Jonathan Thatcher, CSCP | July/August 2012 | 22 | 4
Is your supply chain plagued by deception?
Reader S.Y. writes, “One of our suppliers suddenly is demanding higher prices, claiming an unavoidable shortage. We cannot see any clear reason for a shortage. What are our options?”
There are many possible reasons for this situation. One avenue to explore is a concept known as shortage gaming.
Shortage gaming is the unethical practice of limiting production to force higher prices. It’s illegal in many countries with regulations on price fixing and production manipulation. In normal markets, competition should prevent this practice from succeeding—indeed, in the long term, competitive pressures tend to ease the phenomenon. In the short and middle terms, however, shortage gaming is difficult to detect and can appear without warning. It forces purchasers to consider switching suppliers, reevaluate make-buy decisions, or find substitute materials not subject to the shortage—all at significant cost.
While shortage gaming can occur at any time, it is a greater temptation during difficult periods. In the past 15 years, events such as natural disasters, global economic downturns, market bubbles, debt crises, and high-profile bankruptcies have brought disarray to companies and markets expecting stable demand and supply. When a supplier engages in shortage gaming, efforts to quickly recognize and eliminate it are hindered by the uncertainty and lack of visibility. Further, poorly understood or unclear regulations can pave the way for shortage gaming even in better times.
The best way to avoid shortage gaming is to engage in practices that prevent it from occurring in the first place. Strong selection criteria, transparent relationships, and competitive performance evaluations all are ways to help ensure suppliers are trustworthy. Communication and reporting can quickly highlight unexpected changes in supply and demand. If a supplier reports an incident, trust first, but follow up and verify later. Benford’s law
It is a challenge to prove that a particular supplier is actively engaging in shortage gaming. There are perfectly ethical reasons why a company might reduce output or raise prices—to offset increasing risk, for example. Or perhaps the supplier is in the middle of dealing with a bullwhip effect in its production.
One method that can strongly suggest the presence of shortage gaming or another form of unethical data manipulation is Benford’s law, sometimes called the first-digit law. It states: In lists of numbers from certain sources, “1” is the most frequent leading digit, appearing about 30 percent of the time. Larger digits follow the pattern—2 appears more frequently than 3, 3 appears more frequently than 4, and so on.
The principle is most useful across numbers with large ranges of several orders of magnitude. When values are restricted or short-ranged, Benford’s law does not apply, as in telephone numbers, low-income wages, and human heights. The types of data that work best with Benford’s law include populations, building heights, and other similar statistics.
Fabricated numbers tend not to follow Benford’s law. Instead, their digits tend to be distributed uniformly. Whether or not Benford’s law can detect shortage gaming in a particular circumstance, it is a strong auditing practice to apply when encountering any unusual results, and it can uncover many forms of deception.
If you have good reasons to suspect shortage gaming, either from the application of Benford’s law or the presence of other deceptive markers, suggest to the supplier that the short-term gains do not compare to the long-term costs of the practice. Remind them that trust and reputation are critical at every point in the supply chain, and they are easy to destroy and slow to recover. However, strong supply chain relationships are prime strategic competitive advantages and are very difficult for a competitor to recreate.
Jonathan Thatcher, CSCP, is director of the APICS research department. He may be contacted at email@example.com.
For further reading on the topic of building and enhancing relationships, the author recommends The Speed of Trust by Steven M.R. Covey.