Caterpillar, The Bullwhip Effect and Real Demand

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For those of you who missed it, the Wall Street Journal ran a fascinating supply chain management piece yesterday entitled, “Bullwhip Hits Firms as Growth Snaps Back. The notion of bullwhip refers to the effect of trying to determine inventory levels based on a forecast. The article, which I highly recommend reading, discusses how Caterpillar has worked with its key suppliers (the article cites 500 suppliers representing 80% of manufactured parts) to prepare them for the sudden onslaught of new purchase orders initiated by the heavy duty equipment manufacturer. Jason Busch of SpendMatters covered the supply risk management angle yesterday.

In addition to the points Jason made, one point that we’d like to call out and of particular concern to metal buying organizations involves the substantial price risk that occurs when a supply chain(s) undergoes a bullwhip effect. As we at MetalMiner have started to complete our price predictions for key metals for 2010, (we will publish these reports starting the end of next week) we know that some of these price jumps in certain metals relate to re-stocking activities (e.g. once a company has burned through its inventory it has nothing to do but purchase materials, parts and assemblies for production) and not necessarily underlying demand. We believe this activity helps explain what has happened to steel prices in the last 30-45 days the mills have raised prices because companies have to replenish inventories and re-stock. And as the Wall Street Journal article discussed, the challenge for Caterpillar and its suppliers involves having the labor, raw material inventory and finances to purchase these materials to meet the demand of a company like Caterpillar once the purchase orders start to increase.

But let’s return to how this relates to metal pricing. Based on my recent discussions with various steel industry participants, I can’t help but get the feeling that folks have a very bullish outlook in terms of steel prices. And whereas small upticks in demand can and will have profound impacts on pricing, (and we ourselves believe steel prices will increase this year), I remain rather cautious about the overall state of industrial demand. These re-stocking cycles will only go so far. Eventually, real demand will need to take over. In the meantime, get ready to ride the pricing roller coaster. We think it will be an up and down ride in 2010!

–Lisa Reisman

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