Upstream Volatility in the Supply Chain: The Machine Tool Industry as a Case Study

Abstract

Cyclicality is a well known and accepted fact of life in market-driven economies. Less well known or understood, however, is the phenomenon of amplification as one looks "upstream" in the industrial supply chain. This paper discusses and explains the amplification phenomenon and its implications through the lens of one "upstream" industry that is notorious for the intensity of the business cycles it faces: the machine tool industry. Using a sparse simulation model, we have replicated much of the behavior seen in the industrial world in which machine tool companies operate. This model has allowed us to test and confirm many of our hypotheses. Two results stand out. Even though machine tool builders can do little to reduce their production volatility through choice of forecast rule, a longer view of the future leads companies to retain more of their skilled workforce. This is often cited as one of the advantages that European and Japanese companies have enjoyed: lower skilled employee turnover. The second, and most important result is that machine tool customers can do a great deal to reduce the volatility for machine tool builders through their choice of order forecast rule. Companies which use a longer horizon over which to forecast orders tend to impose less of their own volatility upon their supply base.