Do shortages matter?
Albany-MIT PhD Colloquium
Paulo Gonçalves
October 4, 2002
Motivation
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Networking
Agribusiness
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1
Nintendo is warning they won’t
have enough game cubes to meet
initial demand when they launch
next month
Motivation
Microsoft is saying the same
thing about its xbox game system
Phantom
Networking
You don’t suppose
It’s 25
they took our 20 million now.
million pre-orders I was bored
seriously, do you? yesterday
Agribusiness
Semiconduct.
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Agenda
• Motivation
– Relevance and impacts
• Modeling Phantom Demand
– Dynamic hypotheses
– Model and analysis
– Policy insights
• Field Study
– Networking equipment industry
• Problem and motivation
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Relevance
• Supply shortages occur in several industries
– Automotive – GM Suburbans (Blumenstein 1996)
– Personal Computers – (Greek 2000)
– Pharmaceuticals – (Hwang and Valeriano 1992)
– Semiconductor – DRAM chips (Lode 1992), Pentium II
(Thompson 1998), Pentium III (McWilliams 2000)
– Telecommunications – (Lee et al. 1997b)
• Causes of shortages
– Costly capacity
– Long capacity acquisition delays
– High demand uncertainty
– High process uncertainty
Motivation
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Impacts of Shortages
• Traditional ones
– Lost sales and loss of shareholder value (Singhal and
Hendricks 2002)
– Financial and reputation losses (Greek 2000)
– Poor growth prospects (Savage 1999)
• Others
– Shifts in the modes of operation in supply chains
• Decreased performance and increased instability
– Phantom demand
• Excess capacity and low capacity utilization
• Increased returns and excess inventory
Motivation
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How do companies deal with shortages?
• Increase supply
– Increase production
• Increase capacity utilization
• Improve efficiency
• Expand capacity
• Increase sources and reliability of supply
– Effective in the long-term but limited effect in the
short-term
• Constrain demand
– Decrease product attractiveness
• Increase prices
• Reduce product quality
– Effective in the short-term but limited ability to
implement them
Motivation
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How do Shortages cause Bubbles?
• Suppliers allocate capacity among retailers
– Proportional to orders
– Proportional to past sales
– Fixed quantities
• Supplier reliability decreases
– Service levels drop
– Delivery delays increase
• Retailers reactions generate the bubble
– Inflate their orders with any supplier
– Place the same order with multiplet suppliers
• Suppliers increase production
– Invest in new capacity and increase utilization
– Enter into long-term contracts
• Retailers cancel orders as supply increases
• Suppliers suffer the consequences
Motivation
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Manager’s Intended Rationality
Control the Supply Line
Channel
Order
Backlog
+
B1
Adjust
Supply Line
-
Channel
Orders
+
Customer
Orders
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First Unintended Consequence
Retailers Order Ahead
-
Lead
Time
Capacity
+
R1
Order Ahead
+
Channel
Order
Backlog
+
Channel
Desired
Backlog
B1
Adjust
Supply Line
-
Channel
Orders
+
+
Customer
Orders
Motivation
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Second Unintended Consequence
Retailers Order Defensively
-
Lead
Time
Capacity
+
R1
Order Ahead
Delivery
Reliability
-
- +
Channel
Desired
Backlog
R2
Channel
Order
Backlog
+
Order
Defensively
B1
Adjust
Supply Line
-
Channel
Orders
+
+
Customer
Orders
Motivation
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Supplier’s Balancing Response
Adjust Capacity
-
Lead
Time
Capacity
+
+
R1
B2
Order Ahead
Adjust
Capacity
Delay
Delivery
Reliability
-
- +
Channel
Desired
Backlog
R2
Channel
Order
Backlog
+
Order
Defensively
B1
Adjust
Supply Line
-
Channel
Orders
+
+
Customer
Orders
Motivation
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Model for Supplier-Retailer System
Initial
Channel
Demand
Actual
Demand
(d)
+
Demand
Inflow
Input
(beta)
Desired +
Backlog
+
(B*)
Retailer's
Perceived
Demand
Time to Adjust
+
Backlog (TB)
Backlog
Adjustment
Initial
Cumulative
Demand
(Dc)
++
Cancellations
(C)
+
Excess
Orders
Motivation
+
+
Supply
Demand
Imbalance
Backlog
Backlog
(B)
Retailer
Demand
(R)
Time to
Cancel
Excess
(TC)
-
Expected
Delivery
Delay
+
Delivery
Delay
+
Shipments
(S)
+ +
Desired
Shipments
(S*)
Target
Delivery
Delay
(TD)
Desired
Capacity
+
Phantom
Table
Eff DD
(f)
Networking
+
Capacity
(K)
Orders
Received
+
Time to
Build
Capacity
(TK)
Orders
Received
By Retailers
(Sr)
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Structure of the System
D c  d
d d  f (B / K )  B K

K


K
 B  K
K
Expected Delivery Delay
Sr  K
d  f (B / K )  B

Bd 
K
B
Motivation
Aggressive
Strategy
10
Phantom
Networking
8
Base
Case
6
Myopic
Strategy
4
2
0
0
2
4
6
8
Delivery Delay
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Solve System with Fixed Capacity
d   B / K  B

Bd
K
B
• System is
unstable if
agents are not
fully rational
• Even Myopic
(fully rational)
retailers will
cause orders
to increase
Motivation
Phantom
Backlog
1
1
40,000
1
1
1
1
2
2
2
30,000
2
20,000
10,000
0
1
12
3
2
3
1231
0
Aggressive
Normal
Myopic
2
2
12
1
2
2
Networking
1
2
3
3
3
3
3
3
24
36
Time (Month)
1
3
2
1
2
3
1
2
3
Agribusiness
48
1
2
3
1
2
3
3
60
1
2
3
3
3
Units
2 Units
3 Units
Semiconduct.
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System Stable when Capacity Changes
Backlog
Shipments and Capacity
24,000
6,000
2 2
1
12
2 2
2
31231
4,500
12312312
3 3 31 31 31 31
3
16,000
23
3 2
3,000
8,000
1,500
1231231
2
2
3
1
1
1
0
0
0
12
24
36
Time (Month)
48
60
Shipments
Units/Month
1 1 1 1 1 1 1
Capacity 2 2 2 2 2 2 2 2 Units/Month
Demand
3 3 3 3 3 3 3 3 Units/Month
Motivation
Phantom
0
12
1 3123123123
2
24
36
Time (Month)
48
60
Steady State
1 1 1 1 1 1 1 1 Units
Backlog 2 2 2 2 2 2 2 2 2 Units
Desired Backlog : Pulse
3 3 3 3 3 3 3 Units
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Long Delays and High Cancellations
Delivery Delay
6
Cancellations
1
6,000
2
4.5
4,500
2
1
3
1.5
12 12 12
1
2
1
3,000
1
2
12 12 12 12
0
0
12
24
36
Time (Month)
48
60
Actual 1 1 1 1 1 1 1 1 1 Month
Expected 2 2 2 2 2 2 2 2 2 Month
Motivation
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1,500
0
1
0
1
1
Cancellations
Networking
1 1 1
1 1 1
12
24
36
48
Time (Month)
1
1
1
1
1
Agribusiness
1
1
1
60
Units/Month
Semiconduct.
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Capacity Flexibility is crucial
• Supplier’s ability to build capacity quickly
– Reduce the size of the bubble
– Reduce the duration of the problem
• Strategies to flexibility ramp up production
– The semiconductor industry builds the building
infrastructure (the shell) well in advance of need
– Building is never a constraint in ramping up production
of a new fabrication facility
– The equipment is positioned as it becomes necessary
Motivation
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Impacts of Real Time Supply Chain Mgm
• Alan Greenspan, Chairman of the Fed:
– “The faster adjustment process raises some
warning flags. Business managers have
access to more information, but everyone gets
similar signals. As a consequence, firms
appear to be acting in far closer alignment with
one another than in decades past. The result is
not only a faster adjustment, but one that is
potentially more synchronized, compressing
changes into an even shorter time frame.”
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Business managers views
• “By sharing knowledge of orders or parts shortages
or other factors, companies across the high-tech
industry are probably more in sync than they ever
have been before. This has been the promise of the ebusiness revolution, but no one ever realized how this
information might be used. I'd say we're getting our
first taste of how companies might react to up-to-theminute operational information. In short, they would
move more quickly to protect profits. Even Fed
Chairman Alan Greenspan has theorized publicly that
the improved efficiency of forecasting systems has
exacerbated the severity of the economic slowdown,
which gripped the country more quickly than anyone
predicted.”
Motivation
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Causes of Component Shortages
In the networking equipment industry
• Strong demand from several industries
– PCs, mobile phones, handheld devices, and telecom.
• Wide adoption of lean manufacturing and buildto-order models
– Limited capital investment in manufacturing equipment
• Earthquake in Taiwan in September 1999
– Taiwan is the world's third-largest information
technology provider after the US and Japan
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Industry Response
• Quote attributed to Stephen P. Kaufman, Chairman and CEO
Arrow Electronics Inc.
– “An Arrow customer builds a product that is heavily dependent
on flash-memory devices. On learning that the Palm Pilot
organizers use the same flash chips as his company's product,
the OEM's chief executive summoned all employees to hand
over their Palm Pilots. Production workers promptly pulled the
flash devices out of the units and walked them down to the
production lines. Employees then received vouchers for new
Palm Pilots.” [1]
• Cisco’s action:
– “We made a conscious decision when our lead times were 12 to
13 weeks to build inventory, because we were leaving a sizable
amount of revenue on the table every quarter” [2]
[1] Ojo, B. and C. Serant. (2000) “Parts shortages prompt companies to adopt unusual measures,” EBN, May 22
[2] Byrne, John A. and Elign, Ben, “Cisco Behind the Hype”, BusinessWeek, January 2002.
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Significant Impact to the Bottom Line
• “Cisco’s market value had fallen by some
$430 billion, to $154 billion, one of the
deepest losses of shareholder wealth in
history.”[4]
[4] Heskett, B. 2002. “Chambers’ Tale of Icarus,” c|net News.Com. (http://news.com.com/html/ne/vs/2022-1120-808669.html)
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John Chambers Comments
• Macroeconomic challenges facing the
industry are proof that "a 100-year flood
can happen in your lifetime.“[3]
• “If you told me [sales] could go down 30
percent after 70 percent growth in 45 days
I’d say it was mathematically impossible.
And it did.”[4]
[3] --- 2001. “Cisco issues revenue warning: Says sales will be down 30% in third quarter; announces write-down, new layoffs.” The
Gazette, Montreal, April 17, D1.
[4] Heskett, B. 2002. “Chambers’ Tale of Icarus,” c|net News.Com. (http://news.com.com/html/ne/vs/2022-1120-808669.html)
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Contract manufacturers tried to help
• Susan Wang, Solectron’s CFO,
commenting on OEM’s orders:
– Gee, if each one of the OEM’s thinks they’re
going to gain share, we’re going to have more
than 100 % share. That doesn’t make sense.”
• Although they tried to prevent OEMs, they
did not want to hear bad news.”
– “If we had said no, they would have told us,
‘You’re not a good partner for me – we’ll find
somebody else,’ our only responsible reply
was, ‘Yes, of course, we’ll try.’”
Motivation
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