Simple solutions can sometimes cause another set of unintended consequences

There has been much discussion about logistics and supply chains over the last few months. A subject which normally causes people’s eyes to glaze over. Try telling people at a Christmas party in 2019 that you are a logistics expert and you love to talk about it.

The common refrain at the moment is that there has been too much flexibility wrung out of supply chains in the pursuit of efficiency and cost reduction. That if you have twenty links in a chain and all of them are fully optimised with no spare capacity then any one of them can fail and cause the whole chain a problem. This is a natural consequence of a market based system where the theory is that if everyone economic actor in the system acts in their own self interest then we are better off as a whole. It is the “Red Queen” effect from Alice in Wonderland. We all have to keep running faster and faster to keep pace with the pack or we will fall behind.

The application of this theory brings great benefits until it doesn’t. I had a discussion with a builder last week who said that he was told that people are leaving containers behind when they empty them in Australia because it is cheaper to buy a new one than ship the old one back.

The simplistic solution that is being suggested is that we need to build some slack and extra capacity back into the system. This sounds good in theory but breaks down in practice on several fronts.

First of all who is going to pay for that extra capacity. The reason that companies try and maximise capacity utilisation is that it makes economic sense. Someone has to pay for the extra capital lying around if we have 20% extra capacity at every part of the supply chain. If only some of the companies at each link in the chain agree to put in extra capacity and others do not what happens when the ones that do not offer cheaper prices. Will the upstream companies only support the ones that did the right thing?

Secondly, in practice if links below you in the supply chain all have excess capacity is transfers power to you. In the nineties and early part of this century the supply chain for smallgoods in Australia was fragmented and had excess capacity. This enabled the major supermarkets to player extreme power games with their orders. The supermarkets knew that increasing any individual supplier to 100% capacity, if even for a small time was very valuable. Conversely the threat of a factory dropping from 80% capacity to 60% capacity would be devastating. So the manufacturers fought like cats and dogs for contracts. In theory this was good for consumers as it kept prices low. What the supermarkets realised in the end was that it was also starving their suppliers for cash which was resulting in ageing facilities and a lack of innovation. So they changed and helped some suppliers get good capacity utilisation. Improving cash flow for their suppliers while at the same time reducing unit costs.

If we play that scenario out across multiple parts of multiple supply chains it could create havoc.

So there is no simple solution for industries that stretch across the globe and where coming together to agree on capacity levels could be seen as forming cartels. The solution is not easy to see. What I am trying to say though is lets not just apply a simplistic solution and count that job as done, and move one. We need a new way of looking at supply chains.

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