At the start of most recessions inventory levels are usually high. After all, when times are good, we plump up capacity in hopes that business and cash will keep on flowing. This leads to some fairly predictable behavior. Consider how, when recessions start, the number one cost cutting goal is usually not going back and renegotiating new prices and terms with suppliers. Rather, it's halting orders by cutting inventory. This rather painful shock often leaves lower-tier suppliers holding raw materials and individual parts holding the inventory bag, waiting for orders to pick up as their customers wind through what they're warehousing or stockholding.
But things are different this time around. Earlier in the month, I had a chance to attend a University of Chicago economics forecast lunch where the state of inventories was one of the items that the panelists debated. They suggested inventory levels were low going into the recession. Thanks to the leaning out of supply chains as companies moved to improve their forecasting, scheduling and planning since the last recession -- not to mention introducing JIT and VMI programs -- the majority of organizations heading into this recession aren't facing anywhere near the same level of either materials or finished products inventory relative to what they've had on hand in the past at the start of a downturn.
Why is this important? It means that when companies are cutting orders now, it's not because they're winding down what they have on stock. It's because their customers are cutting orders. It's the opposite of the beer game, in fact. We've become much more demand driven, offering two-way signals more effectively at multiple tiers than in the past. This is scary stuff because when we have suppliers saying "we've never seen business drop off like this" they're actually hearing the voice of the end consumer or business -- not even their direct customer. In other words, demand has literally dropped off a cliff in many markets, going back to the actual end consumer. Fast. Really fast.
This will make companies even more gun-shy about ramping capacity ahead of an order uptake in the future. But as the market does comeback, it's going to be up to suppliers to rapidly deliver, especially considering that companies will be as lean as possible going into an upswing as they were going into the current downturn. It's also a good reason to treat your suppliers well in the downturn, given that they'll be the ones working three shifts -- that is, if they can survive -- to meet your order requirements as soon as the light turns green.
But in the meantime, we should all take the current demand drop off as a signal that things have gone from bad to worse faster than we've ever seen in our lifetimes. Desperate times will lead to desperate measures and government populism of the most dangerous kind, including criminal politicians like Illinois Governor Rod Blagojevich telling Bank of America who they should loan to just to keep labor happy (as if a state that can't even balance its own budget other than by raiding public pension funds should be the final arbiter of the debt markets). As I said, it's scary times indeed.
- Jason Busch