May 19, 2006
More on Wal-Mart, Bullwhip, and Vinson
Last post, I discussed the bullwhip effect and wrote that I would soon be responding to Jack Vinson and his comment.
Jack pointed out that "Wal-Mart is (or should be) providing their suppliers with excellent information about the movement of their products through distribution centers and into stores," and went on to say that this should be keeping inventories "DOWN" for suppliers, not up.
Jack, you're definitely right, the more information a supplier has about his customer, the lower inventory levels SHOULD be. BUT, there are some other issues at hand.
First are the batch sizes. Wal-Mart, as we know runs a pretty efficient JIT system. This means small batches. This makes sense because the factors that determine batch size, as derived from the EOQ, are ordering costs, demand, and holding costs. Because the ordering costs are so low, it makes sense for Wal-Mart to order at the drop of a hat and force suppliers to hold onto the rest of the inventory.
But, suppliers, even if they have the same demand data, have higher ordering costs. In this case, the cost of ordering may include manufacturing setup costs, or it may be the result of economic efficiencies derived from larger batch sizes.
That's all a bunch of fancy talk to say that yes, Jack, the information helps, but the fact remains that ordering costs for Wal-Mart, with their EDI systems, are almost non-existant, but ordering costs, in the form of setup costs, for producing less at a time for the suppliers are not so low.
So, if the EOQ for a supplier is 50000 units, even if the data Wal-Mart suppliers them with data that shows that those 50000 units will be used up over the course of 1 year, that is still 25000 units in average inventory. Now, if Wal-Mart didn't have a JIT system, then they would perhaps be more likely to buy those 50000 at a bulk discount, thus lowering average inventory of the supplier.
The end result is, because Wal-Mart places such high demands on service, and because they now refuse to buy in bulk, suppliers are forced to hold onto more inventory than in the past. The data provided by Wal-Mart to their suppliers definitely helps to keep that excess inventory to a minimum.
However, as I mentioned in my original article on the topic, Wal-Mart's no tolerance level places very high expectations on its suppliers.
Clearly there are lots of what-ifs to discuss here. Yes, Jack is correct, the data helps, and without it, Wal-Mart's demands would result in even higher inventory levels. But it doesn't account for batch sizes, nor for the, as Jack put it, "hiccups" in in demand.
Those "hiccups" are not exactly something to sneeze at either. Statistically speaking, providing a 95% service level, which is common for most suppliers, is a fairly attainable practice. However, Wal-Mart requires near perfect, and statistically, this results in MUCH higher inventory levels. Until the demand data provided by Wal-Mart results in no hiccups, which will never occur, the 99% service level Wal-Mart requires will have a substantial effect on inventory.
Conculsively, Jack is absolutely correct that Wal-Mart's data helps to lower inventory levels across the supply chain as it keeps the bullwhip effect to a minimum. But, Wal-Mart still forces suppliers to hold the lion's share of the inventory, which results in higher inventory levels for suppliers, just as Ms. Lacefield wrote about in her article in the October 2005 Logistics Management (Vol. 44, No. 10).
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Comments
I guess I made an obvious statement. So then, if I am a supplier, and I want to supply Wal-Mart, I need to figure out how to meet their demands AND still survive as a business. I suspect this means that I need to figure out how to change the end of the equation where I have influence: inventory, order lead time, due date performance...
Of course, I totally agree with your above analysis. The tighter control on performance, the better one needs to be. I would suggest that one has more control than strictly inventory on hand. That is, if one is willing to rethink operations: replenishment frequency, batch sizes, distribution, logistics....
Posted by: Jack Vinson | May 22, 2006 9:16:28 PM
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