Inventories in the Economic Recovery: Caterpillar Snaps the Bullwhip

The recession is the
time to cut inventories.  The recovery is
the time to re-stock
.  First, though, you
have to make sure that your vendors are up to the challenge.  The Wall Street Journal recently ran an
excellent front page story about Caterpillar Inc. entitled, “’Bullwhip’ hits
firms as Growth Snaps Back.
so-called Bullwhip effect is the 
cyclical inventory swing, which I describe in more detail in my book, Businomics.  In the recession, three forces reduce
orders from vendors:

  1. With a lower level of sales, there is less ordering to replace recently-sold merchandise.
  2. At a lower level of
    sales, an inventory-sales ratio targets dictates lower inventories.
  3. Many companies lower  their inventory-sales ratio target to conserve
    working capital.

When the economy begins to recover, the opposite
happens.  One dollar’s worth of sales
first triggers one dollar’s  worth of
orders from the supplier.  Then  the 
higher sales level  triggers a few
additional cents worth of orders due to the higher average sales level.
Finally, the company realizes that having inventory in stock is a competitive
advantage, and it now has adequate cash, so it raises its inventory-sales
target.  The swing in inventories is highly disproportionate to the underlying
change in sales

(I’ve previously written about how tight inventories can
cost businesses
both immediate sales as well as customer loyalty, and I think
the inventory swing across the economy will have a large impact on economic
in 2010.)


Caterpillar anticipated this bullwhip effect in its own
operations and had the wisdom to wonder if its vendors would be able to deliver
increased shipments.  Now let’s talk
about  how a company whose CEO is a Ph.D.
in economics handles this challenge.  The
Journal reports,

“…Caterpillar took the unusual step late last year of visiting with key
suppliers to ensure they had the resources to quickly boost output. In
extreme cases, the equipment maker is helping suppliers get financing.

This is a genuine challenge.  I’m hearing stories of businesses that cannot
get the materials they need from their vendors. 
The reasons are various, but all tie to the recession.  The vendor may lack the working capital needed
to buy raw materials and pay newly re-hired workers. Caterpillar is wise to
help its vendors with financing.  Trade
credit usually helps vendors with their raw material costs, but companies  battered by the recession may have  to pay cash up front from their nervous and
cash-poor suppliers.  Labor, of course,
has to paid promptly.  Even if the vendor
has adequate working capital, it may have laid off workers with key skills, and
it may have deferred maintenance on some of its equipment.

A corporate buyer typically talks to a sales representative,
who is not inclined to report potential problems with deliveries.  The 
conversation with vendors has to be elevated to higher level officers
knowledgeable about the companies finances and operations. Caterpillar also
inquired about their vendors’ exposure to the automobile industry, a key risk
to survival in this economic climate.


If your company depends on its vendors, read the entire Wall
Street Journal article
.  Then start a
program to meet with your critical vendors. 
(Personal plug: I have been talking to businesses about business
strategy in the recovery, and I can help firms that want to engage in their own
recovery readiness assessment, or want to make sure their vendors are ready.)