Basic in Flostock’s view is that there is a direction in the real economy: All goods flow from their basic sources, such as mines, agriculture or oil-fields, to the end consumer. In this flow no product gets lost: all matter that goes into the supply chain also leaves the supply chain. This has important consequences. This we call --a bit presumptuous perhaps -- Flostock’s First Law. It says that if no product exits at the end, no product can be put in at the beginning. The supply chain is a tube, and if it is clogged at the end, it stops.  If it is clogged at the beginning, so for a while no new product can enter at the beginning, the chain will deplete. If it is clogged halfway, downstream will deplete and upstream will overstock, until after a while both ends will stop.  As a consequence of the First Law, without clogging, if the end market grows 1%, the upstream supply also must grow 1%. This makes it possible to derive a growth trend in upstream demand from downstream demand.
 

 We defined a fleet as a stock of any equipment that is used for a longer period, and that includes machinery, houses, vehicles, cloths, tires, phones, tooth brushes, etc. : anything that is used but not consumed. The 7^th Law says that Fleets act as buffer between flows. In fact, Flostock believes that the buffering effect of Fleets is the main reason we have economic cycles.  The problem is that most people don’t look at Fleets as stock, and not as buffer.  Most people have a linear view of the world and consider fleets inert, that means not influencing the flows. One example is that the massive introduction of winter tires has maybe doubled the Fleet of tires in use, but increased the flow (=sales) of tires only temporary. 

Stock memory is like potential energy, ready to start flowing. A lake full of water for hydro-energy. A bucket of marbles balancing on a hill top.  A syringe that is drawn vacuum. An under-stocked warehouse. A hill full of snow in spring. An empty shelf. A jungle full of pharmaceutically interesting plants. An empty terrace with a good view. DRAM memory. All savings on the bank. A pension fund. A group of hooligans in a bus. A full battery. Hot water in a boiler.  So I use the word “stock” as in stock & flow, not just as a physical inventory. The flow from the stock gets direction from the equilibrium level: when snow melts it flows down. When people retire the pension fund sends them money. When the syringe is released, it will close. An empty shelf will be filled. Low inventory creates replenishment orders to fill a gap.  In thermodynamics  they call this equilibrium a “lower entropy level”.

In Flostock models this property is used for a flying start: a model can be started at any moment if the stocks (memories) are filled to the right level. This memory property makes it also possible to forecast non-linear: or, to say it in other words: the absence of stocks in a forecasting model makes it impossible to predict anything else but straight lines. This, we believe, is the main reason why most institutions have their forecasts wrong at every turn of the economy.

Lead-time, also known as delay, creates oscillations in all processes around the world, not just in supply chains and logistics, but in chemical installations, politics, societal changes, and guitars as well. Without delay or with a shorter delay most oscillations would not exist or dampen out quickly. And longer lead-times give more and bigger oscillations, so the of-shoring trend of the last 20 years has made the world much more susceptible to volatility. Your warehouses at the far end of the world probably have the biggest fluctuation in storage level. Demand for Made-to-Order products often fluctuates more than for Made-to-Stock products. Capacity for electricity generation is cyclic. Slowly but steadily growing smog (i.e. with long lead time) in China will kill its industrial growth before it recuperates. The monthly variation of your sales is also caused by lead time. 3D printing will reduce oscillation. Good planning, a reliable forecast and full transparency could prevent oscillation, but in many cases that is not possible and volatility is the result. 

All oscillations in the real world are damped because there is always friction and there is no such thing as perpetual motion.Even a gigantic oscillation like the orbiting moon is damped by the tide of the oceans: its circular speed is slowing down and at some point in time the moon will crash into the earth. The same is true for economic waves. Phenomena like the hog cycle, which seemed to continue forever, in reality are damped. The Lehman Wave was certainly damped, although much less than most people anticipated. Royal DSM and Flostock wrote in a recent article, that the damping of a single destocking pulse in the resins business was only 40% per year, so taking 4 years to subside.

If we define behavior as “the response to an input”, we have found that, contrary to what most people think, most managers do not adapt their behavior to the circumstances.  When someone’s behavior is split in small enough domains, it appears that in each domain the behavior is stable, also in a heavy crisis. The managers have targets, rules and regulations and continue to work according them. Moreover they have habits and routine.  Some behavioral elements do follow the crisis pulse, but the response of each element is the same as outside the crisis.

So if normal purchaser’s behavior is to order the average of last month’s sales, this will be continued also if sales drops in a crisis.  When the crisis hit the coating industry, and Flostock predicted an upward peak, all experts said that this would not take place because supply chain professionals would be “much wiser” and adapt their behavior. Nothing of the kind: the wave took place completely as predicted and everybody bought product in the same way as before, resulting in big overstocking. This continuity in behavior makes modeling and forecasting possible. 

Oscillation has debilitating effects on a business, so it is surprising that so many businesses accept it as an inevitable part of their existence. More than this, they actively contribute to it via their sourcing decisions. Flostock has identified a link between the well-known “Prisoner’s Dilemma” and the phenomenon of market oscillation. Understanding this connection can help companies mitigate the harmful effects of oscillation. 

As stated in Flostock’s 16^th Law of Demand, impatient systems oscillate. Stocks generally have a desired level. When that level is in danger of falling below acceptable limits, people hurry to close prospective gaps. The time for attempting to close such a gap is called the leveraging time.  

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A remarkably large proportion of business activities are in oscillation at any given time, driven by the fear of being unable to keep their customers supplied. The fact that various players are all eager to compete perpetuates the system: they are (naturally) keen to compete downstream by keeping their customers supplied, and so they order too fast upstream (from their suppliers).

If all players would relax and take their time over re-ordering stocks, the effects of oscillation would subside. If only one player were to do this, however, that player would be at a disadvantage compared with the others who are still ordering plentiful stocks. In Game Theory, this phenomenon is called the Prisoner’s Dilemma: all players would benefit if they would only collaborate, but the fear of being outdone by one another leads to behaviors that disadvantage them all. We call this Flostock’s 17th Law of Demand: “Prisoner’s Dilemma maintains market oscillation”.

Click here for more on the Prisoner’s Dilemma.  For help identifying the causes of oscillation in your own market and developing strategies to deal with it, please email info@no-spam-today-flostock.com or call us on +31(0) 6 11356703.

Investment(t) = Demolishing(t) +  d(underutilization(t))/dt + α*d(Sales(t)/dt +α* d(Inventory)/dt²

whereby α is a conversion factor describing how many inventory units can be made per capital unit per time, and ignoring delays. In words: Investment is equal to replacement plus a higher idleness plus growth in sales plus a change in the growth of inventory. This formula helps understanding the dimensions and the dynamics of investments. E.g. Sales and Inventory follow iron laws anddictate that investments are made, certainly for the industry as a group. If Sales goes up and nobody would invest, stocks deplete, a shortage develops, prices goes up and investing becomes more attractive, so will eventually be done.  Delay in sales-driven investments creates wave around the α*sales curve. Lack of credit during the Lehman Crisis had two effects:  1) it caused companies to reduce their inventories strongly, making d(sales)/dt strongly negative, and 2) it prevented people from investing. Companies who could not afford a large d(underutilization)/dt, had to close, which is equal to strong demolishing.   Surviving companies delayed demolishing, so delayed investment for replacement and let their fleet of capital goods grow older, but not bigger. This aging fleet will require extra investments in the future (see above Law 6). This formula works for a company, and for an industry, and for the whole economy, if the proper settings are used.  One caveat: in reality delays play a prominent role in investments: so calculating real investments should be done dynamically.  

Flows can be stopped by people at any moment, immediately, and restarted immediately, that is, if the source stock and target stock allow it.  Stocks, au contraire, cannot be changed easily and can certainly not be stopped. If the out- and inflows of a stock are stopped, the stock freezes but continues to exist.  It never goes away. When you come back after a week, everything is still there. In contrast: if a flow is stopped, it immediately ceases to exist, for 100%. When your customer stops buying, your sales stops, but your inventory, your capacity and your debts remain. When the world stops burning fossil fuels, the CO2 flow stops immediately, but the amount of CO2 in the atmosphere will continue to be there and contribute to the greenhouse effect.  This inertia of stocks is what makes them reliable, but also a hindrance.  Just being there already cost money, in warehouses, occupied cash, interest, etc. 

 A building full of machinery, a fleet of trucks or a safety stock of canned food can superficially look stable, safe, and inert. But be aware: such a fleet can contain a hidden time bomb of volatility if the fleet build-up was not evenly spread over time. In such case the replacement will also be unevenly spread over time. Examples are the asset built-up of China over the last 20 years, the buying of a full wardrobe of fashionable clothes at the start of your career, and the aging of the baby boom workforce.