Bad assumptions, more stock-outs
By sticking with 'violated assumptions' used to determine appropriate safety stock levels, we're making supply shortages worse
Welcome to the sixth edition of The Fifth Wheel with Bill Cassidy, a weekly look at a particular aspect of trucking and transportation that’s on my mind or in the news or just caught my eye. Something of a reporter’s notebook. I’ll also post occasional insights and reflections on transportation history.
“Everybody is asking why we are running out of things. It’s because we’re violating the assumptions of how we set safety stock.”
-- Jason Miller, Eli Broad College of Business, Michigan State University
We’ve all experienced the COVID-19 stock out. An item we expected to be in the store, or available online, just isn’t there, or anywhere. Last year, it was toilet paper and hand sanitizer. This year, it’s anything from cars to plastics to ammunition to sofas.
But wait, the economy is well into its recovery phase, right? Shouldn’t such stock outs be last year’s problem? Alas, no. The US economy is expanding at an impressive rate — 6.5 percent sequentially in the second quarter according to IHS Markit, with a 6.1 percent growth rate expected for 2021. But that rapid consumer-driven growth is contributing to supply chain disruption that causes shortages.
Those shortages could get worse this year, not despite the massive wave of containerized goods hitting US shores, but paradoxically because of them. We can’t order and ship enough to meet demand.
Of course, the disruption manifest in goods shortages is tied to COVID-19. An outbreak in Malaysia that interrupted the already tenuous supply of semiconductors led to the shutdown of Nissan’s Smyrna, Tennessee, plant this month, a closure now extended into September. That story echoes not just among automakers but from industry to industry.
However, it’s not just COVID-19 outbreaks, a lack of containers, port congestion, or a truck driver shortage that’s to blame for supply chain disruption. Blame also our recurring inability to accurately forecast how much stock we need to meet consumer demand, and a predisposition to underestimate the amount required.
We’re "violating the assumptions” we use to determine appropriate levels of safety stock said Jason Miller, associate professor of logistics at Michigan State University. And those violations are going to cause physical goods shortages as long as demand remains high. They will actually make them worse, he told me last week.
“One of the assumptions we make when setting safety stock levels is that lead times are uncorrelated day-to-day,” Miller said. In other words, the reasons the lead time for one order may be lengthened do not necessarily recur with the next. Delays also are assumed to be uncorrelated, so one delayed trans-Pacific crossing doesn’t mean the next voyage from the same port will be delayed. That’s not the case today.
“In a period when you have massive amounts of panic buying, those assumptions break down. That’s why we ran out of everything in March 2020,” he said.
And it’s still happening. Across many industries, orders are at record highs, and that’s buckling supply and transportation networks. And as delayed deliveries multiply, vendors look for more stock — and you can see we’re headed back in a circle to square one. “Lead times for orders are now positively correlated, and if your lead time today is now longer than usual, the next time will be longer, too,” said Miller.
That means you need to carry more safety stock, he said. But for a generation of logisticians, safety stock was something to keep as low as possible.
“People had the ‘inventory is bad’ mindset, and now people are saying ‘I wish we had inventories,’” said David Correll, co-director of the MIT FreightLab at the Massachusetts Institute of Technology. A basic principle of logistics was that “an effective supply chain manager minimizes money tied up in inventory,” he said.
This two-year (so far) period of supply chain turbulence may change that, he said, especially among young logistics managers beginning their careers.
And as e-commerce reshapes distribution networks, it’s time for a reset in our assumptions about how much safety stock we need to build up and keep. “Unfortunately, the way we figure out safety stock levels is complex,” Miller said. “The assumptions about lead times and delays are there to make things easier. Without them the math gets ugly real fast.”
Inventories levels in many industries are rising, with US business inventories rising 6.6 percent in June, according to the US Census Bureau. But US business inventory-to-sales ratios, a measure of how many months it takes to deplete inventories, have been dropping, falling to 1.25 in June compared with 1.41 in June 2020, 1.42 in June 2019.
Because inventories-to-sales ratios are still substantially below where they were pre-COVID, “we need more safety stock today than we had pre-COVID just to deal with the violated assumptions,” said Miller. “We don’t even have the regular inventory to cover it. So high demand will result in substantial stock-outs.”
Warnings about consumer goods shortages that could “cancel Christmas” may exacerbate the problem by encouraging the type of panic buying that creates shortages. This may be a good year to just put some cash in an envelope under the tree — if you can find a Christmas tree, that is.
Here are some recent stories related to this topic from the folks at JOC.com:
Port congestion sapping major Asia-US ship capacity injection (Aug. 30, 2021)
Trans-Pacific schedule reliability slid again in July (Aug. 26, 2021)
Ocean delays lengthening already stretched US inland transits (Aug. 24, 2021)
And also, a detailed Substack column on changing retail inventory strategies from my friend and colleague Cathy Morrow Roberson, senior contributor to JOC.com:
Thanks for subscribing to this newsletter. For those that don’t know me, I’ve been the senior editor for trucking and domestic transportation at The Journal of Commerce and JOC.com since 2009. Before that, I spent 13 years as an associate, managing and executive editor at Traffic World, a weekly magazine once owned by the JOC.
I began my career at McGraw-Hill, working as an intern at Electrical Marketing Newsletter before being hired full-time by Fleet Owner, a monthly trucking magazine.
The luck of the Irish occasionally holds true, as my first editor at Electrical Marketing was Keith J. Kelly, the reporter’s reporter, who spent the last 23 years writing the Media Ink column for the New York Post. I learned more from him about covering beats, working sources, and developing a nose for news than I would have from four years at a top J-school. Really, you could say he saved me a lot of money.