How to Skip the Bullwhip

How to Skip the Bullwhip

At the end of the day, businesses rise and fall on the waves of supply and demand. In an ideal world, these trends would be predictable, allowing executives plenty of time to plan ahead. Inventory orders could be made months in advance, arrive on time, and not cost an arm and a leg. However, the pandemic was a hurricane to this perfect system.

Give consumers lots of time at home and some stimulus money while simultaneously closing manufacturing facilities and delaying container ships and you’ve created an environment primed for inventory shortages. Not to mention, the trends stay-at-home orders sprouted. Say goodbye to luggage, suits, and premium cruises, and say hello to lots of pajamas, workout gear, and Costco toilet paper. The demand was unprecedented — Amazon’s sales jumped 44% year-over-year in the first quarter of 2021.

These rapid changes left virtually every retailer on the back foot and they spent most of the next two years trying to pick up the pieces and maximize their business. Shortages were frustrating, they were leaving money on the table. Kohl’s estimates it lost $250 million in sales in 2021 because it didn’t have sufficient merchandise. Consequently, brands boosted their orders, forcing distributors to follow suit, prompting manufacturers to majorly bulk up. Workers in these facilities, particularly in the garment industry, were forced to work additional shifts, sometimes without compensation and in dangerous conditions (for more on this, check out this article in Vogue.)

This ripple effect is known as the bullwhip. It was coined by engineer Jay Forrester, hence why it’s sometimes known as the Forester effect, and it describes the tendency for shifts in consumer behavior to have a disproportionate effect on the supply chain the higher you go. Imagine a whip — a slight movement at the handle can produce a mighty crack at the end.

Brands extrapolate orders based on consumers in store, distributors react to brand orders with enthusiasm, and manufacturers are forced to meet the reported demand. However, by the time we get to the manufacturing level, we are several degrees removed from the consumer, and plenty of nuance can get lost along the way. This was made exponentially worse during the pandemic due to increased delivery times which made it more difficult for retailers to realize and communicate shifting shopping patterns. In 2019, it took 45 to 50 days for a container ship to cross the Pacific and reach the United States, by January 2022 it took 110 days. 110 days is not an insignificant amount of time, meaning by the time ships and their merchandise reach shore, they may already be out of fashion.

This Bull has Bite

Taking a look at some of our favorite retailers, it’s abundantly clear we are riding the buoyant waves of the bullwhip. Bring on deep discounting, increased warehouse space, and a bite to margins.

Our first sign of trouble emerged from Target in early June. Prior to releasing their quarterly earnings, Target’s management announced that the company had more than $15 billion in inventory, almost 50% more than it would have had prior to the pandemic. This would force the famed retailer to cancel $1.5 billion in discretionary orders and begin a scorched earth discounting campaign to clear shelves in preparation for the fall season.

When questioned on this, CEO Brian Cornell stood by the company’s radical actions, stating that keeping the inventory, much of which was pandemic essentials, would be expensive and impact the consumer experience. We forget, but storing stuff costs money. Prologis, a REIT focused on warehouses and a member of the MyWallSt shortlist, “expects another 800 million square feet of warehouse space to be needed beyond earlier projections to handle the bloated inventories.” Prologis’ customers include Amazon, FedEx, Home Depot, and Wal-Mart.

Rather than spending on space, Cornell believed that Target was better off decimating its margins for a few quarters than attempting to maintain them and gradually sell off excess merchandise. In Q2 2022, Target’s gross margin fell to 26%, it typically floats around 30%. Combine this will slowing sales and gross profit was down 25% year-over-year.

As you can see, excess inventory really has a bite to it. However, Target’s troubles also reveal the rock that will catch retailers in a hard place: decreased spending. Stimulus checks are long gone and inflation is taking hold, meaning consumers are decreasing discretionary spending and focusing on what matters. Target is responding by doubling down on essentials like food and beauty but these categories are low-margin so they won’t make up for all of the pajamas on clearance racks. So now, retailers have a bunch of merchandise they’re desperate to sell and no one who wants it. They may be struggling for a while.

Looking beyond Target, inventory glut is impacting virtually every consumer-facing brand, but it seems to be having an especially potent effect on the clothing industry. Here, manufacturing and shipping delays have had a devastating impact, with many of our favorite brands only receiving their summer shipments as the fall was setting in.

These businesses also place orders months in advance so they are less agile to sudden habit changes. Clothing and accessory spending has remained largely flat since the beginning of the year and yet inventories are booming. Nike, Kohl’s, and Gap reported inventories were up 44%, 48%, and 37% respectively. In order to get consumers in the door, the deals are going to have to be pretty good. Urban Outfitters CEO Richard Hayne stated: “I hesitate to call it a blood bath, but it’s going to be ugly in terms of the amount of discounting and markdowns.”

Can You Double Dutch?

Now, it can’t all be doom and gloom, surely some businesses managed to time the tides? And the answer is yes, here’s how they did it:

  • Utilized data to keep an eye on spending habits.

We don’t often talk about Macy’s but it managed to predict the downturn in consumer spending at the beginning of the year. Using credit card data, management was able to see that shoppers were becoming more conservative and adjusted their ordering accordingly. In Q2, inventory was only up 7% and the company expects more than 50% of its holiday merchandise to be brand new. Other management teams have reported that consumer behavior changed very quickly this year, hence why they were caught off guard. But, clearly, there were signs if you went looking for them.

Macy’s also benefited from its lack of private-label (or own-label) goods. If you’re ordering stock for your own brand you take ownership of it earlier in the supply chain making last-minute adjustments difficult. This was part of the problem for Nike, Gap, and Old Navy, by the time they realized orders needed to be reduced, it was too late.

  • Had a small merchandise spread focused on the essentials.

It wouldn’t be an Anne Marie piece without a shameless Costco plug, but the wholesaler just keeps delivering. To be fair, Costco rarely sells seasonal items and much of its inventory is food so it would be difficult for it to build excess inventory. Additionally, each location only stocks about 10,000 items, a far cry from Target’s 100,000, so ordering has always been precise and measured. If an inventory excess were to occur, each store is also more equipped to bank the stock, as they are self-described warehouses with abundant in-aisle storage.

  • Spent more to keep stock coming in on time while having a premium, desirable brand.

One of the more creative solutions comes from Lululemon which would appear to be exiting the pandemic like a victorious warrior. Not only was it recently announced to be the second most popular brand with teens, it seems to be borderline recession-proof with sales rising 28% in the last quarter.

However, in the same quarter inventory rose by 85% year-over-year.

Why aren’t we running for the hills? Because this is compared to an especially lean year prior and is measured on a dollar basis, which isn’t the most appropriate when you’ve opted to spend more on transport.

For the last several quarters, Lulu has been flying mass shipments to meet aggressive consumer demand in the United States. Throughout 2021, the legging brand was routinely out of its top styles so it decided to bite the bullet in the name of top-line momentum. But don’t worry, its strong gross margin remained in place, it simply raised prices.

If we look at inventory on a unit basis, it has increased at a three-year CAGR of 38%. That seems reasonable to me given sales are still flying high. Even better, according to management, panic discounts don’t seem to be on the horizon: “our markdown activity is in line with past penetrations pre-pandemic.”

While paying for air freight isn’t an option for every brand, as you would need to be very comfortable with your pricing power, it was one for Lulu and it ensured the company was able to keep on top of its supply and demand.

A Hard Pill to Swallow

The bullwhip will reverberate around our economy for the next couple of quarters. Expect to see brands adjusting guidance, reporting decreased margins, and promising to order more conservatively in the future. Heading into the holiday season, it may mean a less exciting end of the year than we’re used to seeing. I would predict consumers will get some nice deals and retailers will be delighted to off-load all their throw blankets. Meanwhile, Lululemon and Macy’s can take a stride of pride and charge full price.

Anne MarieAnne Marie

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