Friday, January 29, 2010

Is Caterpillar doing the right thing?

Jan 29, 2010

The Wall Street Journal reported that Caterpillar is “promising to stick by "freeze periods" as it transitions to growth: For a three-month span after it places an order, it promises not to change it.” In the current environment where demand picture is uncertain, this is a bad move.

Caterpillar’s suppliers were feeling the effects of the bull whip – when Caterpillar’s production went down, the suppliers’ orders from Caterpillar went down even more. The suppliers have adjusted to the leaner periods through lay-offs and plant shutdowns. In addition, they have been financially squeezed by the lack of bank loans, thanks to the credit crunch. Now Caterpillar wants to set itself up for higher production level, in part because of inventory build-up at the dealers. They want to make sure that the suppliers are going to be able to meet the increased demand (which is distorted by bull whip on the upside now). To help the suppliers, they are offering to give them better visibility to future demand. Their way of putting this into action is by sticking to three month freeze windows.

Though freeze windows sound like a good idea at first, they have a significant downside. The economy and the customers of Caterpillar don’t wait around for freeze periods. The economy is dynamic and the demand for Caterpillar products is going to change with that. With this approach, Caterpillar shields their suppliers from seeing the demand shift for the products for three months because they have frozen the orders. This will mean that the orders outside the three month window are going to be very different from the orders in the freeze period, just a significant bull whip in demand. In this scenario, the ability of the suppliers to respond is going to be worse and not better. Imagine Wile E Coyote chasing roadrunner-the-demand discovering slightly too late that the ground has fallen off below it!



The better approach is to keep the freeze window small and provide suppliers the visibility to inventory at Caterpillar facilities and dealers. This allows the suppliers to see what firm orders they have, and get the ability to react as fast as they can to the imbalance (either positive or negative) between demand and inventory. The sharing of the downstream picture and allowing orders to change as and when necessary provides the visibility to the supplier and mitigates the swings in demand. Interesting how retailers react and how Caterpillar is reacting.

The “sticking to the freeze period” strategy is going to make it worse rather than make it better. What do you think?

Karthik

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