordering against many common supply chain assets like factories 10,000 miles away and then using common shipping and storage assets at all points in-between, these said actors make judgment calls that are in their self-interests. Furthermore, these judgements are heavily influenced by the actions of other actors, particularly competitors. Thus starts a complex series of interacting, spiraling, unintended, and reinforcing decisions that are sort of like those expressed in Will Hunting’s NSA interview answer in the movie Good Will Hunting. The result is something that looks out of control; this is what we experienced in 2020 and 2021. When the party ended, the inventory hangover started. We are now in the later stages of working off this inventory hangover.
Let’s Get Lean
Last year the refrain from all corners was “years of cost cutting have made supply chains too lean.” This was deemed to be the root of all manner of problems in global supply chains, including clogged ports, truck, equipment, and labor shortages, and late and missing orders. This conflated the literal meaning of the word lean with the concept of lean manufacturing, ergo, lean manufacturing and all its concepts were over done and had created this mess. The implication was that companies should be carrying significantly more inventory and capacity. Certainly, the capacity of ports and the various assets for moving containers out of ports needs assessment in terms of ability to handle surges in demand.
But sometimes, as George Costanza learned, the opposite is true: too much inventory is the problem, not the solution. Or, as Yogi Berra put it: “No one goes there anymore, it’s too crowded.” To be sure, there are shortages in certain areas, but the current phase of the supply chain saga of the past two years is more characterized by too much inventory than the opposite.
This is anti-lean and is caused by violation of the first principle of lean: drive all operations from real demand and only release material into the system based on real downstream orders. It is important to reiterate that we arrived at this situation through the decisions of perfectly rational actors, each making decisions in their self-interest. These same rational actors are now reversing these decisions by canceling orders. This will surely help to normalize operation of the overall system but may also result in over-shoot, as would be predicted by Forrester and others in the past sixty years.
Is There Really Excess Inventory?
Aggregate global inventory turnover has been decreasing for the past ten years, as shown in Figure 1. In other words, inventory has been growing faster than sales in almost every industry over this period. This is based on analysis of 19 goods producing and product-moving industries comprising more than 3200 companies and roughly $39 Trillion in revenue on a trailing twelve months basis as of October, 2022. A summary of this analysis is compiled into a report that can be downloaded here.
Figure 1 – Global Aggregate Inventory Turns, 2010 to October 2022
The inventory turns shown here are based on aggregate inventories and aggregate cost-of-goods sold (COGS) across all 19 goods producing and product-moving industries across the globe. The data set includes $27.3 trillion in cost of goods sold and $4.6 trillion in inventory for the trailing twelve months as of October 2022. The study data set is large enough that this is deemed to be a strong proxy for all supply chain operations. The formula for aggregate inventory turns shown here is (n=number of companies):
Both COGS and inventories are pegged to end-of-fiscal year results for each company for each year (with the exception of trailing twelve months, which is pegged to the last twelve months of results for each company as of October, 2022).
Since 2010 aggregate inventory turns have dropped by 15%. If these 3200+ companies were operating today with the same inventory turns as in 2010, they would be carrying $640 billion less in inventory. These are stunning numbers.
Let’s examine a couple of things in Figure 1. The first is denoted by the period between the end of 2014 and the end of 2017. This period represents the largest part of the decline in inventory turns (and thus the increase in overall inventories). Detailed examination of this period indicates the drop in inventory turns is due to significant increases in inventory in the A&D, Automotive, Chemicals, Hitech Electronics, Semiconductor, Energy / Utilities, and Oil and Gas industries. Energy / Utilities and Oil and Gas industries can see fluctuations because of rapid and significant changes in input prices. These should be cancelled out because COGS and inventory pricing typically move in lockstep; however, rapid changes may temporarily make COGS prices change faster than inventory values and vice versa. There may also be some companies during this period that were impacted by accounting rule changes regarding the value of inventory carried on their balance sheets.
The second is the decline between the end of 2019 and now. This was undoubtedly caused by the pandemic – first because of a precipitous drop in demand and then by the opposite – a precipitous rise in demand that included panic ordering.
Note: the retail component of the automotive industry is included in the Retail industry, not the Automotive industry.
A Tale of Two Retails
Despite media headlines highlighting excess inventory in the retail industry, inventory turns for this industry have stayed relatively flat. In fact, overall retail inventory turns went up in 2020 and 2021 and have since leveled off to 2019 levels on a TTM basis as of October, 2022.
This is because inventory increases have been largely limited to apparel, discount stores, home improvement stores, and specialty retail. This has been offset by stable or increasing inventory turns in automotive dealerships, department stores, grocery stores, internet retail, and drug stores.
Figure 2 – Retail Segment Inventory Turns 2019 to Current (TTM, October 2022)
Therefore, excess inventory at the retail level and upstream in various supply chains is largely limited to those segments that over rotated during the pandemic, particularly in those areas that supported spending more time at home and related remote work.
Aggregate Industry Inventory Turns, 2019 to Current (TTM, October 2022)
Figure 3 provides more detail on aggregate inventory turns from the end of 2019 to today.
Figure 3 – Aggregate Industry Inventory Turns
Let’s highlight a couple of industries from Figure 3: Automotive and Hitech Electronics.
Automotive dealership inventories are hovering around all-time lows, so why have automotive inventories increased (inventory turns have decreased 12% since the end of 2019). This brings us back to the basic question we posed at the beginning of this article – if there is excess inventory then why do we still have shortages?
The answer in the case of automotive is that the automobile is a complex product with roughly 20,000 detail parts and about 1000 subassemblies. A single part can hold up the shipment of a $50,000 finished vehicle. When that happens, partially finished goods inventory is held upstream and shows up on the balance sheets of automotive OEMs. Furthermore, other upstream suppliers continue to produce; the parts in shortage cause excesses for the other parts that are not in shortage. This is called material coordination. OEMs and upstream suppliers must make judgment calls to either shut down when there are shortages somewhere, or to continue to produce other material flows, and in some cases build finished vehicles that are partially complete.
The irony is that fifteen years ago, automotive OEMs in the US were shipping excess finished vehicles to overflow storage lots simply because dealers had no room for them. Now they are shipping partially finished vehicles to storage lots to wait for parts that will be retrofitted when they arrive.
Automotive has been particularly hard hit by semiconductor supply. In the meantime, the overall semiconductor has gone from shortages to excesses (see the recent Wall St. Journal video “Chip Glut Ripples Through Industry;” subscription required). If the overall automotive industry is making far fewer vehicles than its peak years, why is there a shortage of semiconductors? This is due to several factors:
In the US, the mix of vehicles is skewed towards luxury, which use far more semiconductors than economy cars
The rapid rise of electric vehicles, which also use far more semiconductors than internal combustion engine vehicles
Chips used in hitech electronics and other industries are often not interchangeable with those used in the automotive industry
These factors are gating overall volume output to a level significantly below demand. This gating has also increased pricing power, resulting in significantly higher operating profit margins for vehicle manufacturers. Higher operating profit margins furthermore reduce the incentive to fix the problem. These factors are self-reinforcing, which means it may be some time before volumes return to pre-pandemic levels. In the meantime, demand has been slowing because of inflation and interest rates; this will further slow the rate at which output is increased.
Aggregate inventory turns in the hitech electronics industry fell by a stunning 23% between the end of 2019 to today (TTM as of October 2022).
The story here is simpler than that for automotive – people bought all manner of products associated with remote work, home entertainment, and home appliances at significantly elevated levels in 2020 and 2021. This created a bubble on the long-term trend demand curve for hitech electronics. That bubble has now been deflated, with demand declining significantly. Companies that expected the pandemic demand curve to continue have been left with excess inventories. Previously discussed over-ordering and other bullwhip-driving behaviors added to the excesses currently experienced.
Excess inventory is one of the resulting characteristics of a “push” system. Material gets pushed into the system based on forecasts, without regard to what is being pulled out of the system by end customers. When this goes on for a long time, the system becomes clogged, causing lead times to dramatically increase. This contrasts with a pull system, in which a constant amount of work-in-process (or intermediate) inventory is maintained in the system and new material is only released into the system when finished goods are released out of the system.
In 2020 and 2021, there was a frenzy to push stuff into the system, with the hope that herculean efforts by downstream transportation modes would absorb it. The result was large queues, increased lead times, and in many cases, indeterminate lead times. Today, many of the queues have been cleared, but there is still excess inventory that is causing increased lead times.
This is not to say that all supply chains operate as push systems. Many operate or try to operate as pull systems. However, when you have hundreds or even thousands of supply chains that intersect in a competitive context, even the best pull systems break down. Humans acting completely rationally may be forced to take actions that are not in the best interests of the overall system, because of the need to match their “dumbest competitors,” just as Bob Crandall described in the context of the airline industry of the 1980s.
CONWIP (constant work-in-process) is a term introduced by the book Factory Physics, which was published in 1996. The book uses the idea of constant WIP to describe pull systems and contrast them with push systems. In a factory, CONWIP means that you maintain a constant level of WIP between the start of operations and the end of operations; you only release new material (work) into the system when a finished product is released from the system. Early advanced planning and scheduling systems (APS) were based on this concept through pegging between orders, bills of materials, and routings.
It is difficult to maintain CONWIP in our global supply chain, simply because it is not a single supply chain in which one downstream company is dictating the release of upstream materials into the system. There are many intersecting supply chains driven by thousands of companies with different operating models. These intersecting supply chains use lots of shared transportation and storage assets along the way. Such a system is prone to disruptions. The bigger the disruption, the more out of whack the overall system can become, as competitors vie for shared assets. Thus, while the global supply chain has many issues related to visibility, synchronization, and improved decision making, the human element – in a competitive context – is as important as anything else in creating excesses and shortages.