Reactive destocking

Active destocking caused the Lehman wave and reactive destocking deepened it. The strong dip in the manufacturing industry seen at the end of 2008 was caused by cumulative and synchronized active destocking followed by reactive destocking, triggered by the bankruptcy of Lehman Brothers. Said bankruptcy created a sudden peak in the Libor interest rate, causing the banks to recall credit and companies to start freeing up cash by active destocking, so reducing their stocks. When the customers of a company start active destocking it is experienced by said company as lower demand and said company will respond by doing reactive destocking. End markets also responded by going down, but slower and in most markets not so strongly. The drop in end market plus the active and reactive destocking created a giant damped wave, the so-called Lehman wave.

Fig 1: Red curve is the Lehman Wave as a fluctuation around the equilibrium, in this simplified example the black line represents the longer term economic cycle.

When a company takes an active destocking decision, said company expresses the wish to reduce the inventory to sales ratio. In a real world, the actual inventory can first go up, before going down, depending on the behavior of the other players in the supply chain.

Active and reactive destocking explains why some companies can see a strong dip in sales while their end markets are fairly stable. If the supply chain between a company and its end-customer would have a stock depth of "250 days' sales", meaning that it takes at least 250 days for a molecule to travel from a companies' warehouse to the end consumer, and if each firm in such a 250-day supply chain decides to do active destocking of 12%, an amount of stock equal to 30 days’ sales (a whole month) is taken out of the chain. For a company at the beginning of the supply chain this will result in either a business standstill for a whole month or a 33% decline during three months. This discovery of active destocking, reactive destocking and the Lehman Wave can have important implications for manufacturing scheduling, inventory management, work force management and budgeting.[5]

While the existence of the bullwhip effect has been extensively documented (e.g., Forrester (1961),[6] Sterman (1989),[7] and Lee et al. (1997),[8] Croson and Donohue (2006)[9]), there have been arguments about its existence in the overall economy or in supply chains encompassing numerous companies. Cachon et al. (2007)[10] recently argued that no evidence of the existence of the bullwhip effect could be found. Fransoo and Wouters (2000)[11] and Chen and Lee (2009)[12] argue that in order to observe the bullwhip effect it is crucial to measure it correctly. Both these papers argue that improper aggregation essentially takes away the opportunity to observe the bullwhip effect. In the beer distribution game (Sterman, 1989[7]), the bullwhip effect is created by a single pulse. In Sterman's experiment, this single pulse is an increase in the demand level. In the case of the Lehman wave that started in September 2008 the single pulse is active destocking, in this case a synchronized decrease in the target inventory-over-sales level along the entire supply chain. A reduction of inventories under stable or slightly decreasing sales can only be achieved if purchases are reduced or postponed. As a consequence of the decision to reduce inventory, therefore, many companies substantially reduced their purchases of supplies or raw materials. Obviously, companies further upstream in the supply chain were hit more than companies downstream. Therefore, the Lehman wave can be described as a synchronized bullwhip caused by active destocking, followed by reactive destocking.