Toilet Paper Surplus, Ketchup and Semiconductor Chip Shortages – Supply Chain Forecasting is Hard

Toilet paper now seems to be in ample supply, ketchup packet shortages are vexing restaurants, and semiconductor chip shortages are causing major economic damage to auto makers. Why is it so hard to get these supply chains straightened out, and what more thrills are likely in store?

A little over a year ago, I wrote about how shortage gaming was affecting the toilet paper supply chain. I didn’t realize that would become my most popular Forbes article ever, making me seemingly a renowned expert in toilet paper (which I really am not). But the gist of that piece was that you didn't have to be an expert to know that since demand for toilet paper was more or less flat, eventually there would be a correction when people stopped stockpiling it and started to burn off their “pantry inventory.” That is what appears to be happening now. For manufacturers who invested in additional capacity, sorry – you’ll likely have some slack capacity for a while. This is a well-known effect in supply chains – demand spikes cause re-forecasting and gaming along the different tiers in a supply chain, getting amplified as they move up the chain.

This “bull whip effect” is the phenomena of demand variability increasing as you go upstream in a supply chain. It is mainly  caused by:

• Poor demand forecasting and over-reactive ordering. When a supply chain manager or a buyer sees an increase in demand, they might try to get ahead of the trend and order “a little extra” so they don’t get caught short. Unusually high demand over a short period of time is exciting! To some product managers, it means people love their product. So wanting to believe that, they might optimistically think there is a new rising trend in demand. For a multistage supply chain, people at each step have the opportunity to get excited as well and amplify the trend.
• Lag times before the order gets filled. You order more stuff, but it doesn't show up for a while. The natural tendency is to order even more because you know it will take a while to receive it, and you want to have some safety stock so you don't get caught short. If you already are short, this can lead to panic ordering, which of course your supplier might interpret as, “my customer really loves my product, I better order more from the factory” or if you are the factory, “let’s add more capacity!”
• Shortage gaming. This typically happens when you have a hot product, and customers know they might be put on allocation, which limits how much they can buy. So they order more. This can be aggravated if, for example a manufacturer has generous return policies, or when a retailer imposes policies that allow them to throw excess inventory back at its suppliers.

The best way to mitigate the bull whip effect is to share information about true demand and make sure everyone in the supply chain knows and understands it. This of course is very difficult if consumers are stockpiling, because retail point of sale (POS) data won’t tell you how much of a bubble is building up in homes. But common sense, for example in the toilet paper case, would argue that actual usage was flat, and eventually people would run out of places to stash it. Yet when we run a supply chain simulation that produces this bull whip effect in our MBA classes at the Harvard Business School, sharing POS data along the whole supply chain helps somewhat, but invariably few students are able to stamp out the effect entirely. It’s embedded in the psychology of planning and forecasting.

How about electronics and semiconductors? There is a lot of talk about double-bookings in the semiconductor supply chain right now, and the possible consequences of that. I have been questioned by a number of people for saying that these bull whip oscillations occur with mind-numbing regularity, and eventually this one will correct too. One manufacturer told me they were requiring firm commitments with orders, meaning cash up front, and orders were still holding up. This is a smart move on their part, as tech companies are notorious for backing away from the volumes that they had previously committed to and telling their suppliers to go pound sand.

While many manufacturers don’t think we are in a bubble, eventually consumer demand will be satiated. My friends Cheng Ting-Fang and Lauli Li at the Nikkei Asian Review told me that one of the big notebook computer makers has been watching POS sell-through of their products, and the sell-through demand continues unabated. This is consistent with the recent Gartner IT 0.0% report that PC sales grew 32% in the first quarter of 2021, the fastest in two decades. Secular shift or one of the biggest demand spikes we’ve ever seen? The question one has to ask is since the replacement cycle for computers is relatively long (like three or more years for a notebook PC), when the short term demand is satiated, shouldn’t we worry about a demand fall-off? The insanity defense is that right now with demand hot, a PC maker needs to ensure they have plenty of supply on hand so that they can preserve or gain market share. Or at least not let their rivals gain an advantage because they have more chips on hand. If you are a semiconductor chip manufacturer like TSMC, you might be wondering how all the major PC makers think they can simultaneously gain market share. That seems to be a numerical impossibility. I think I’ll wait for the mark-down sales that will inevitably follow this overstocking binge. One has to imagine similar kinds of issues will face other goods producers, like furniture and exercise equipment.

The HMM Algeciras, currently the world's largest container ship with the capacity to transport ... [+]GETTY IMAGES

By the same argument, in several years there may be too much container ship capacity. The Journal of Commerce recently reported that ocean carriers have ordered a wave of new ultra large container ships. While there is a current shortage of capacity and demand growth will outpace it for a few more years, IHS Markit INFO +0.1% says that by 2023 there will be little “margin for error.” That means when all the new ships come on stream, excess capacity could cause pricing softness. This has happened regularly in the past. Can the industry dodge the bullet this time? In the meantime, we can ask whether U.S. ports actually have the infrastructure and capacity to handle even larger ships.

Any time you have a time lag in fulfilling demand, there is the opportunity to create a bullwhip effect.  That’s one of the things that makes the job of a supply chain manager so exciting!

Written by:  Willy Shih, Professor at Harvard Business School, for Forbes.