@ Supply Chain Management


Marrying business cycles with business activities

InformationWeek’s Q&A with UC professor Peter Navarro about Riding the Business Cycle more wisely
According to the professor,

Enterprises can be more competitive by better managing the ups and downs of the business cycle, notably via sharper control of inventory and capital outlays such as technology spending.

Well, that’s something that harkens me back to my days working in the semiconductor equipment industry which is notorious for its expansion and contraction cycles. I went through two cycles of expansion and contraction which was more magnified in the South-East than in the US. The management in my firm was very keen on synchronizing their business decisions with the cycle because it was simply impossible to sit on equipment worth sometimes a quarter of a million swiss francs each and hope to ride out the cycle. The cycles in that time were getting shorter and shorter in time periods. However, my firm had one foot stuck firmly in the past as they manufactured their machines exclusively in Switzerland which meant that even though the quality of the machines were well acknowledged, agility and speed to market were not up to the competition. The market had no problem informing us of the same too.
Professor Navarro avers:

But timing, very often, is as [important] or more important. In terms of inventory-type management, the kind of micro approach to managing inventory is to increase your inventory turnovers as much as possible all of the time. In fact, what you want to do going into or out of a recession is to cut inventory more subtly. When you are coming out of a recession, you want to be building up because you want to be the first on the stock shelves and have the opportunity to sell.

Easier said than done. Imagine the plight of an inventory manager acting contrary to all the information he is getting from the marketplace and his peers in the industry. I’m a fan of contrarian investing but I’ve also found that investing contrary to the market is no easy thing – fear, herd mentality, emotion – they just overpower the rational decision making process. However, there is something else that is missing – in stock trading parlance, it would be, “Never catch a falling knife” or “Don’t try to call the bottom”. If you called the bottom or the top as the case maybe, you’d reap the maximum benefit but then you’d also be trying to catch the falling knife. Nothing like this could work without involvement of the top management but then again that would mean that if the timing were wrong it would be their heads on the chopping block with inventory write-offs and the like. I don’t think that they like their heads getting chopped no matter the bounty of future reward.

You can’t wait until good times are back. Moreover, recessions tend to be shorter than expansions, so there is a window of opportunity there. If you move three, six or nine months faster than your rivals, then you’ve got them.

Well, that’s probably true from government statistics but I don’t think thats the case with reality (Or that’s what I think of government statistics). Official recessions are short and recovery is swift. Take a look at this chart and then tell me that recessions have been swift uniformly.

One thing is certain as we speak. Looking ahead, there seems to be a real chance of a recession looming not in the distant future (like the end of the year). That means that companies ought to be tightening up right now but then government data reports some of the lowest unemployment rates (Ok, I have a quibble with the government data on how unemployment is measured) and from my experience firms have opened up their hiring again. So who’s cutting back right now in the industry at large? I’m seeing more furious M&A activities at this moment instead.
So what should business executives be paying attention to according to the professor:

One of the things I preach is that executives need to be attentive to economic information on a daily basis, and it does not take a lot of time compared to the payoff. The weekly Economic Cycle Research Institute (ECRI) has two really good indices for businesses to keep their eyes on. The first is the Weekly Leading Index, and the second is the Future Inflation Gauge. Together, they provide executives with a simple but powerful forecasting tool.
In addition, the yield curve, which measures the relationship between short-term and long-term interest rates, has a tremendous amount of information in it. The Federal Reserve determines short-term rates, while long-term rates are basically determined by thousands of savvy investors betting billions of dollars on the direction of the economy. When you get the unusual case of an inverted yield curve, where longer-term rates are actually lower than short-term rates, this is can be a sign of a coming recession. An inverted yield curve has, in fact, predicted five out of the last six recessions. …

Here’s something more that Professor Navarro has to say about using the supply chains themselves as forecasting tool:

A well-constructed supply and distribution chain can be its own forecasting tool. I urge your readers not to think of the goal of supply-chain management to always inventory as slow as possible just to tighten, tighten and tighten. In times of recovery, economic recovery and expansion, you actually want to decrease your inventory turnover ratio. But that is not the goal in and of itself. The goal essentially is to move more products into the sales channel at a time when you think demand is going to be moving upward. That way, you can push out your competitors and take advantage of the pent-up demand that gets unleashed. This goes to the point of macro-managing vs. micro-managing your inventory. I think that is a really important distinction, because businesses tend to focus on micro-managing their supply chain, in a sense that they are always trying to squeeze things down, when in fact it is often better to move things up.

I think businesses to a great extent do this that is build up inventory in anticipation of great sales coming up but whether they do this in concert with business cycles I cannot say. However, what I have seen is that there is no risk management applied to the efforts to ramp up or ramp down. I’m looking into how I can adapt stochastic optimization into supply chain design and development and that would address the matters of uncertainty that crop up with business cycle forecasting.
In conclusion, I think that the Professor has some great points and insights to offer but then again do those recommendations jive with the behavior of man in general. I think what the Professor is advocating is contrarian business cycle management or efforts that go towards that. But there’s a reason why there are only a few good contrarian investors and that’s because there are only a few good investors to begin with.

Category: Reviews, Strategy, Supply Chain Management


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June 2006