The 'bullwhip' effect describes one of the most central and probably most popular problems of supply chain management: actual demand is not passed on linearly along the supply chain, but is subject to increasing fluctuations from the end consumer to the manufacturer.
Jay Wright Forester († 2016), American computer scientist and pioneer of computer technology. He is considered the founder of system dynamics and was the first to develop large memories with direct access, the forerunners of RAM
To paraphrase Umberto Ecco, every complex problem has a simple solution - and the solution is wrong. This is also true in the case of the current allocation, which was triggered by a wide variety of influencing factors, some of which are reinforcing each other.
Due to the sheer complexity of the situation, a brief overview can therefore hardly present the problem in all its facets. It also stems from the subjective views of its authors and is based on condensed impressions and information from conversations over the last few weeks and months. We also venture an outlook on the extent to which the situation will 'normalize' again compared to previous years - and what this means for the market. So let's embark on a journey through the allocation period.
The initial situation
Looking at the ecosystem in the production of electronic parts and components, it is noticeable that a vanishingly small proportion of the leading companies in the chip industry manufacture their products in-house. Instead, production is outsourced to a few contract manufacturers such as TSMC or SMIC, which are located almost exclusively in Asia [2].
This risk of failure is further exacerbated by the high proportion of hardware, software and design in the overall value creation process. The production of semiconductors or the equipment required to manufacture them, on the other hand, only accounts for a very small proportion.
This inadequate diversification foreshadows the system's vulnerability to regional factors such as lockdowns or climate catastrophes. The limited number of equipment manufacturers alone also makes it extremely difficult to expand production capacity at short notice.
Regardless of such unfavorable conditions, the negative influencing factors of recent years could not have been foreseen either in this quantity or in this rapid succession - and certainly not in these extreme effects.
The trade dispute between the US and China, which hampered the economy, was followed by a global pandemic that initially brought consumption to a standstill worldwide, while individual sectors such as consumer electronics and infrastructure prospered. Subsequently, the slow recovery in demand was met with reduced production and transportation capacities. Extreme weather phenomena such as the cold spell in Texas, the water shortage in Taiwan that was detrimental to chip production and the necessary allocation of electricity quotas in China all contributed to exacerbating the situation.
The confrontation of an unstable system with such extreme influences did not go unnoticed by the public. The original concern about possible material shortages ultimately led to actual material shortages, as safety stocks were built up along the value chain against better judgment. This is still common practice. The inevitable consequence of this: Further undercapacity and incorrect assumptions about actual requirements along the entire value chain.
Allocation becomes real
To make matters worse, the extent of the allocation only gradually became noticeable without immortalizing itself on the canvas of the global economy as a big, sudden bang. While component warehouses were still partially filled in the first part of the allocation at the beginning of 2021, for example, this was no longer the case in 2022.
So even if things were slow, they were still going ahead, and as long as the allocation only cast its shadow ahead, there was hope that it would remain a shadow.
At this point at the latest, profiteers are exacerbating the situation: buying up urgently needed components and reselling them immediately at horrendous prices has become a risk-free and booming business model. Demand regulates the price, and the price lacks a corrective. In the current situation, programs ('scrapbots') are being used to automatically buy up quantities as soon as they are listed by manufacturers or distributors. In this way, the rare goods are not secured for production, but for intermediate sale. The result is endangered jobs on the one side and enormous profits on the other side of the economic Maginot Line.
Those who can rely on partners in the procurement of problematic components at this time, who do not subordinate their strategy to short-term profit and focus on the time after the allocation, are fortunate.
Very few business models are able to cope with the enormous additional burdens that arise, especially in the purchasing departments along the value chain. Distributors are particularly affected by this, as too many components in their line cards are currently subject to delivery difficulties. Each individual delay requires clarification from the customer. It is therefore almost impossible to prevent administrative overload, resulting in difficult accessibility and a slow flow of information at best.
First come, first serve
The current developments are sobering. While price increases in existing (!) contractual relationships were unimaginable until recently, such an approach is now part of everyday work. Applicable contract law and the principles of regulated cooperation are thus not only theoretically, but de facto suspended. The availability of materials has become the highest good. If prices are not accepted, no further deliveries are made.
In order to cope with the incoming demand and at the same time offer a certain degree of traceability, distributors refer to an existing FIFO principle in the processing of orders. First come, first serve; it is not only the date of your own order placement that is decisive, but also that of your competitors.
However, even the higher prices and the earliest orders do not guarantee fixed delivery dates. Instead, further postponements are commonplace - sometimes until the end of 2024, if a delivery date can be given at all.
If this is unacceptable for an EMS company and its customers, the search for alternatives begins. Either by defining a replacement component.
Or by finding an alternative procurement source on the broker market, which is slowly but surely drying up. Both of these measures result in enormous additional costs and are exacerbated by the fact that, in an increasing number of cases, material can no longer be canceled free of charge.
If the necessary components can now be sourced from a service provider specializing in the procurement of problem components, the uncertainties resulting from uncertain procurement sources increase at the same time. The horror stories of faulty, incorrect or simply counterfeit components that have been circulating on the market for years are increasingly becoming a reality.
These risks, as well as the increased costs of material procurement, cannot be borne by EMS. For this reason, it is necessary to make customers aware of the risks from these procurement sources and to at least reduce them through intermediate testing laboratories - and at the same time to work transparently when passing on the costs in order to make the additional costs comprehensible for the customer.
The pain of the EMS industry
EMS service providers are feeling the 'bullwhip' effect on a daily basisEMSare in the midst of the current allocation tension, and the pressure is increasing. Incoming orders have also risen disproportionately in recent months compared to previous years, which is normally a very welcome development that creates planning security. However, it should be noted that some of these incoming orders are also due to the bullwhip effect.
A special feature of the EMS business model is that the probability of one or more components not arriving on time for the production date increases during an allocation, especially with extremely long parts lists. Consequently, production cannot take place and the deadline is postponed. Usually by days, often by weeks, sometimes by months. Sensible production planning is only possible once all components on the bill of materials have passed through the incoming goods department and capacity planning is no longer restricted by Covid outages.
The bullwhip effect is now gradually increasing the probability of missing components for the reasons described above. At the same time, delivery times are increasing while the number of customer orders remains unbroken. However, in order to receive material at all in accordance with the FIFO principle, it must be planned as early as possible in the hope that the allocation will not become more difficult in the meantime, but rather less difficult. A deceptive hope.
The result: safety efforts by customers lead to increased component inventories at EMS. Working capital increases, and with it the risks resulting from liquidity bottlenecks.
The occasional and recent demand from customers for EMS service providers to store all material from framework agreements without corresponding financing from the customer is already a potential existential risk in quieter times and is by no means common practice. Given the current situation, such an approach is completely out of the question for any prudent businessman.
On the other hand, a viable option is for customers to provide order-related financing support in the form of advance payments in order to enable the EMS to order the entire quantity of frame material for the next possible delivery date. This at least increases the probability of receiving all components on time. Alternatives also only need to be clarified once if necessary.
Anyone who objects at this point that layout changes are indirectly more expensive must be countered with the fact that in the current situation, even a layout change offers little protection - if any - against the effects of the volatile component market. After all, which component can still be procured without friction in two months' time?
If the complete frame material is now procured, significant additional costs are incurred in work preparation, purchasing and sales at the EMS until the goods are actually received. Alternatives have to be defined, costs approved and clarifications carried out. A single component that is difficult to procure can result in hours of work - and many components are currently difficult to procure. Things become difficult when the growth in administrative costs exceeds the growth in capacity.
If the eagerly awaited component finally passes the incoming goods department, costs also rise in all downstream departments. Due to the high volume of incoming orders, storage space is running out. Smaller packaging quantities, bars instead of rolls and hastily produced partial quantities lead to longer set-up and throughput times and therefore to a considerable drop in productivity, which has to be met with rising fixed costs from electricity and gas.
The realization remains that the classic EMS process that has been practiced for years no longer exists in this form. This is a painful admission, but as a sector that provides services to customers, there is no alternative. Especially in the current situation, current developments make it necessary to present the status quo openly and transparently.
However, despite all the uncertainty, one thing is clear: the allocation will pass.
Before this point in time is reached, the pain it has caused will have triggered developments and improvements in many EMS companies that will benefit customers and therefore the EMS industry in the long term.
With the start of 2023, there are now initial signs that the supply situation is beginning to ease, at least across the board, even if not all critical components are still available. In addition, the tools created are proving their worth in the long term and successful handling of the problem situations identified is becoming increasingly familiar.
What can be done?
In the event of hail, nobody would blame the meteorologistBeforepointing out possible solutions, it is helpful to describe what can be avoided. First and foremost, this includes maintaining reassuring misconceptions. The situation appears critical and can be called so. Nevertheless, it is unrealistic to assume that EMS can solve a global economic problem in a regional economic way. It's like expecting the weather forecast to repair hail damage.
Anyone who could have foreseen such a development is now a private individual and hardly dependent on earning a living. Accordingly, recriminations rarely serve as anything other than fig leaves for the trouble and stress that purchasing departments have to endure along the entire value chain. Worse still, blame does not solve problems, but wastes valuable resources that suppliers, EMS and their customers could be putting to better use. Ultimately, complex problems do not know who is to blame. The question of possible courses of action remains. Here, too, a confrontation with the truth is inevitable.
Doesn't the FIFO principle and the resulting early scheduling of safety requirements reinforce the bullwhip effect mentioned at the beginning? Definitely. Is there a sensible and practicable alternative to this approach? If every European company along the supply chain undertook to transparently distinguish its actual demand quantities from safety orders, then yes. However, such an assumption is unrealistic utopia; we do not function rationally in times of uncertainty. Even if this standard could be introduced in Europe, success would still be hampered by the small European share of the global electronic market (approx. 10 %).
What we should expect from each other, however, is to at least signal in our orders what is urgently and immediately needed and what is intended to build up security of supply. And if the delivery date doesn't work out on the first shot, it helps to remember that no company does NOT want to deliver and make sales.
Everyone is doing their best at the moment. Changing EMS partners is not advisable in the current situation. In addition to the additional burdens of working together for the first time on the customer and EMS side, the new material orders that have just been placed would be placed relatively far back due to the FIFO procedure of the upstream suppliers. Loyalty is now required.
Despite all the additional burdens, EMS is constantly working on further expanding the existing supplier portfolio. The increasing value of resilient and actual partnerships between EMS and their system partners is also no coincidence. Customers who work together with their EMS service provider to identify problem components on the global market are already an important step ahead. At the same time, both companies should not start a wide range of inquiries at the same time, so as not to further boost the bullwhip effect (and therefore the price) by creating a false demand.
Overall, transparency is king. Especially when it comes to presenting additional prices from broker orders in a comprehensible and open manner for the customer. This also applies to other conditions such as date codes, the tested or possible condition of the components and the potential resulting risk for the assembled module. Even if it sometimes hurts, customers must receive the maximum amount of information and thus the best possible basis for decision-making.
Furthermore, EMS service providers are not only responsible for the demand for components, but also - albeit to a certain extent - for their supply. The limited influence can be exerted by placing surplus quantities and slow-moving items on appropriate platforms and making them available to other EMS providers without extortionate prices. Or, if even the smallest quantity helps, EMS can quickly contact a colleague and ask if they can spare something. And yes, it actually works!
It is clear that joint cooperation between customer, EMS and distributor is becoming increasingly important. Only a clear distribution of tasks with shared responsibility along the supply chain guarantees joint success. The more projects that are set up under this credo, the more resilient the entire supply chain will be in view of the certainty that some supply bottlenecks cannot be completely avoided even in 2023. What has proven itself in the organization also applies in this case: the greater the complexity, the more brains, trust and commitment are needed to master this complexity. Collaboration is key, and the new tools created by many EMS for the early detection of problem situations are paving the way to the 'new normal'.
References
[1] Jay Wright Forrester (1918-2016) was an American computer scientist. He is considered the founder of system dynamics, developed precursors of RAM memory with direct access in the Whirlwind project and held a professorship at the Sloan School of Management at the Massachusetts Institute of Technology (MIT).
[2] See also the article by Heiko Weckbrodt in this issue, p. 213.
