Inflation in 2022: Is the bullwhip effect responsible for the retail inventory glut?

Last week I saw a headline from the Washington Post stating Michael Burry’s ‘Bullwhip’ Tweet Deserves Serious Attention. Michael Bury (@michaeljburry) is best known as the hedge fund manager portrayed by Christian Bale in the film “The big court.” His track record rightly gathers many followers on Twitter – 895,000 according to the account. Michael Burry’s tweet said the retail supply glut is a result of the Bullwhip effect and there will be deflationary impulses from that. Deflationary impulses are important to understand in our current environment of generalized inflation and a recent commitment to tighten monetary policy to bring it under control. Deflationary impulses seem counter-intuitive in this environment, much like a surf at the beach. This talk of deflation caught me off guard. As a supply chain analyst and economics enthusiast, I was curious to know more. I did a little digging to uncover the details of excess inventory, stated causes, and potential implications. Here is my take on the subject.

Retailer Inventories – Just keep your returns?

Michael Burry’s tweet referenced the CNN article Just keep your returns: stores pay you not to return unwanted items. This article reported that Target, Walmart and others recently reported on earnings calls that they had too much inventory in certain item categories and that the cost of holding inventory was negatively impacting their profit margins. . In turn, some stores may not want to handle your returns, preferring to just let you keep the items.

Target revenue call transcription explains that she experienced a more drastic shift in her sales mix than they had anticipated, resulting in excess inventory, much of it in bulky categories. Additionally, Target said “Apparel, Home and Hardlines, we saw a rapid slowdown in year-over-year sales trends starting in March, when we started to annualize the impact of last year’s stimulus payments. Although we anticipated a post-stimulus slowdown in these categories and expected consumers to continue to refocus their spending on goods and services, we did not anticipate the magnitude of this shift..” This statement indicates that Target attributes the slowdown to a rapid change in demand patterns and an overall easing of demand due to the halt in government stimulus payments. Additional content from the earnings call indicates that the slowdown in sales was more pronounced than expected in kitchen appliances, televisions, outdoor furniture, sporting goods and apparel.

Walmart Earnings Call transcription states”we knew we were facing stimulus dollars from last year but the rate of food inflation took more dollars out of GM than expected as customers had to pay for food inflation.” This statement indicates that Walmart believes general merchandise sales are negatively impacted by rising food prices (presumably without a corresponding amount to spend.).

Conclusion: whiplash and not whiplash

These sources suggest that excess inventory at retailers is due to rapidly changing demand patterns as well as reduced purchasing power even as inflation discourages some discretionary spending. The traditional definition of the bullwhip effect (The Bullwhip Effect in Supply Chains MIT Sloan Management Review”, 1997) was that of the amplification of the demand order variabilities in the supply chain as they move up the supply chain. That doesn’t seem to be the case with Target and Walmart. It appears to be primarily a “boost” of a drastic and sudden change in demand patterns. So let’s call it a “demand boost.” Unfortunately, I’m not sure of the order of magnitude or duration of these inventory lags. But as I explained earlier, optimal order quantities increase when inflation is high relative to the cost of capital, as it is today. Therefore, it is likely that retailers and distributors have ordered larger quantities and are holding more inventory than they would in a low inflation environment (all other things being equal). And that doesn’t bode well when demand changes are volatile.