00:00:00 Introduction and definition of scarcity
00:01:33 Scarcity and alternative uses of resources
00:04:22 Critique of mainstream supply chain theory
00:07:37 Constraints and time dimension in supply chain
00:10:32 Evaluating inventory and alternative uses
00:13:21 Mainstream view’s limitations and time series forecast
00:16:37 Manpower allocation and truck capacity issues
00:19:33 Time as a disposable asset in allocation
00:22:53 Pricing strategies and scarcity in supply chain
00:26:41 Scarcity in luxury brands and limited catalog capacity
00:29:27 Retail chains’ struggle with reorder points
00:32:39 Flaws in KPIs and metrics in supply chain
00:35:41 USSR’s poor planning and mainstream supply chain similarities
00:38:42 Absence of economic drivers in supply chain theory
00:42:37 Comparing supply chain to financial risk management
00:46:04 Post-WWII focus on production in supply chain
00:49:30 Paradigm shift in production and Lokad’s approach
00:52:36 Modes of delivery and their impact on scarcity
00:55:40 Mainstream supply chain theory’s limitations
00:58:11 Importance of financial assessment in supply chain
In a dialogue with Conor Doherty, Joannes Vermorel, founder of Lokad, criticizes mainstream supply chain theory for overlooking resource scarcity and alternative uses. Joannes Vermorel argues that traditional theory assumes a known future, eliminating the need for resource allocation decisions. He emphasizes the importance of time in supply chain management, stating that no resource is truly scarce given enough time. Joannes Vermorel also criticizes the mainstream view for ignoring the complexities of allocation decisions and the importance of financial assessments. He suggests that supply chain optimization should involve probabilistic forecasting and stochastic optimization, assessing all possible futures and making decisions based on expected returns.
In a thought-provoking conversation between Conor Doherty, the host, and Joannes Vermorel, the founder of Lokad, a software company specializing in supply chain optimization, the duo delves into the concept of scarce resources in the context of supply chain management. Joannes Vermorel, a French entrepreneur, criticizes the mainstream supply chain perspective for bypassing the issue of resource scarcity and alternative uses. He argues that the conventional theory assumes a known future, thereby eliminating the need to make choices about resource allocation. This perspective, he contends, ignores the reality of scarcity and the alternative uses of resources.
Vermorel further criticizes the mainstream supply chain theory for implicitly assuming that companies have the cash to buy safety stock and that this money is better spent on safety stock than anywhere else. He argues that this perspective ignores the concept of scarcity and alternative uses. He explains that the time dimension is what differentiates supply chain from general economics. He argues that no resource is truly scarce given enough time, but the more swiftly you want to ramp up, the higher the price point. He emphasizes that scarcity reflects the idea that if you want to press any of the dimensions, it’s going to be very expensive because you’re hitting time-dependent limits.
In the context of inventory availability, the scarce resource is the inventory that you already have. He argues that each unit of inventory has multiple alternative uses, such as being sent to different stores, which compete with each other. Joannes Vermorel agrees and gives the example of a part that contributes to two bills of materials. He explains that whenever you decide to allocate one of those parts for one product rather than the other, there is an opportunity cost.
Joannes Vermorel criticizes the mainstream view for ignoring these issues. He argues that the mainstream view assumes that you know the future and that you can just ask your bank for a check that matches in terms of working capital whatever needs to be allocated. Lokad’s approach to supply chain optimization involves probabilistic forecasting and stochastic optimization. This involves assessing all possible futures regarding demand, lead time, returns, and other uncertainties, and then evaluating each decision, such as allocating a unit to a store, based on the average expected returns.
For perishable products like strawberries, allocation decisions are made based on where the product will sell the fastest. The first pack of strawberries might go to one store, while the second pack might go to another store that will benefit more from it. He also mentions that the value of a product for tomorrow also takes into account potential losses between now and then, such as carrying costs or spoilage for perishable products.
Joannes Vermorel discusses how pricing strategies can drive scarcity in supply chains, and how scarcity can exist even without pricing. He emphasizes the importance of financial assessments in supply chain decisions, which he says is often overlooked in mainstream supply chain theory. Even luxury goods like expensive cars compete for the same parts, and decisions must be made about which clients to serve first. He criticizes mainstream supply chain theory for ignoring these complexities and stresses the importance of financial assessments in making these decisions.
Joannes Vermorel criticizes mainstream supply chain theory for not acknowledging the complexities of allocation decisions, leading to problems like erratic delivery flows. He argues that this theory does not provide a way to decide what the next unit produced should be, especially for luxury goods that can be highly customized. He agrees that these KPIs are flawed and argues that companies manage to operate despite this because people manually correct for these shortcomings. He criticizes the current situation where software and processes ignore scarcity and alternative uses, leading to a lot of micromanagement.
Joannes Vermorel argues that mainstream supply chain theory and practices do not align with the idea of maximizing return on investments, as economic drivers and finance are often absent from these theories. Joannes Vermorel explains that alternative use is about understanding the options available, not quantifying them. It’s about assessing the financial expected outcome associated with each option. Joannes Vermorel agrees, stating that opportunity cost is computed by looking at the alternative uses and their expected return on investment.
Joannes Vermorel disagrees, stating that while finance has been using sophisticated methods for decades, these practices have not been adopted in supply chain management. He criticizes the simplistic approach often used in supply chain, arguing that it ignores the problem altogether. Joannes Vermorel explains that the mindset of mainstream supply chain theory was formed during a time when the main problem was producing more. However, most companies now have the capacity to produce more than the market needs, making this mindset outdated.
Joannes Vermorel agrees that product ranges have inflated and this creates extra complexity. He criticizes classical supply chain books for not addressing the cost of this complexity. He also mentions that companies often underestimate the cannibalization that occurs when they introduce new products. Joannes Vermorel agrees and criticizes mainstream supply chain theory for ignoring this aspect of modern economics.
Joannes Vermorel suggests starting by appreciating the economic drivers, including opportunity cost and alternative uses. He advises making a financial assessment, even if it’s rough, as it’s better than ignoring the problem. Doherty concludes the interview by agreeing with Joannes Vermorel’s point about being approximately right versus perfectly wrong.
Conor Doherty: Welcome back to Lokad TV. Supply chain, much like economics, is the allocation of scarce resources that have alternative uses. It’s precisely because they’re so scarce that we must learn how to best allocate them. Here to explain why is Lokad founder, Joannes Vermorel.
So Joannes, I think most people have an intuitive understanding of what resources, and particularly scarce resources, are. But they would struggle to explain it. So right at the start, could you explain what both these terms are in the supply chain context?
Joannes Vermorel: What economics tells you is that everything is prohibitive in terms of price. It’s literally the very idea that something has a price, it means that it prevents you from getting more of it, and that’s true for pretty much everything. The whole idea, for example, of having unlimited anything, it’s kind of bogus or at least it defies the modern understanding of economics.
The puzzling thing is that all resources are finite. Economists go further, they say not only are you limited, but those resources have alternative uses. That’s what puts a true limit to what you could do with any single resource. So yes, in a sense, you could always get more. There is no company facing a hard limit on the amount of pig iron they can acquire, but at some point, if they acquire even more pig iron, the money would be better spent into doing something else, investing in software, machinery, whatever. So fundamentally, it is the alternative uses that matter.
The interesting thing is that the mainstream supply chain perspective mostly entirely bypasses that. It bypasses the entire problem and thus the mainstream perspective on supply chain doesn’t discuss economics at all, or in a very shallow perspective. The idea that there is any kind of scarcity in the resource or that there are alternative uses that compete with each other, all of that is very much absent.
The way the whole thing is approached in order to bypass those ideas is if you know the future. If you know that, and that’s pretty much the cornerstone of the modern, I would say, mainstream supply chain theory, is that if you know the future then you don’t have really any choice to make about those resources. All the choices, all the allocations that you will do will be a direct reflection of this future that is supposedly known, potentially with a little bit of buffer, you know, the safety stocks everywhere, and this is it.
The interesting thing is that if you assume that the future is known within a certain amount of tolerance, then you don’t see the issues of scarcity emerge or the alternative uses. For example, mainstream supply chain theory doesn’t really tell you anything about what if I can see a lot of demand but I don’t have the cash to fulfill this demand. No, mainstream supply chain theory doesn’t even ask this question.
When you compute your safety stock, it is implicit that the company has the cash to buy this stock and it is also implicit that if you compute the safety stock, the money that you put here is better than being allocated anywhere else. So you see, that’s a lot of assumptions being made implicitly. That’s why from the classical perspective, again mainstream supply chain theory, the very odd thing is that scarcity doesn’t really exist because you at no point assume that there is anything that prevents you from raising your safety stock even higher.
Those alternative uses are also simply absent. So the modern supply chain theory pretty much operates laterally compared to modern economics.
Conor Doherty: If we talk about resources that are scarce in a natural context, we can say things like oil or water depending on where you are geographically and people again understand that. When we’re talking about supply chain, I don’t want to get too fuzzy. Specifically, when we talk about resources in the context of supply chain that have alternative uses, is it only money we’re talking about here?
Joannes Vermorel: Most economists approach the economy as a system with a somewhat stationary perspective where the time dimension is pretty much absent. I think what differentiates supply chain compared to general economics, you could see supply chain as being like a subset of microeconomics, is the time dimension where your resources are. No resource is truly scarce if given enough time. That’s the thing, if you have an unlimited amount of time, your storage surface, you can always build a second warehouse, rent an extra warehouse, etc. So there is, if money is not an issue, you can always kind of get more of anything, people, storage space, transport capacity with more trucks, more drivers, everything. But everything takes time and the more swiftly you want to ramp up, the higher the price point.
So if you want to get something delivered one week from now, that can be a lot more expensive than getting the same thing delivered let’s say 15 weeks from now because people will have to ship by air freight instead of doing sea freight, the latter being much cheaper. So scarcity reflects the idea that if you really want to press any of the dimensions, it’s going to be very expensive because you’re hitting limits that are really time-dependent. All those constraints that you have in supply chain, with time and money, they can go away. There is very little in terms of supply that are truly hard constraints within the field of supply chain.
Resources are scarce and if you look at this time constraint, for example, if you look at what you could do in terms of inventory availability for tomorrow, well for tomorrow, you have clients that you want to serve. The reality is that it is a very short time frame to produce or replenish stock within such a time frame. So most likely if you want to be able to serve your client tomorrow, you will operate on the inventory that you already have. So your scarce resource is the inventory that you already have at this point of time.
And now, what are the alternative uses? Well, the alternative uses, if you have multiple stores and you have like wells, you can decide for every single unit to where do you want to send it and maybe you don’t want to send it anywhere. So you see, you have one unit that is in stock, this unit is scarce in the sense that in the relevant time frame, you can’t really allocate more because it would be very steep in cost. I mean, yes, you could potentially ask for an overnight delivery from your supplier direct to the store, etc. But the cost is probably going to be through the roof. But you still only have one thing right now that you can allocate. It’s much like spending a dollar.
So now you end up with this scarce resource and it has multiple uses such as for every store where you could put it. That’s one option and so you have those alternative uses and they compete with each other. And that’s interesting because that’s economics 101. I have my scarce resource, that’s the things that I have in stock right now. It depends on the time frame. In general economics, people don’t usually bypass this aspect. In supply chain, due to the fact that everything has to be kind of planned ahead, the time dimension is very important.
Beyond that, we have those alternative uses and again from the mainstream supply chain perspective, those alternative uses are typically never even mentioned. The safety stock perspective only discusses about bringing more or less units to a single SKU. It doesn’t discuss that every single unit that is already in stock for this SKU should be evaluated separately and can have a different value of being positioned at one place or another.
Conor Doherty: I want to dig deeper on that point because that’s quite a profound insight. Once you’ve acquired something, again we’re just talking about stock you already have, you can continue to carry it or and you incur costs carrying costs, you can allocate it to any one or divide between your stores, and again that’s another alternative use. If you don’t think you’re going to sell it, you can liquidate it, you can sell it at a discount, and you can try and return it. These are all the alternative uses and they have financial consequences.
Joannes Vermorel: Exactly, and even others that are very basic. Whenever you have bills of materials, imagine you have a part that contributes to two bills of materials. So you have two finished goods that depend on the same part that feeds the two products. Now, whenever you decide to consume one of those parts or allocate one of those parts for one product rather than the other, it means that the other product is going to be short of one unit if you want to produce more of this one unit. So there is opportunity cost there.
You might decide that, despite seeing demand for one product, you don’t produce as much as you want. This could be because you believe that doing so would endanger your capacity to serve another product, which is deemed superior in terms of criticality for the client’s profitability. The idea is that whenever you have a part that contributes to both products, there is a question at some point to decide if you’re not going to sell it anymore standalone. You might have a few units left and you say, “No, now this part is reserved for the better clients who want to buy the bundle because I don’t want to not be able to sell the bundle anymore just because I’m missing this one part that can be sold standalone.”
Conor Doherty: It occurs to me that there’s a horizontal plane in terms of the options that you have. You can allocate, you can liquidate, you can sell at a discount, you can carry. But then that kind of stacks vertically in terms of for each unit. If I bundle them, if I sell them in threes, there are all these implications and there’s a lot of computational power involved in processing that. How is that generally handled in, let’s say, the mainstream view?
Joannes Vermorel: It’s not handled at all. The mainstream perspective says, “Okay, you know the future, so here are all the allocations that you need to happen. Then go see your bank and just ask for a check that matches in terms of working capital whatever needs to be allocated.” That’s it. The mainstream supply chain view, with time series forecast, service levels, safety stocks, that’s what I consider the mainstream view. It just completely ignores these things. They are not discussed.
We have discussed the units of stock being scarce, but you have this scarcity that pops up again. It’s time-dependent all over the place. If you can only send a single truck to a store for replenishment, that’s your capacity. So today, it’s going to be a single delivery and there is the capacity of the truck. The question is, with the mainstream view that assumes that you compute your safety stocks and you compute your replenishment and then you put in the truck what needs to be replenished. But what if it exceeds this capacity of the truck? Then in this case, we need to decide which units should make it into the truck today.
Even if your truck has plenty of capacity, the staff in the store has a limited amount of manpower available on any given day to put the merchandise on the shelves. Thus, there is a scarce resource which is the manpower available in the store. All the units that you send compete for the same manpower in the store today that will be available to put those things on the shelves in a timely and orderly manner.
Conor Doherty: Okay, so as is often the case, you’ve mentioned at least three things I want to come back to and I need to make a mental note. But first, what you just said about determining what things make it into the truck, that’s a really interesting point. Could you expand a little on that?
Joannes Vermorel: The general way we do it for this type of problem is we would literally look at this probability forecast followed by stochastic optimization. The probabilistic forecast would have all possible futures with regard to the demand, the lead time, the returns, all the things where there is uncertainty. And then we will assess every single decision such as, “I put plus one unit in this store, just one.” So I take the first unit and I look, what is the payback looking at all the possible futures on average in dollars? What are the returns? So I have this one unit that I can allocate in this store, it gave me a certain score. I could have the same unit allocated in another store or maybe I can have the same unit that just stays in the warehouse and it will have value because I will maybe be able to have one more unit to send to another store tomorrow.
Conor Doherty: You mentioned that’s worth following up on, and it hints at the idea of time and scarcity. You said we can take a unit, we can allocate it here, we can allocate it there, or we can keep it in the warehouse and possibly sell it again. That presumes a disposable asset being time. Now that might be true for some verticals, let’s say if you’re selling clothes and you have classic white shirts, they never go out of style. If I sell it today or a month from now, whatever, I’ll get the same amount of money. If you’re dealing with fresh produce, you don’t have that. You can’t keep milk in the warehouse, or if it’s not UHT treated, you can’t keep it or fresh fruit, etc. How does that then factor into scarcity, alternative uses, prioritized allocation?
Joannes Vermorel: When you do your economic calculation, let’s say you have strawberries, the archetype of the super perishable product. Your alternative uses are first, send those strawberries to one store today. So all those stores compete for the same strawberry. So if you have the first pack of strawberry, you could say, “What is the store where I am going to sell those strawberries the fastest?” You allocate those first pack of strawberry to this store. Now, what about the second pack? Well, maybe the second pack you want to allocate it to another store. Why? Because you’ve already allocated the first pack of strawberry to the first store, so the first store already has something. So most likely, it’s going to be another store that now benefits the most from the strawberries. So you see, the interesting thing is that when you think about the value for tomorrow, you also take into account the sort of bad things that occur between now and tomorrow. It can just be basic carrying cost, but in the case of perishable products, the economic penalty would be much steeper. Pricing strategies can be a driver of scarcity in supply chain. If you don’t have prices, you don’t have scarcity. However, this is not entirely true. You can have scarcity even if you operate under federalism with no pricing. From a broad economic perspective, you can have scarcity even without pricing. But this is more like an exercise of thought because that’s not the sort of economies in which we operate. So, the bottom line is that there are prices, cost assignments, and opportunity assessments all over the place. This is something that is very much absent from mainstream supply chain theory. If your future is not uncertain, then you don’t have to do those assessments. You already have this grand, semi-perfect vision of the future and it’s just a matter of orchestration. If you start to think about those competitive uses, then you need to do all those financial assessments. That means putting a lot of financial estimations on tons of things.
Conor Doherty: It occurs to me that scarcity may be more acute or less acute depending on the nature of the good you’re selling. For example, you have many alternative uses right now for punnets of strawberries, fresh milk, and shirts. You gave the example earlier of bundling them. So, there are certain classes of product that we can bundle together. That’s an option in terms of the alternative uses. In the context of luxury goods or labeling goods, you can’t bundle Mercedes together, surely?
Joannes Vermorel: No, but if you’re selling expensive cars, you have different types of cars and they compete for the same parts. Not for everything, but most cars have tons of parts in common so they do compete for the allocation of those parts. Your distribution networks also compete. For example, Mercedes would be an example where it’s made to order. But nonetheless, you have to decide how do you serve your clients. Who gets served first? The idea that it will be first order, first served might be appealing, but why would that be completely aligned with your strategic interest? Maybe you have some VIP clients that you want to serve very swiftly. If someone buys an outrageously expensive car from this brand, why would this person not be served more swiftly than someone who buys the entry model of the same expensive brand? I’m not saying that is what this brand should do. I’m just saying that there are decisions to be made. You cannot just assume that there is a canonical solution to the problem. There isn’t. So, when you decide to serve a client rather than another client, this is again a decision being made. The mainstream supply chain theory tends to ignore all of this and just pretend it doesn’t exist. But it does. The only way to rationalize that is to put a sort of price so that you can compare. You try to make a financial assessment and that gives you a value in Euro or dollars and then you can make a comparison.
Conor Doherty: That’s actually a potentially good example because when I gave the example of cars and luxury goods, I was talking about them on the product level. Then you deconstructed that from the supply chain perspective and said that it’s composed of individual parts, all of which are in competition for other allocations.
Joannes Vermorel: Yes, and there are also other things to consider. For example, as a luxury brand, you have a limited capacity. Your catalog is limited. If you have a catalog that would be half a million products, that would be completely unreadable for customers. So, even if the resource that is scarce is the attention of your customer, it’s still there. At some point, you could decide that you want to pile up more stock for one product or just allocate this money for another product and expand your range. Then you might run into another scarce resource, which is the attention of your clients or just general understanding of the market of what you’re doing.
Conor Doherty: If traditional or what you call mainstream supply chain theory doesn’t explicitly acknowledge, as you said, “push the dust under the rug”, but then you also say that there are financial mechanisms for measuring the value of these allocations, how is that done? How can you measure how efficiently you’re allocating scarce resources that have alternative uses if you’re not acknowledging that there are alternative uses?
Joannes Vermorel: It’s hard. The mainstream view doesn’t acknowledge these things, so you can’t really do it. It’s not even part of the paradigm. It’s literally absent, and thus you end up with very strange problems that have no solutions. For example, retail chains struggle with reorder points, which have plenty of undesirable effects such as generating erratic flows in terms of deliveries. After a good weekend, there is a large demand for shipment from the warehouse to the stores, and the paradigm doesn’t offer any way to smooth this flow. The same thing applies to luxury goods. The mainstream theory doesn’t offer you any way to think about what should be your next unit produced. If you’re doing hard luxury, you have very small series so you can afford to think unit by unit. But again, this sort of thing is literally absent. You could even think of whether you need more of something that exists or something that is novel. If you’re doing hard luxury, your potential for novelty is enormous because you could almost make every single unit that you create unique. Even if you take something that is a little bit in between, like a company such as Louis Vuitton, they can do very short series. They can decide pretty much when they want to produce something that would be a novel color, a novel pattern, a new texture, a slightly different variant. Most of those companies do not do that because they operate on the classical paradigm that is very much top-down. You predict the future and then you do your grand planning exercise once or twice a year.
Conor Doherty: So, when you say “well, it still works”, that implies that you can measure it and demonstrate that it functions. My question is, if your position is that mainstream supply chain theory completely ignores the alternative uses of resources, does that then mean that KPIs and metrics that are used to evaluate the return on investment are essentially flawed?
Joannes Vermorel: Yes, they are flawed. The corollary of that is that companies manage to operate because people, when they have their spreadsheets and they do all their manual corrections on top of the systems, are accounting for those alternative uses, risks, and economic drivers. They have a system that ignores all of that, but then they pause, think for a minute, say “no, this can’t be right”, and then they do some kind of manual tweak. Due to the fact that it doesn’t fit into the paradigm, it’s a lot of micromanagement of the system. We have a situation where the software pretends that we know the future, the processes are geared around this idea that scarcity is not a thing, that those alternative uses do not exist. The software and the KPIs reflect that, and then people operationally just do something else. We assess the metric and it doesn’t make sense, but since the company still manages to move forward, the charade goes on. You can operate for decades with a fairly dysfunctional system if the company has good products and good branding.
Conor Doherty: That’s something we talked about before in the context of ABC XYZ analysis. Someone might say “well, it works for me”, and the response to that is “compared to what exactly? Something could work better.”
Joannes Vermorel: The paradigm in which the USSR was operating is very much aligned with the mainstream supply chain paradigm, which is the idea of the grand plan. You can make a grand plan five years ahead where you’re going to know the future and then you just orchestrate the rollout of the allocation of resources. Most companies with their S&OP plans and traditional forecasting processes are just doing that at a smaller scale. It kind of works, especially since you do the grand plan and then people do all sorts of accommodations all the time with this academic thinking. We have this paradoxical situation where the paradigm governs the software, the processes, the design of the company, and then people do something that is very much outside this paradigm. But it’s thanks to that that the company actually operates correctly.
Conor Doherty: If in terms of evaluating the financial impact of one’s decisions, whether or not one is taking the mainstream or the alternative uses perspective, if KPIs like ROI, return on assets, etc., are not good metrics, then what are?
Joannes Vermorel: The problem is that when you say return on investment, you’re thinking about competitive use. We are going to assess every single alternative use based on the return on investment. But the question is, is the mainstream supply chain theory and most of the practices truly aligned with this idea of maximizing return on investments? Not really. Economic drivers and finance in general are absent from the classic supply chain theory. You could read entire books about supply chain theory and they do not have any KPI in Euro or dollar.
Conor Doherty: To consider in the discussion of the alternative uses, I mean, how do you quantify that if it’s a KPI?
Joannes Vermorel: No, alternative use is just to understand what is at stake. It doesn’t quantify anything. It’s more like a categorization of the possible options on the table. This unit in its stock can stay where it is, be moved in a list of places, or be scrapped, or be bundled or consumed in other ways and whatnot. So, when we say alternative uses, it’s just about surveying the options. It doesn’t say anything about how you assess the financial expected outcome associated with this option. That’s a completely different thing.
Conor Doherty: So, for people who’ve never studied economics or have never heard again about scarce resources that have alternative uses, would a simpler way to put this just be opportunity cost? Like once you have a thing, there are many things you can do with it and once you commit to one course of action, it prohibits the alternative.
Joannes Vermorel: Yes, the opportunity cost is literally something that you compute looking at the alternative uses. Once I have one unit in stock and I allocate it to a store, then I can’t allocate it to any other store and thus I forfeit all the other options. Forfeiting all those other options has a cost and that’s this opportunity cost. But this opportunity cost is completely dependent on the expected return on investment for the alternative uses. If I have one store that presents a gigantic return on investment because the unit is out of stock, so if I put it there, it’s going to be the only one. So, it’s a very large expected return on investment and this is a big store so I expect that this unit is going to be sold very swiftly. And all my other stores are overflowing with the stuff. Thus, the alternative uses, in terms of expected returns, are very small and for this store, the expected return on investment is very large. Thus my opportunity cost is very small because the difference between the option that I pick and the other that I forfeit is very large. Conversely, if all my stores were out of stocks, then the opportunity cost would be kind of large because there are plenty of other places where those stores are in dire need of the same unit in stock. So, when you say you want to think about opportunity costs, opportunity cost is literally what you compute once you’ve made an assessment of the return on investment that you could have for those alternative uses.
Conor Doherty: Some companies have entire divisions dedicated to assessing financial risk and it kind of sounds like the lost dollars or the increased dollars of error or the reduced dollars of error, the alternative uses, the opportunity cost, this is just kind of like financial risk management ultimately. And there are specialists in risk management in companies. So maybe this doesn’t fall under traditional mainstream supply chain theory but it falls into that.
Joannes Vermorel: Not really. It’s a bit strange. In the world of finance, people have been doing things like that for literally four decades plus and they use extremely sophisticated methods. But those things stayed in finance. The future is already there, it’s just not evenly distributed. So, we can have practices in finance that are four decades ahead in just embracing basic economics compared to what is being done in supply chain. It’s very strange. So, you can have people in the same companies that do incredibly sophisticated financial engineering for the pure financial aspects of the company and then when we go back to the supply chain, we are back to something that would be junior high school level of math. And then people say we should keep it simple. But simplicity should not be simplistic. If you’re so simple that you ignore the problem altogether, you don’t get a good solution for your company.
Conor Doherty: How is it possible to have nowadays multi-million or multi-billion dollar companies that have multiple divisions with people specializing in all of these individual disciplines and yet, what is the most fundamental aspect of economics, the most basic, is just now being considered?
Joannes Vermorel: The interesting thing is that if we go back a few decades in the past, to essentially World War II, the problem was just producing more. So, all the supply chain was just about producing more. And for many companies, that was literally the only problem, to produce more. What was truly scarce was the capacity to produce more and thus the rest was not a problem. That was the mindset that went into the mainstream supply chain theory as we know it today. But now, most companies could flood the market with twice or three times what the market actually needs. So, we have those four decades where people were lacking everything after World War II that defined the mindset that went into the software that was produced in the 80s. And then for the last four decades, people are just continuing the same paradigm. And in most of the practices that you can see in the companies, they are just a continuation of those things. And those practices were very successful when it was about producing more and your capacity was just ever no matter what you produce, you will sell it. But now we are in a slightly different industrial age where the limit on the production capacity is not the one constraint that overrules everything.
Conor Doherty: It occurs to me, because I’ve heard you tell that anecdote before, and purely because of the context in which I’m hearing it now for the first time, I realized that, in the context of scarcity and alternative uses, we’ve discussed it from the perspective of sellers or producers, but we haven’t actually looked at the idea that there are alternative uses from the perspective of the consumer. So, the example you gave was your parents buying a second-hand stroller, not a new one. They went on to a secondary market and picked one up. How do companies factor in this new constraint? I mean, that’s a whole other world that many companies have not come to terms with.
Joannes Vermorel: Indeed, the product ranges have inflated enormously and they keep inflating. Having more diversity in your offering is great to be more competitive, but suddenly you have to consider all the costs that are associated with that. If you go into a classical supply chain book, the idea of factoring the cost of the complexity of your offering, how much are you willing to go in terms of diversity of products and diversity of modes of delivery, is not well addressed. You have plenty of companies nowadays that say, “Well, you can purchase from us in many ways. You can have overnight delivery, slower deliveries, or we can put the product somewhere and you come and pick up.” The lines are more blurry than ever. Even for example, Original Equipment Manufacturers (OEMs) are increasingly selling through many channels, not just through a super classic path where the OEM is only selling to a few big clients who deal with the distribution and whatnot. There is increasingly a diversity of sales channels, and that creates extra complexity. Those alternative uses mean that the clients can pick something else. Very frequently, for example, companies do not really have a correct appreciation of the actual cannibalization that happens. The alternative use, if you’re lucky, of the money of the client is just the same money, the same clients just buying another product still from you, the same offering from the same company. In this case, for the company, it’s still good because they make the sale, but it means that they still incur the cost of the complexity. If the only thing that you do by having a greater offering is just generating internal cannibalization, so you introduce products but they just end up cannibalizing the products you’re already selling, this is not a great proposition. That kind of comes back full circle to the idea of time because there could be immediate or longer-term cannibalization. I can introduce product A right now and sales of A right now compete with sales of B, or I can produce Rolexes today, people buy them today, hang on to them for 20-30 years, and then sell them on the secondary market, and that’s cannibalizing much farther down the line. But again, time as a driver of scarcity,your alternative allocation of resources now are directly impacted by not just present conditions but longer-term conditions. Yes, if you go into longer terms conditions, the things that you look at with statistics quickly lose relevance. But the bottom line is that you need to look at the alternative usages that you can create among your customer base as well. That can be into making your products repairable. But here the interesting thing is, and that will be my message, the mainstream supply chain theory just ignores entirely this angle of modern economics. And when I say modern economics, I just mean economics that is defined by the study of scarce resources which have alternative uses, which is the modern definition.
Conor Doherty: Yes, well, it seems like we’re kind of wrapping up, but we’ve covered a lot of new ideas today. And again, it would be unreasonable to expect someone who has come into this conversation from the mainstream safety stock-based perspective, and then we say, think about 30 years in the future, potential second-order cannibalization, that’s way too much. But in terms of today, what are some considerations that supply chain practitioners could take into consideration today to start grappling with the effects of scarcity in supply chain?
Joannes Vermorel: You need to start appreciating the economic drivers, and those economic drivers include the opportunity cost and the opportunity costs include those alternative uses. All the alternative uses are not equally important. It is right to make a judgment call and say this thing is too remote to probably be important, and that’s fine. It will be an illusion to have this sort of pseudo-scientific approach where you say I’m going to have everything. It’s perfectly fine to say, at first, I’m only going to say the alternative uses for a unit in stock is just the other area, the other locations where I could have the same unit in stock. There are alternative uses beyond that, but we can start with those one and say well they are the most important ones.
That’s an approximation, and then start doing a financial assessment. Maybe it’s going to be crude, and the interesting thing is that people say, “Oh my, I don’t know.” I say, “Well, guess.” Because the thing is, it’s better to have a very rough financial estimate than no financial estimates and pretend that the problem does not exist at all.
Conor Doherty: So, approximately right versus perfectly wrong. Well, Joannes, as always, I’ve thoroughly enjoyed this and learned a lot. Thank you very much for your time. And thank you all very much for watching. We’ll see you next time.