Have Supply Chains Overreacted to the Economic Downturn?

Increased complexity of supply chains, due to globalization trend, is not news to people who work in this field. What is unprecedented, however, is the combination of this complexity with a severe global recession. One of the consequences of this combination is the spread of extra conservative behavior in different stages of supply chains.

In March, Best Buy Co. said it could have sold more electronics equipment in the three months ended Feb. 28, but its suppliers' deep cuts made it tough to keep shelves stocked. Suppliers "all decided to build a lot less," says Best Buy merchandizing chief Michael Vitelli.

reports the Wall Street Journal in its May 18, 2009 article titled "Clarity Is Missing Link in Supply Chain."

The article relates the conservative behavior of supply chains to reduced visibility which in turn is a result of more complexity. For most firms, there are many stages upstream and/or downstream of their complex supply chains. If something goes wrong in any of these stages, which is quite likely in a global recession, the consequences could be severe for the firms.

It is like driving in a road full of unexpected turns and obstacles. If you want to drive in such a road in a foggy night where you can see only a few yards ahead of you, you have no choice but to drive very slowly and with extra caution.

When firms are under financial pressures of a recession, they lose their appetite for any kind of risk. In addition, firms' limited ability to see what is happening in their extensive supply chain intensifies this risk-averse behavior. When most of supply chain stages turn into extra cautious, risk-averse decision makers, the supply chain profit could drop considerably.

To ease this problem, we can look for solutions which either decrease the level of uncertainties or their impacts, or increase the risk tolerance of the supply chain decision makers.

The above mentioned article suggests that we could reduce the level of uncertainties by creating more visibility through information and forecast sharing. That is, different stages of supply chains should share the related information to help each other make more informed decisions. Although, information sharing can always increase the supply chain profit, it has an even more important role when the uncertainties have dramatically increased due to a global economic crisis.

Another solution which might decrease the impact of uncertainties on each stage of supply chains is risk-sharing agreements (contracts). Revenue-sharing, buyback, and quantity-flexibility contracts are among mechanisms which let the stages of supply chains to share the inherent risk and therefore feel less vulnerable to unexpected changes. Hence, the supply chain as a whole could act more aggressively and gain more expected profit.

I am wondering if there are other ways to address this problem. Is there any way that we can increase the risk tolerance of decision makers in supply chains? What do you think?

I should thank my friend Jon Freeman who brought the above Wall Street Journal article to my attention.