Can effective Supply Chain Management impact the effects of the Financial Downturn

The financial crisis, triggered by the bankruptcy of Lehman Brothers in September 2008, resulted in a spectacular dip in industrial production in, 2009, 2010 and into 2011. However, over the same period, retail sales remained fairly constant. Was it therefore the reaction of the manufacturing companies in adopting overtly cautious inventory strategies through de- stocking and re-stocking, resulting in real demand being distorted along the value chain, that accentuated the crisis or could closer monitoring of 'actual' consumer demand provide a truer picture of consumer confidence?

The economic recession in 2008-2010 caused significant turmoil in the business world - especially in the manufacturing sector. When tracking the index of retail sales against the indexes of production and industry sales over the period from 3Q 2008 to 3Q 2010, the index of retail sales remained fairly constant, averaging 98.5 over the period. While the index of production ran considerably lower, hitting a low of 85 in 2Q 2009, which presents clear evidence there was an over-reaction to relatively small fluctuations in retail sales.

When you also track the percentage change in value add in the manufacturing sector in 2009 compared to the corresponding period in 2008, versus the percentage change in final consumer consumption, the figures show that consumer sales dropped marginally, whereas production dropped dramatically.

Why therefore was the over-reaction so dramatic and why did it happen so quickly?

As the variation in consumer demand increases, demand variation increases at each stage of forecast level of the supply chain process - from retailers to wholesalers to manufacturers and their suppliers. In other words, small changes in consumer demand become amplified from customer/consumer throughout the supply chain. In many cases, this happens because an individual link in the 'value chain' will forecast its desired final inventory and production level, mainly on the production needs of its direct customer and not on the demand at the end of the value chain. So any demand variance is exaggerated through out the supply chain from first tier to second tier and third etc.,

The demand decreases in this recent crisis were significantly enhanced than in previous economic downturns as a result of the catalyst being the bankruptcy of Lehman Brothers and the subsequent credit crisis that ensued. Companies increasingly focused on cash as a result. Minimising capital expenditure and reducing their working capital, which meant, organisational restructures and optimisation of inventory holding. The latter being most poignant during this time in having a significant 'domino effect' on their supplier base first, second tier and beyond.

The second half of 2010 saw a surge in orders and an overall improvement in consumer production. With supply chain over the last two years focusing on inventory reduction and lacking the confidence to invest, this surge created a number of inefficiencies. The main reason for the growth was not that consumers were buying more, but businesses stopped reducing inventories and, therefore, had to produce more of what they sold. As production needs rose rapidly, companies who had cut inventory severely due to the crisis had challenges satisfying the new demand. Manufacturing capacity was insufficient due to the reluctance to invest and insufficient inventory result in a lack of rigidity and low fulfilment rates.

There are pros and cons to the contraction and expansion cycle in the consumer sector as a reaction to the financial crisis. Pragmatism surrounding supply chain strategy is justified in economically turbulent times. However, it could be said that in this case the 'right-sizing' was actually an over-reaction. Flexibility is not the issue - it's over-reaction that has to be avoided. What is missing in global supply chain networks is end-to-end visibility or multi-tier supply and demand visibility.

The right people, systems and processes have to be in place as does cross functional relationships and communication channels. This has resulted in the continuing rise of initiatives such as S&OP(sales & operational planning), IBM etc., and customer supply orientation, which should be corporate initiatives versus functional. It is essential for companies to really know their end markets, as misaligned inventory practices and 'real demand' distortion can play their part in adding further instability against a backdrop of financial uncertainty.

As a rule, manufacturers should gear production closely to the real-world demands of distributors and retailers. However, the magnitude of the financial crisis caused a lot of companies to react in panic. Seeing their revenues and profits declining, they chose to aggressively cut costs.

The more pessimistic economists warn of a so-called 'double dip' recession, where a small recovery after a crisis is followed by another recession. In the current economic environment, the possible causes of such a double dip could be a slowdown in demand for goods and services) or continued layoffs despite economic recovery, reducing consumer demand.

Recently Tesco, started its price war after cutting the cost of 3,000 products in response to cash-strapped consumers shopping around for the best deals. Initiatives of this nature, benefit the consumer in the short term, as competitor retailers align their strategies to match these reductions. However, there will be no doubt concurrent marginal pressure put on suppliers by the retailers as a result, which has economic implications in their own right.

There should be a degree of optimism as a consumer sales in the first quarter of 2011 and beyond seem promising but effective and close monitoring of consumer demand and confidence need to be continuous to ensure any economic fluctuation is not exacerbated.