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The 2nd Wave
...And never the twain shall meet:
The Waves of Growth and Under-investment
TU Eindhoven and Minase BV
It looks like the economy is picking up again, or at
least in most places it does. That means it is time to issue a serious warning
to successful companies: Beware! Your success may be hazardous to your health!
The following story has been going on for several decades. Suppose you work
with a company lucky enough to find a "niche" that works well for it. You offer
products or services that customers like, and you are very good at developing
and delivering them. You offer great quality and fast delivery at reasonable
prices. You're lucky, but it happens all the time across all industries.
Henk Akkermans is one of the founders of Minase,
a consulting firm based in the Netherlands that focuses on helping companies in
improving design and coordination of the supply networks they form a part of.
System dynamics modeling and simulation play an
essential role in this, both to engage stakeholders from different backgrounds
in a constructive strategic dialogue and to provide the analytical rigor needed
to tackle complex problems effectively. Henk has been developing system
dynamics models with major companies from the aerospace, electronics, ICT and
life sciences industries such as AKZO, Ameritech, Atos Origin, Boeing, Compaq,
DSM, KPN telecom, Philips Electronics and Stork Aerospace for the past eleven
years. He is also an assistant professor at Eindhoven University of Technology,
from which he holds a Ph.D., and where he teaches supply chain management and
system dynamics and conducts research, often based upon his client work.
E-mail: firstname.lastname@example.org or
But, what happens next? Customer demand increases and
keeps increasing. In fact, as demand keeps increasing, it becomes more and more
difficult to keep up this great quality, and delivery delays start growing as
well. Increases in capacity are on their way but are not there yet. These
things take time. Buying and installing new equipment, hiring new staff and
training them does not happen overnight. In retrospect, you would have liked to
decide on new investments earlier, but hindsight is easy. When you had to put
your money and that of your shareholders on the line, things were not at all so
clear-cut. Forecasting the future is very difficult.
Luckily, your new equipment and new staff finally come online. But then, the
nightmare part of this story sets in, as customer demand starts dropping. How
can this be? Surely everybody loved you? Yes, but some of the loving has cooled
off in the past few months, as your quality kept going down and delivery delays
continued to go up. This was as a direct result of your firm's capacity
shortfall when customer demand grew faster than your capacity could
accommodate. Now that you have the capacity to serve your customers well, you
discover that they have left you.
Fortunately, you haven't lost them all. So, if your finances can survive a
sustained period of losses, while demand is smaller than your capacity to
serve, there may still be hope. The customers who do remain are now served very
well. Delivery delays are very short, and quality is fine. So, gradually, the
word starts to spread once more that your business is a great one, and sales
slowly start to increase again. Meanwhile, you try to shed any excess overhead
as quickly as you can, though not necessarily your latest equipment and staff,
just excess capacity. Again, these things take time, especially in
welfare-state Europe. But, provided you do not go bankrupt during the process,
there may be a brief moment where supply actually meets demand.
It is odd that classic economic theory starts with assuming equilibrium,
because in my world, as well as in this example, equilibrium is the exception
and not the rule. Just as you have finally been able to shed excess capacity,
customer demand has grown so much that your delivery delays and quality start
deteriorating rapidly again. You are ready for the next tumble on your roller
coaster ride. As mentioned before, success can be hazardous for your health!
Stories like this one are likely to appear in the business press this year and
next. But, the analysis behind it goes back to the sixties. In 1971, Professor
Jay Forrester, the founder of the field of System Dynamics, published an
article entitled "Market growth and under-investment" in the predecessor of the
Sloan Management Review. In this paper, he described precisely the behavior and
structure discussed above. Forrester's insights were based on his experiences
with Digital Equipment Corporation, a high-tech company. But, just about any
high-tech firm has a similar story.
The fundamental problem here is that changes in the supply capacity typically
take longer to implement than changes in the behavior of the customer base.
And, because of the perceived delays involved, decisions to change capacity
always lag behind the real need to change capacity. As soon as there are more
new orders per time period than there are orders shipped, called the
book-to-bill ratio in many industries, backlog goes up and delivery delays
increase over time. There is some lag time before customers start to get
annoyed and leave. Moreover, it takes the company even longer to realize that
capacity is inadequate. And then, when the company has decided that more
capacity is needed, it takes quite some time to get this operational. High
performance strategies will focus either on shortening these perceived
implementation delays, or saying "No" to customers sooner, or a combination of
both. That requires synchronizing sales and production, and in most companies,
"Sales is Sales, and Ops is Ops, and never the twain shall meet." Indeed!
This article is the third in a series of eight
articles by Akkermans about Supply Network Dynamics. The 3rd Wave will be
described in the May/June edition of the Connector. To read the introduction to
this series, click here.