25 April 2012

Bad policies hurt the supply chain

I think just about everyone involved with understanding and managing supply chains agree that the supply chain works best when volatility is minimized. Some organizations go to great pain and expense trying to figure out ways to manage their supply chain when faced with sudden demand changes and volatility.

Nevertheless, many supply chain participants continue to maintain policies that actually increase volatility in their own supply chains. Here are some examples:

  1. Short-term promotional pricing
  2. Volume discounts linked to shipment batches
  3. Period-end promotions
  4. Salesperson incentives linked to period-end dates

Short-term promotional pricing

Short-term price promotions contribute to the bullwhip effect and create tremendous inefficiencies all up and down the supply chain. The policy—especially when repeated with some frequency—causes buyers to hoard product. They buy extra-large batches of product when “on sale,” and store it up against the days when the product is not “on sale.”

Some short-term promotions are so predictable that buyers actually delay purchases at regular prices knowing that, if they wait, they can buy at a lower price later.

By the time all of the costs and expenses to the supply chain are added up, it would be difficult—in most cases—to prove that short-term promotional pricing actually adds to the bottom line at all. In fact, studies by some firms specializing in creating and managing pricing mechanisms have shown that consistent pricing at a marginally lower level actually produces more sales and profits than higher prices accompanied by short-term promotions.

Consider a brand like Wal-Mart. This is a firm that has master-crafted its supply chain and built its reputation on consistently lower prices. By doing so, it has—over the last several decades—supplanted previously known giants in the retail industry such as Sears, Penney’s, Kmart and more. Yet, Wal-Mart is not known for “sales” (i.e., short-term promotions). It is known for its consistently lower prices.

Volume Discounts linked to shipment batches

Let me say, off the bat, that there is nothing wrong with volume discounts, per se. The problem is linking volume discounts to transfer batches. In order to realize volume discounts without causing supply chain hoarding and needless volatility, the volume discounts should be separated from the shipment batch.

For example, your customer might get a volume discount if they agree to buy 100,000 units next year, but you might agree to transfer them to them in relatively equal weekly or monthly shipments. This evens out production (on the supply end), warehousing (on the receiving end), and doesn’t make it look like someone sold 50,000 units in March and another 50,000 units in September with little or no activity between.

Period-End Promotions and Salesperson Incentives linked to Period-End Dates

These two are frequently related. Salespeople with the need to reach certain goals for end-of-quarter or end-of-year sales, in order to boost their commissions, begin a big push. This push is usually accompanied by some authority to also offer special discounts.

All up and down the supply chain, prices are being discounted, volatility is being recklessly increased, and, all the while, production lines and warehouses are increasing their operating expenses to meet the boost in demand. Overtime and extra staffing costs are eating up the lion’s share of the profits that might otherwise have been generated if volatility had been reduced, rather than increased, by rational policies.


Of course, there are other wrong-headed policies that needlessly lead to higher volatility in our supply chains, but these are a few that come to mind. These are things well within the span of control of executives and managers where corrective action is easy and at little or no cost. It just take rethinking the way we do business and not being afraid to gore some existing “sacred cows.”

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