Russian Roulette is a lethal game of chance in which participants place a single round in a revolver, spin the cylinder, place the muzzle against their head and pull the trigger. The game is usually associated with big prize money, and the chances of winning are 5/6. However, there are 1/6 chances of getting shot. Not many people come forward to play this game.  The Indian middle-class growth story, the infrastructure investment, the industrial growth, and the vehicle penetration percentages tell us that there is a good chance of the auto industry growing much larger than the current level. However, the auto OEMs are finding it difficult to convince all the suppliers to add adequate capacity. OEMs are dependent on suppliers for most of the components. Unless capacity is added by every one of the component suppliers, there is no way the OEM can enhance their production.  Many suppliers are now seeking guarantees of capacity utilisation for adding new capacity, which was not the case earlier. They don’t want to play the Russian Roulette as they have experienced, in 2008, the impact of the 1/6 chance of getting shot. Knowing well that severe dips in demand, like what happened in the second half of 2008, can occur again, OEMs are reluctant to offer such guarantees. The industry seems to have reached a stalemate trying to answer the question, “Who dares to play the Russian Roulette?”  To understand the stalemate and evolve a Win-Win solution, we need to understand the crisis of 2008.  In the middle of 2008, OEMs, from the rising finished vehicles inventory in warehouses and dealers, were getting the signal that demand was slowing down. Yet, under pressure to utilise capacity, many of the OEMs kept on producing to full capacity, obviously based on a forecast, for about 2 months. When these OEMs finally made the decision to cut down their production, nearly 2-3 months of stock piled up in the sales pipeline.  The same effect was seen with the Tier-1 suppliers; they continued to produce full blast even after the OEMs started to slow down, as they wanted to utilise their capacities. This led to the piling up of their FG and WIP. It was the same scenario for the Tier-2 and Tier-3 suppliers.  When the OEMs dropped their production rate, the inventory of 30-45 days with the Tier-1 suddenly ballooned up to 60-90. The Tier-1 supplier started supplying from its current inventory and drastically curtailed production. They now had raw materials and parts for 60 days instead of 30 days. At the same time, the inflow of payments dried out, both due to OEMs money stuck in not selling finished vehicles and the low demand. Component vendors started finding it difficult to manage the expenses, let alone buying fresh raw materials. Hence, they reduced drastically the pickup from the Tier-2 vendors, leading to a huge drop in demand for the Tier-2 vendors.  The Tier-2 suppliers now had more than 90-120 days of inventory, with a very low pickup rate. The income was far less than the requirement to cover fixed expenses. They were faced with the Hobson’s choice and inevitably had to lay off people in order to ensure survival.  The most devastating impact was that Tier-2 and Tier-3 vendors started using the working capital, meant for buying raw materials, for daily expenses, interest and salaries. The rotation of their working capital was severely affected. Soon, they did not have money to buy RM (for the reduced demand), further affecting their ability to generate money. A vicious cycle!  When the time came to ramp up, the workforce (laid off and now extremely disgruntled with the employers) and capital were not available, and some of these suppliers took 2-4 months to gather the workforce and the capital. So even when significant demand was coming in, they could not service it fully. Thus, lengthening the period of lower production rate.  Since the OEM depends on all component suppliers to ramp up together to get a net impact of increased production of vehicles, they suffered till the last supplier ramped up. A lose-lose for both parties.  Many suppliers made huge losses. With the baggage of the pain of 2008, it is not a surprise that component vendors are wary about adding capacities. Additional capacity means fixed higher costs, and their ability to survive another slowdown decreases. It is not difficult to appreciate why suppliers don’t want to add capacities without any guarantees. The argument that the suppliers are independent businesses and hence, should be prepared to take risks does not hold good. No businessman will ever take risks, that have the potential to wipe out their business.  The only way out of such a dilemma is to diminish the risks significantly.  We need to understand the key lessons from the crisis of 2008. While the OEMs saw a dip in 10%-20% of their total volumes for the year, many of the Tier-2 and Tier-3 suppliers made nearly 50% less than their yearly plan. While the dip lasted for 3-4 months for the OEMs, the production levels dipped below 40%-50% for the Tier-1 supplier, for 4-6 months, while that for the Tier-2 and III supplier it was for nearly 6-9 months. The higher the capacity (of the total business) dedicated to the OEM segment, the bigger was the damage.  The only way to reduce such risks is to ensure that when demand drops, the suppliers should not experience a large period of a drastic dip in production, but a smaller dip spread over a shorter period. It is clear from the experience of 2008 that the higher the inventory between the supply nodes, the more is the extent and period of correction.  While most auto companies swear by Lean Production System, the dark underbelly of the auto <a target="_blank" rel="noopener noreferrer" href="https://www.vectorconsulting.in/en/research-and-publication/articles/dealing-with-variety-in-supply-chain/">supply chain</a> is seen at the dealers, the transportation godowns and the plants of the vendors. Months of inventory is piled up between 2 entities that are just a few hours /couple of days away from each other.  The reason for the high inventory is the wide fluctuation of the average daily requirement of the month. The wide fluctuation in demand is triggered when one supplier does not deliver a component in the required quantity. The OEMs have the pressure to utilise their capacity fully, so with many items in various states of availability, they have no option but to load the lines with anticipated arrivals, resulting in some vehicles being loaded much more than the daily rate conveyed to the suppliers. The spikes could be as high as 5-10 times the average demand.  Tier-1 suppliers know that their fortunes are dependent on the OEMs. If they are repeatedly unreliable, the OEM will decrease its volumes or develop other suppliers. This risk for the supplier is very high as he has built the capacity specifically engineered items, and he cannot find new markets immediately. (A peculiarity of the auto industry).  So, suppliers try to overcome the problem with very safe (high) finished goods and raw material stocking to cater to any spikes /increases. The same logic applies to Tier-2 suppliers, but they have to keep an even higher level of inventory as the Tier-1 supplier is producing in large batches. This means that if the OEM is carrying 2-3 days of parts, the Tier-1 suppliers will carry 15- 30 days of finished goods and about 30 days of parts and raw material inventory. The Tier-2 suppliers carry about a month of FG+WIP (due to high batches of production) and about 30-45 days of raw material stock.  Since the excess inventory is causing the problem, the way out is a perfect pull system in the entire supply chain, right from the dealers to OEM production to the supplier’s production.  A perfect the pull system in entire supply chain will prevent 2 major problems. <ul style="list-style-type:disc;"><li>The lag in reaction by OEMs to demand signals</li><li>The huge inventory carried by most suppliers. </li></ul> The lag in OEM’s reaction to market slowdown is because OEMs’ production is based on forecasts. If the production is based on the actual sales from the dealers, there will be minimal lag in the reaction time of the OEM. Since the plant is an aggregation point for all sales variations across the dealers in the country, the load on the plant for any SKU will be fairly uniform on a daily basis. This has two dramatic impacts. <ul style="list-style-type:disc;"><li>The ability to react to slowdown in 3-7 days  </li><li>The uniform load on suppliers reduces the Tier-1 FG inventory by almost 1/4th of current levels</li></ul> At the same time, if the pull system of customer drawing daily requirements from a designed buffer of the supplier’s node is also implemented between the Tier-1 and Tier-2 suppliers, then RM inventories of Tier-1 and the finished goods and raw material in Tier-2 (and III) will also reduce by about half of the current levels. This will not only reduce the bull-whip dramatically but also reduce the period of large dip in demand for Tier-2 and III.  Suppliers do understand that dips will exist; they don’t want huge dips for longer periods.  The auto industry swears by the Lean Management. Most of them will agree that the way out of this is to implement the Kanban system of flow management right from the dealers to the suppliers’ suppliers. But most of them have not been able to do so because of the environment of widely fluctuating demand across time horizons, not just at the vehicle level but also at the component level. The other problem with the Kanban/JIT system is that it takes a long time, years, to implement across the supply chain. With everyday firefighting, it is very difficult to sustain the effort for a very long time. A Kanban system augmented with strategic buffers  and dynamic replenishment is more useful in such an environment. Not only does it help implement a supply based on consumption, but it also helps to dynamically adjust the inventory norms (equivalent of the no. of Kanban cards). It can also be implemented for a link in less than 6 months. <figure class="image"><img style="aspect-ratio:4000/1672;" src="https://backend.vectorconsulting.in/storage/editor_uploads//auto-article-16-img-1_1735288692.jpg" width="4000" height="1672"></figure>This is powerful system which enables the whole supply chain to work at much lower inventory and can correct the inventory on a daily basis is the way to assist suppliers in reducing their risk in adding capacities i.e. mitigating the 1/6 chance of being shot dead.

Key Takeaways

Following a forecast-based production schedule is as good as playing the lethal Russian Roulette. A pull-based production system can help auto OEMs and component manufacturers improve their manufacturing and inventory levels.

Who dares to play the Russian Roulette?

<h5>Who dares to play the Russian Roulette</h5>

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Understand why auto supply chains struggle with demand fluctuations and how daily consumption driven pull system ensures steady production, lower inventory and quicker recovery. Read the full article here!