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February 2011 Business Topics
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Kouvelis: Flexibility is Best Defense Against Risky Supply Chain Dynamics

By Dan Markham, Senior Editor

Risk is an inherent part of life in any supply chain. But the recent economic crisis and its aftermath have made life even more challenging for metals service center executives, said Panos Kouvelis, an Emerson distinguished professor of operations and manufacturing management at Washington University’s Olin Business School in St. Louis.

“Supply chains were always risky. Now they’re riskier,” Kouvelis told attendees of the Metals Service Center Institute’s Tubular Products Conference last month in Phoenix.

Managing through these riskier times requires an understanding of what causes some of the uncertainty in the supply chain, and what steps can be taken to minimize its effects.

Among the increased risks facing metals distributors is the fluctuation in exchange rates, a problem that’s become more urgent as the marketplace has become more global. The dollar, the yen and the euro experienced considerable movement throughout 2010. That is not likely to change going forward as inflationary fears persist in many of the world’s largest trading nations, Kouvelis said, particularly in emerging markets such as China and India where the expectations for inflation are strongest.

Also factoring into the risks for metals distributors are the fluctuating prices for critical industry commodities, including many of the steelmaking raw materials, as well as rising oil prices. Service center executives determined to reduce the amount of risk in their operations must monitor all of these conditions closely.

Just as important, Kouvelis said, is truly understanding what historically has created risk in the supply chain. The biggest factor behind all the uncertainty in distribution remains the “bullwhip effect.”

Defined simply, the bullwhip effect is caused by the uncertainty in demand forecasts and the natural tendency of suppliers to order more goods than necessary to make sure they don’t run out. In any chain, the farther one gets from the end-user, the larger these “safety stocks” become.

Kouvelis cited four key reasons for this phenomenon: information distortion, order batching, price fluctuation and gaming by both sides of the supply chain. Gaming is the tendency for service centers to place orders for more than they need, then canceling them. Mills are equally guilty of gaming by sending out signals of scarcity to boost those orders.

Misinformation is rampant in any distribution system. “If you’re sitting at the head of the supply chain, in most cases you don’t see the end market. You have to interpret what’s happening in the end market through orders—and the orders can be a really bad signal,” Kouvelis said.

This misinformation leads to forecasts with a high degree of error, causing longer lead times, greater safety stocks and more uneven order rates. “It creates peaks and valleys that are very hard to predict. How high the peaks and how long the valleys, and the timing of them, is what really drives the bullwhip phenomenon,” he said.  

Order batching is another driving force behind the bullwhip. Kouvelis noted that while demand may be fairly stable at the end-use level, batching orders distorts that signal. If the end-user puts through orders every third day to fill daily demand, and that process is repeated up the chain, the demand picture for the manufacturer may look nothing like the original steady demand from the consumers. This effect is present in even the least volatile consumer markets, such as diaper purchases in the U.S. or pasta purchases in Italy.

To combat the bullwhip effect, Kouvelis recommended a number of strategies, including increasing visibility and reducing complexity inside the chain, and making decisions more quickly and more frequently. “In an environment that is volatile and involves a lot of risks, you have to speed up your decision cycles. Making forecasts over six months doesn’t help. You have to forecast more frequently.”

He proposed creating “war rooms” inside the company where important decision makers can gather frequently to reach quick solutions. He also recommended rethinking choices from the past, such as where warehouses are located, which suppliers are used and whether changes can be made to transportation and logistics, among others.

Ultimately, the key for any successful supply chain is to embrace flexibility and the three A’s—agility, adaptability and alignment, he said.

Agility allows the service center to “respond to short-term changes in demand or supply quickly and handle internal disruptions smoothly.” Agility is obtained through a variety of methods, including promoting a flow of information across the chain; developing collaborative relationships with suppliers; dependable logistics systems and partners; and strong contingency plans and crisis management teams.

The objective of an adaptable service center is to adjust the chain’s design to meet structural shifts in markets and modify supply networks to new strategies, products and technologies. Such adaptability is met through a close monitoring of world economies to spot new supply bases and markets; the use of intermediaries to develop fresh suppliers and logistics infrastructures; and evaluation of the needs of the ultimate consumers instead of just the immediate consumers, among others.

Finally, an aligned supply chain creates incentives for better performance throughout the chain. It does so through the exchange of information and knowledge freely with vendors and customers; establishing roles, tasks and responsibilities for each member of the chain; and equitably sharing risks, costs and gains of improvement initiatives.

“Supply chain coordination is as challenging as ever, but the answer is always the same. Reduce complexity, increase visibility and collaborate,” Kouvelis said. n

  
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