By H Brian Hwarng
WHEN managers are faced with a seemingly chaotic business system, they usually blame the external environment instead of themselves for the state of affairs. Rarely do managers realise that at times, it is actually the decisions they make that contribute to the phenomenon of chaos.
Let's take an example of a business chain to illustrate chaos. A typical business chain involves moving goods from the factory to wholesalers, then to retailers and finally to the end customers. Along the way, decisions have to be made concerning inventory or stock management. This is easier said than done as uncertainties in demand, production and delivery can occur that disrupt this chain, making the chain dynamic.
Take Dell for example. Ideally, the safety stock level at its centralised hub should be kept as low as possible to minimise holding costs. However, time delays in the form of long and uncertain lead time, coupled with build-to-order practices and decision making behaviours, can adversely contribute to the variability of the safety stock level.
Such dynamic and complex behaviours can be modelled from a chaos perspective. Chaos is characterised by (1) non-randomness, (2) apparent disorder, (3) strange order, structure or pattern, and (4) large repercussions arising from small changes in initial conditions.
Decisions regarding inventory replenishment can contribute to complex dynamics and chaotic behaviours were investigated. Managers make at least two decisions regarding inventory. The first decision concerns how much to order to make up for the shortfall in inventory, in response to demand. A full adjustment means a firm decides to order the exact amount of the shortfall. If the decision is partial adjustment, then only part of the shortfall is replenished. The second decision concerns the supply line - when to place the order and when delivery will take place. Even when an order has been placed, the delivery may not occur as desired because of production and transportation problems.
We found that these two decisions affect how much chaos there is in the system. When is it most chaotic? Interestingly, the system is most chaotic when managers' decision-making behaviour is imbalanced. For example, a case in point is to fully adjust for inventory but partially adjust for supply line, ie, completely replenish the stock to desired level but not fully account for delays in production and delivery. Because of this imbalance in the magnitude of adjustment - one being complete and the other partial - the supply chain system becomes more chaotic.
However, if managers decide to adjust for inventory and supply line to a similar degree, ie, partially adjust for both inventory shortfall and the associated supply line issues, chaos is minimised. Hence, the managers' decisions, and not just the external environment, contribute to the amount of chaos.
We also noticed that external conditions sometimes aggravate the system chaos level. For example, the stock level of a supply chain system adopting the above decision-making behaviour may become more chaotic when customer demand jumps to a higher level for an extended period of time. This may occur, say, when there is a prolonged price cut that leads to a sustained demand increase. If the increase in demand is temporary, the system is less chaotic. Firms should therefore manage the lead time needed for ordering and shipment to cater for these sustained demand increases as well as collaborate with others in the supply chain to respond to the increased demand. It appears that quick reactions to such increased demand are needed. Management therefore needs to be able to discern when a demand is sustaining and when it is not.
To this end, management needs to set certain benchmarks that signal the permanence of an increased demand and be quick-footed to fulfil it. For instance, 7-11 in Japan has a sophisticated management information system whereby a store, having met a sudden tremendous demand for a certain product, can inform not only its head office but other 7-11 stores within its neighbourhood to anticipate the increased demand.
In a complex value chain, different parties in the chain have different levels of visibility and exposure to customer demand. Retailers are more visible than wholesalers to customer demand. We found that system chaos can be reduced when retailers order only what is needed by customers and not more. Giordano, for instance, restocks its inventory for each store according to the amount sold the day before. This reduces inventory holding costs and chaos.
Another interesting phenomenon that we observed is chaos amplification. Chaos can be amplified at the upstream levels in the supply chain. Decisions made by managers at the retail level can create much chaos at the wholesaling and manufacturing levels.
Managers need to watch out when the chaos is created by their decision behaviours, and when by external factors.
The writer is Associate Professor in Decision Sciences, NUS Business School. He specialises in business dynamics and value creation through process management
This article was first published in The Business Times.