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TOC in Distribution · Lesson 3 of 8

The distribution problem

Stock-outs and excess stock of the same product, at the same time. Why it happens, the conflict every supply chain manager is caught in, and what it costs.

14 min · Not completed yet

You have seen this problem

Has it ever happened to you? You liked a shirt in a store, but not in your size. Meanwhile, your wardrobe has clothes you bought at an attractive discount in an end-of-season sale.

When what you wanted isn’t there, do you always buy something else? Sometimes. But with a doctor’s prescription for a specific medicine, you won’t take a substitute; you’ll walk to the next pharmacy, and the next. Yet the same pharmacy that didn’t have yours has medicines on its shelf that are close to expiry. And have you ever put a loaf of bread back because it wasn’t fresh, on a fully stocked shelf?

The challenge: the right stock, in the right place

Ask anyone who runs a distribution network what their biggest challenge is, and you will hear the same answer: maintaining the right inventory levels. Not too much, not too little, for every product at every location.

The usual way to decide is to order according to a forecast: last month’s sales, adjusted for what we expect next month. And forecasts are never accurate. The deeper into the supply chain, and the further from the consumer, the more wrong they are.

The result is a pattern every distribution manager knows:

  • The same product, at the same time, in different places: sold out at one warehouse, gathering dust at another.
  • The same product, in the same place, at different times: short this month, piled up next month.

The network keeps swinging between stock-outs and excess, and often has both at once. When managers see surpluses, their instinct is to cut inventory; that soon causes shortages and lost sales, which forces them to raise inventory again. The two actions undo each other, and most supply chains oscillate between them.

There is an even more painful version. A particular bike or car model sits at one dealer where nobody in that area wants its colour or configuration, while customers at another dealership are asking for exactly that model and can’t get it. The supply chain had the product the customer wanted, just not in the right place, and the sale was lost anyway.

What have companies done about it? Usually some mix of:

  • Keeping more inventory where shortages were seen.
  • Improving the forecast: new and more sophisticated software, multi-factor algorithms.
  • Forecasting further ahead: a firm forecast for one month, a tentative one for the next two.

Pause and think: it’s the last week of the month and the plant is behind its sales target. What usually happens?

  • The plant accepts the shortfall
  • Distributors receive exactly what they asked for
  • Sales are moved to next month
  • Stock is pushed to distributors: whatever the plant has, not what the distributors need

Month-end targets are measured on primary sales, so the easiest way to hit them is to push stock into the channel. What gets pushed is what the plant happens to have, which is rarely what the market is asking for.

The dealer’s credit loop

Follow one distributor through a few months.

  1. The company pushes stock to hit its targets. The distributor’s money is now locked in the company’s products, many of them slow sellers.
  2. The distributor stops paying on time, not out of bad faith, but because the cash is sitting on their shelves. They hit their credit limit, and supplies stop.
  3. Slowly they sell down the stock, their cash comes back, and they start buying again.
  4. The company, eager to grow, pushes more stock. And the loop starts over.

Meanwhile, during the months the distributor couldn’t buy, the fast sellers they needed were out of stock. The company lost sales it never saw.

The conflict underneath

Every link in the chain, from plant warehouse to depot to distributor, is caught in the same conflict.

The assumptions underneath

Read the cloud like this: in order to make more profit, I must protect sales; in order to protect sales, I must maintain high inventory. And: in order to make more profit, I must control costs; in order to control costs, I must keep inventory low. The two actions can’t both be done, and there’s no clear rule for when to prefer one, so the chain swings with whoever is pushing hardest: sales raises inventory, finance trims it.

Why must we hold high inventory to protect sales? Put yourself in a store manager’s shoes.

  • You plan for a month, but some products sell out before the month ends. Next month, will you order more? Almost certainly, because lost sales reflect on you. You keep more stock because the forecast is inaccurate.
  • Some products sometimes arrive in days, sometimes not for two weeks, because the warehouse above you is short. What do you do? Exactly what we all did with groceries during the lockdown: keep more than usual. You keep more stock because supply isn’t reliable.
  • Two otherwise identical products, one replenished in 10 days and one in 30. You keep more of the second. You keep more stock because the supply lead time is long. And a long lead time means forecasting further ahead, where the mismatch between forecast and reality grows. The longer the horizon, the deeper the hole you dig.

And why keep inventory low? You have an inventory budget. When stock goes above it, your manager asks you to control it, so you order less next month or cut the range you carry. You keep less because carrying stock costs money and cash is limited.

What the swinging costs

Both sides of the swing are expensive.

Exercise: trace each consequence back to its side

  • Lost sales and lost customers
  • Urgent orders to the plant
  • Rescheduling and disrupted operations
  • Damages and write-offs
  • Less working capital
  • Distributors delay buying
  • Discount sales to clear stock

Both branches end in the same place: income falls, costs rise, profitability drops. And because different products sit on different sides of the swing at the same time, a company pays both bills at once.

“The right product, at the right place, at the right time”

You have probably heard this slogan many times. Every supply chain claims to aim for it, and very few achieve it. When so many capable people keep missing the same target with the same method, something in the method must be wrong. The next lesson looks at what.

Check your understanding

Answer all five. Get four right to complete the lesson.

1. The typical pattern in a distribution network is…

  • Stock-outs and excess of the same product at the same time, in different places
  • Steady, balanced stock everywhere
  • Excess stock only
  • Shortages only

Too much and too little at once: it’s the signature of a forecast-driven push.

2. Where in the supply chain are forecasts least accurate?

  • At the plant
  • At the central warehouse
  • Closest to the consumer, for individual products at individual locations
  • They are equally accurate everywhere

Small numbers at a single location swing the most.

3. Why does a loyal distributor stop paying on time after a big push?

  • They are a bad customer
  • Their cash is locked in the stock that was pushed to them
  • They prefer a competitor
  • They forgot

Their cash comes back only as the stock sells, and then the loop restarts.

4. In the distribution conflict, the need behind “maintain high inventory” is…

  • Control costs
  • Hit month-end targets
  • Reduce working capital
  • Protect sales

High inventory protects sales; low inventory controls costs. Both serve profit.

5. Damages, write-offs and distributors delaying their purchases come from…

  • Shortages
  • Accurate forecasts
  • Surpluses
  • Short replenishment times

Surplus stock rots, ties up cash and stops the channel from buying.