Burnt by the bullwhip effect

Wednesday, 1 June 2022 — Albert Park

[7 min read]

Dear Reader,

In today’s edition of The Daily Reckoning Australia, Jim Rickards looks at the science of risk in the context of the supply chain collapse we are currently facing.

This science makes something very clear — the massive impact that seemingly small events can have on complex supply chains.

To see how this works, read on below…

Regards,

Callum Newman,
Editor, The Daily Reckoning Australia

Dear Reader,

Analysis of complex systems dynamics begins with the principle that minute changes in inputs result in catastrophic changes in outputs due to exponential recursive functions. Here’s a good example of how sensitive the supply chain is to the smallest changes in input. It comes from Daniel Stanton, one of the world’s leading authorities on supply chain management. He describes a phenomenon called the ‘Bullwhip Effect’:

‘A customer comes in to buy a widget, which turns out to be the last widget in the store, so the store needs to order more inventory from its wholesaler. But the wholesaler doesn’t sell individual widgets; it sells widgets in cases of 100 units. Now the store has to buy a full case — 100 widgets — even though it sold only one. If that case was the last one in the warehouse, the wholesaler will replenish its inventory by ordering more widgets from the factory. The factory, however, sells widgets in batches of 100 cases, so the wholesaler has to buy 100 cases of 100 widgets each. The wholesaler just bought 10,000 widgets even though it sold only 100.

‘How many widgets did the factory sell? 10,000. How many did the wholesaler sell? 100. And how many did the customer buy? Yep: 1. A small demand signal at the end of the supply chain became amplified at every step, creating a Bullwhip Effect on inventory. The store may never sell another widget, so it would still be stuck with 100 widgets in inventory…All that inventory costs money for everyone in the supply chain without adding any value.’

Of course, there are remedies for the Bullwhip Effect. Factories and wholesalers can sell in smaller batches. All parties in the supply chain can get better at forecasting so they can place orders before inventory runs so low. The store, the wholesaler, and the factory can improve communications to help do a better job of managing inventories.

Still, the Bullwhip Effect is real. The point of describing it is not to critique supply chain participants, but to illustrate the acute sensitivity of global supply chains to the most minute perturbations.

How extensive is the supply chain crisis today? The chart below provides a partial answer by showing the percentage of manufacturing firms reporting shortages of materials and equipment in the UK, eurozone, Australia, and Canada.

In the past year that percentage has spiked from a range of 5–15%, to a new range of 25% (Australia) to 63% (the UK). This is far higher than the range of the past 40 years and the highest since the Arab oil embargo of the mid-1970s:

The US$400 million lightning strike

Supply chains also have embedded risks that often aren’t understood or properly managed by supply chain participants. One example is ‘the US$400 million lightning strike’ from the book Resilient Enterprise by MIT Professor Yossi Sheffi, as described by Daniel Stanton:

‘Two cell phone companies bought their processor chips from the same manufacturing plant in New Mexico. One day, the manufacturing plant was struck by lightning, which started a small fire in the facility. One of the phone companies realised how serious this problem was and immediately started sourcing ships from other suppliers. The other phone company assumed that the chip facility would be repaired quickly, so it waited.

‘When the repairs took longer than expected, the phone company that chose to wait wasn’t able to get the parts it needed and had to shut down its entire supply chain. The lightning strike had a modest financial impact on the suppliers, but it cost the unprepared customer $400 million in lost revenue.’

The first company engaged in rapid response. The second company engaged in wishful thinking. The fire that shut the manufacturing plant might only have cost a few hundred thousand dollars to repair. But the damage to the second phone company was US$400 million in lost sales. Again, this demonstrates the exponential impact of small changes in large, complex systems. Understanding how complex systems operate is the first step in the efficient risk management of supply chains.

The global supply chains were created, and the cost savings were realised, but now the hidden costs are being revealed. Global supply chains are extremely vulnerable to even minor disruptions. Major disruptions have occurred, and those supply chains are in disarray. The main question for consumers and investors is whether these disruptions will get worse…and I’ll give my answer to that in my next edition of The Daily Reckoning Australia.

Regards,

Jim Rickards,
Strategist, The Daily Reckoning Australia

This content was originally published by Jim Rickards’ Strategic Intelligence Australia, a financial advisory newsletter designed to help you protect your wealth and potentially profit from unseen world events. Learn more here.

Dear Reader,

Prices rising. Shelves empty. This is a ‘good thing’, isn’t it? It’ll mean less consumption, less production, less CO2 in the atmosphere, lower standards of living, people will get less of what they want…and they’ll be poorer. But it will save the planet, right?

Right.

Yesterday, we made some suggestions about how you can enjoy your indigence with a sniffy, superior air.

Today, we focus on the bigger picture, the whole economy. How can we impoverish other people too? And here we connect some big, fat dots.

Let’s look first at the basics.

Home to hovel

You don’t have to do anything to be poor. In fact, for an individual, the less you do, ceteris paribus, the more poverty you get. Poverty is easy. It gives you plenty of time to read The New Yorker magazine, update your Facebook page, or watch CNN.

Prosperity, on the other hand, takes work, self-discipline, investment, learning, savings, innovation — and a few rules. Respect for each other’s property is one of them. If you can’t hold onto your stuff, it won’t work.

A rich man’s house, for example, is the product of many generations’ worth of trial and error…and a multitude of inputs by skilled artisans and engineers — with HVAC systems and stylish mouldings…and carefully laid tile work…expert carpentry…and all the other things that go into a modern, expensive house.

Nobody would bother to build such a house if he thought it might be taken away from him.

The poor man’s house, by contrast, is a hovel, little changed in the last 2,000 years. In our area of Argentina, for example, people still live in mud huts. Mud on the floor. Mud on the walls. Mud on the roof. Few inputs. And those few are rude, rustic, and unskilled. Doors are made of wooden planks held together with rawhide strips. There is no plumbing (and until recently), no electricity.

Poverty is a natural condition. But it’s also natural for people not to want to be poor.

The human species was barely better off than orangutans for the first 290,000 years of its existence. People lived in small family or tribal groups, with little change from one generation to the next. It’s only in the last 10,000 years or so that it has made much material progress.

And now, people can get ahead in life…and live in comfort, with the satisfaction of getting richer than their brothers-in-law. They innovate, work hard, go to college, etc. As if by an ‘invisible hand’, are they guided to win-win deals, giving to others so that they get from them what they want too. One learns how to treat cataracts. Another builds treehouses. Progress is made.

Left alone, in other words, growth happens. Wealth increases. And ‘the people’ are better off.

From riches to rags

So if we want to move the meter in the opposite direction — towards poverty — we’re going to have to backtrack; we’ll need to get control of ‘the people’. We can’t allow them to do what they want…live their lives the way they want, trying to get what they want by working, saving, building, learning, inventing, etc.

Prosperity depends on letting ‘the people’ do their thing. But degrowth and poverty depend on stopping them. And that’s what the feds are for. If they’re going to make us poorer, they’ll have to step up to the plate…and whack us with the bat.

And they have plenty of models and ‘five-year plans’ to guide them. North Korea, for example. Cuba. The Soviet Union. Baltimore.

There’s a reason South Korea is a lot richer than North Korea. The difference is public policy. The latter is a society tightly controlled by a political elite, swinging a big stick. The former is a ‘light touch’ society, with much more individual freedom.

So if poverty is the new prosperity, we will have to imitate North Korea, not South Korea. The North Korean deciders know how to stimulate poverty, and they’re good at it. And the North Korean people are model citizens for the Brave New World of planet-savers. No Hyundai for them. No Samsung. No Korean barbecue. No Squid Games. No passports: if they were let out of the country, they may not return.

Few of them have cars. They eat little…and very little meat. Their clothes are drab. They rarely travel…almost never leaving the country. In short, they use little fossil fuel. The Davos elite applauds their tiny carbon footprints. And some are even virtuous enough to starve to death.

The eight-fold path…to poverty

Right. So let’s get into it. How can we make the US more like North Korea?

Oh…and why not go all the way? Design a new emblem for the country. Forget the stars and stripes — depicting independent, sovereign states. A picture of a dead sheep would be more appropriate. Like the Brooks Bros. logo, with the sheep upside down, its legs sticking up, it can be emblazoned on sweaters or jackets, marking wearers as obedient comrades…loyal dimwits…and reliable stooges.

Make wearing it obligatory.

Regards,

Bill Bonner,
For The Daily Reckoning Australia