Updated: Feb 10
Floating bottlenecks caused by a confluence of factors roil global supply chains.
I’ve been in many complex factories that are made up of primary operations that feed manufacturing operations which in turn feed assembly operations. The primary operations might involve heat treating and machining; these operations are followed by inspection and then subassembly. There might be multiple primary and manufacturing operations creating multiple sub-assemblies that then feed final assembly.
The most difficult of such factories to manage are those that are capacity balanced. What does this mean? A capacity balanced operation in this case is one in which the respective capacities of the primary operations, manufacturing operations, subassembly, and assembly operations match each other closely. Furthermore, factory capacity closely matches demand.
Capacity balanced – in name –sounds like a good idea, doesn’t it? Wrong. In the presence of any level of variability, capacity balanced situations lead to floating bottlenecks, which create the commonly known “whack-a-mole” problem. You cannot “gate” factory output to any one operation; each operation must execute within a precise window of its stated capacity for the overall factory to operate smoothly. Otherwise, on Monday your problem might be primary operation A, on Tuesday subassembly operation B, and on Friday subassembly operation C.
Such a dynamic is playing out in a big way in today’s global supply chains, particularly as it relates to downstream distribution in the US. The most visible manifestation of this is the number of ships sitting off the coast of California. News crews can fly over and take pictures of ships and the lengthy lines of trucks backed up to pick up and drop off containers. What they haven’t taken pictures of is the inventory at all downstream stocking points. When the capacity of the port matches the capacity of the trucks which matches the capacity of the importer warehouses, which matches the capacity of the retailer warehouses, you have a capacity balanced situation, which leads to floating bottlenecks, ergo the whack-a-mole problem.
Capacity balanced situations are particularly vulnerable to variability and volatility. It’s safe to say that both variability and volatility (for a discussion of both see Supply Chain Volatility) have been at all-time highs over the course of the past 18 months. This includes rolling shutdowns, worker shortages, equipment shortages, and gaming-the-system ordering.
Overlaid on top of these structural problems are bullwhip-effect behaviors, which are making matters worse.
What About the Bullwhip Effect?
Let’s examine bullwhip effect behaviors and see if they might be present in today’s global supply chains.
Lee, Padmanabhan, and Whang showed in their paper of more than twenty years ago that the bullwhip effect is the result of four sources – demand signal processing, supply shortages, order batching, and price fluctuations. These four sources were previously discussed in Forrester’s work, about sixty years ago (Forrester discussed them in terms of order and inventory policy, limited factory capacity, advertising, and order handling). Forrester also discussed at length the impact of information processing delays. Below is a description of the sources of the bullwhip effect, along with an assessment of whether these are exacerbating today’s supply chain problems (Note: this is a subjective assessment).
Demand signal processing – this means that end-of-the-supply chain real demand changes are distorted as they are translated into upstream orders (i.e., as the demand signals are processed). Demand signal processing is the process of taking a demand signal and translating into an upstream order. Forecast updates based on recent demand signals tend to exaggerate the update in the direction of the recent demand signals. Furthermore, the amplitude of the distortion increases with the replenishment lead time. Assessment: it is likely that this behavior is happening to a greater extent than normal in today’s supply chain environment.
The rationing game – this behavior occurs when there are supply shortages. It involves the behavior of customers when an upstream supplier must put customers on allocation because of shortages (for whatever reason). The game goes something like this: If the downstream customer node anticipates that it will be put on allocation by an upstream node (e.g., a manufacturer), it will rationally increase its order to try to get a larger percentage of the pie relative to its competitors. In situations where demand for an item has increased, the rationing game adds to the distortion caused by the previously discussed demand signal processing. Assessment: it is likely that this behavior is widespread in today’s environment. The media is adding to this every morning by exhorting consumers to “order early, order soon.”
Order batching – in the case of multiple downstream customers, said customers may have different ordering patterns, based on different economics. These orders are consolidated at upstream nodes. There may be cases when many or all orders arrive in the same time bucket, leading to upstream distortions. Some of this is driven by company order patterns that overlap (company A and company B order at the same time), and some is driven by dynamics specific to certain industries and products. An example of the latter is the hockey stick end-of-quarter orders prevalent in many B2B industries. Assessment: there is no reason to think that today’s environment is causing any more or less of this behavior.
Fluctuating prices – Time-windowed pricing strategies requiring time-windowed ordering results in upstream orders differing significantly from downstream demand. This is particularly true when end-consumer pricing is not synchronized with upstream price changes. When prices are relatively low, downstream customers will order more during the period under which the low price is in effect. Conversely, when prices are relatively high, customers will order less during the period. This behavior is typically seen most notably in promotion-driven industries such as CPG. Assessment: in today’s price inflation environment this behavior might be widespread across all industries, as each upstream node announces price increase deadlines to their customers, causing customers to pull ahead orders.
Information delays – Feedback systems with information delays tend to distort responses.
For example, a 10% uptick in real demand at a retailer that is seen by a distributor a week later will tend to result in a larger than 10% response. Companies without strong visibility capability (either technology or process-driven) will experience delays in understanding the actual status of their orders. This will cause them to react by changing, deleting, or adding to their orders. Assessment: it is likely that this behavior is widespread in today’s environment.
The clear conclusion here is that bullwhip-driving behaviors are distorting today’s supply chains, which are already struggling with underlying structural capacity problems.
Is Too Much Demand the Problem?
Demand for certain products (furniture, exercise equipment, home improvement goods) has increased significantly above 2019 pre-pandemic levels. The overall US economy is expected to grow 6.5% in 2021 over the recessed levels of 2020; this represents a 4% increase over the more normal levels of 2019. That doesn’t sound like the kind of demand increase that would send supply chains into the tank (obviously, supply chains are constraining the growth numbers, but only by something like one half to one and a half percentage points).
What about imports and exports? The following graph (from US Bureau of Economic Analysis data) shows US imports and exports in real dollars (not inflation adjusted) for the years 2018 to the present. This shows that the sum of imports and exports for the eight months through August 2021 is 23% above 2020 levels and 7% above more normal 2019 levels (for the same period). Obviously the 23% number is extraordinary and represents the starting and stopping of the economy and associated supply chains. The 7% number is large but sounds like something supply chains should be able to absorb, albeit with some level of strain. (It’s important to note that demand is above this number by the amount of the backlog).
Through August, compared with the same period in 2019, imports were up $163B (13.7%) and exports $36B (3.3%). Interestingly, the import increase of $163B is about 21 days worth of imports, which is slightly higher than the queue that was sitting off the coast of California at the end of August (LA and Long Beach had 48% market share of container imports in the US in 2020 ).
It's clear the starting and stopping effect has had an outsized impact on supply chains. An immediate snapback in demand in 2020 created backlogs that have only elongated through time (for many of the reasons discussed above).
The Way Out
In situations like this, bottlenecks float daily so that it appears that bottlenecks are simultaneously occurring everywhere, which is in fact the case. The only way out of this situation is to a) lower demand below capacity; b) raise capacities everywhere significantly above demand; c) significantly reduce variability and volatility; d) improve synchronization between operations along the chain; e) reduce bullwhip-causing behaviors (discussed above); or f) some combination of the above.
Furthermore, when it comes to capacity, it’s the right type of capacity that must be added. The skills and equipment need to match the demand. In addition to the capacity balanced problem, right now there is a significant synchronization problem between operations along the supply chain. Capacity is often available, but it’s not the right equipment or skills to match the load that needs to be moved. How much of the problem is related to this? It’s impossible to know, but it’s safe to say that if exact matches were available at each point along the chain, the backlog problem might be significantly reduced. It’s clear that running port terminals longer hours (alone without other changes) is not going to solve the problem, even if they had the space for offloaded containers.
When will things moderate? This is the question asked of CEOs everyday on the TV business channel. Some are saying these problems will last well into 2022, and some 2023. There is no way of knowing accurately; in today’s environment agility becomes even more important. Structural problems require time to sort out; in this case the solution requires cooperation, coordination, and synchronization of hundreds of parties across the end-to-end supply chain, which is no mean feat. Furthermore, simultaneously raising capacities at all points along the supply chain may encounter hard and competing constraints. Labor shortages are one such constraint; the cooperating parties are trying to hire the same constrained resources.
It's no doubt that things will eventually moderate. An important question is: what will things look like when they do? If the bullwhip effect is part of the problem, history tells us that we might have the opposite problem when the shortages go away. What does this mean? By 2023 or thereafter, in certain industries, we might be looking at excesses.
Only time will tell. In the meantime, winning will go to the agility leaders. All companies should be using this challenge as an opportunity to increase their agility. We will address the general topic of agility in a later article (to understand its importance, see “Supply Chain Management and Dealing with the Unknown”).