“Just In Time” for a recession

In this must-read article in The Wall Street Journal, Phred Dvorak explores how the recession has hit the supply chain in the most ruthlessly efficient JIT (just-in-time) manufacturing industries, like high tech. While most readers of this blog at least partly subscribe to the fantasy version of entrepreneurship — where entrepreneurs deal directly with the customers — a major plurality of entrepreneurship and entrepreneurial idea-generation are slotted into a supply chain somewhere, In fact, the overwhelming majority of innovation in this economy actually takes place in a supply chain line somwhere than in somebody’s garage.

For that reason, charting the economic effects of how JIT supply chains have been hit especially hard by the recession gives an important lesson to entrepreneurs and businesses of all stripes.

Money quote:

Just a decade ago, the supply chain had far fewer links, . . .

At one end of the information flow are retailers such as Best Buy. For the U.S. market, it sends orders to its suppliers once a week, along with private forecasts for the coming 52 weeks, based on sales at its 1,000 U.S. stores and broader economic data. Manufacturers scrutinize reports like these to decide what parts they need to order.

The system is geared to respond quickly to changes in consumer behavior. But that puts risk on suppliers’ shoulders.

Take DVD players: Best Buy orders them about six weeks before it wants them on shelves. However, a player’s guts may take twice that long to make — forcing gadget makers and their suppliers further down the chain to guess at demand for the various pieces.

Companies all along the supply chain live in mortal fear of piling up inventory. Profit margins are razor thin, and unsold inventory only loses value as newer technologies hit the market.

Last fall, as the financial crisis struck Wall Street in full force, shoppers at Best Buy became an endangered species. By early October — the deadline to place orders for the all-important Thanksgiving shopping season — Mr. Vitelli, the merchandising chief, abandoned Best Buy’s prior forecasts and slashed orders to electronics giants such as Japan’s Toshiba and South Korea’s Samsung Electronics Co.

Demand was shrinking so rapidly, he says, he wasn’t even sure how deeply to cut. “You actually had to pick a number with no knowledge whatsoever, because nobody knows anything,” he recalls. For the three months ended Nov. 29, Best Buy’s net income fell 77%.

If Best Buy felt ambushed, its suppliers had even less insight into consumer demand. The slashing began.

Just-in-time supply chains demand greater complexity (more suppliers doing smaller bits in the supply chain) and put most forecasting risk on the suppliers. So when demand lowers, inventory piles up at the supplier level, not the final manufacturer or retailer level.

Now, electronics inventory piled up at the manufacturer or retailer level can at least be sold. At a steep discount, granted, but at least it can be sold. Inventory at the supplier level can’t be sold. And, if it sits long enough, can never be sold.

Which puts the entire supply chain at risk since it’s being managed by its various parts. On the consumer level, if Gottschalk’s goes down, consumers move their business to Target or Wal*Mart. If, on the other hand, a key supplier in a supply chain goes down, that leaves the next link in the chain scrambling to replace it.

The lesson, then, for entrepreneurs in or considering entry into a supply chain is that consumer forecasting becomes a critical internal competency. Or you find yourself staring at idle employees.

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