Last week I saw a news headline from the Washington Post stating Michael Burry’s ‘Bullwhip’ Tweet Deserves Serious Attention. Michael Burry (@michaeljburry) is most well-known as the hedge fund manager portrayed by Christian Bale in the movie “The Big Short.” His track record justifiably garners many followers on Twitter – 895,000 according to the account. Michael Burry’s tweet stated that the supply glut at retail is a result of the Bullwhip Effect and that there will be deflationary pulses from this. Deflationary pulses are important to understand in our current environment of widespread inflation and a recent commitment to tighter monetary policy to reign it in. Deflationary pulses seem counter intuitive in this environment, kind of a like an undertow at the beach. This talk of deflation caught me off guard. As a supply chain analyst and an economics enthusiast, I was curious to learn more. I did a little digging to find out the specifics about excess inventory, the stated causes, and the potential implications. Here’s my take on the topic.
Retailers’ Inventories – Just Keep your Returns?
Michael Burry’s tweet was referencing the CNN article Just keep your returns: Stores weigh paying you not to bring back unwanted items. That article stated that Target, Walmart, and others recently reported during earnings calls that they have too much inventory in certain item categories and that the cost of holding inventory is negatively impacting their profit margins. In turn, there is the possibility that some stores may not want to handle your returns, preferring to let you just keep the items.
Target’s earnings call transcript explains that it experienced a more dramatic change in its sales mix than they anticipated, resulting in excess inventory, much of it in bulky categories. Furthermore, Target stated “Apparel, Home and Hardlines, we saw a rapid slowdown in the year-over-year sales trends beginning in March, when we began to annualize the impact of last year’s stimulus payments. While we anticipated a post-stimulus slowdown in these categories and we expect the consumer to continue refocusing their spending away from goods and into services, we didn’t anticipate the magnitude of that shift.” This statement indicates that Target attributes the slowdown to a rapid shift in demand patterns and an overall softening of demand from discontinued government stimulus payments. Additional content from the earnings call indicates that the slowdown in sales was more pronounced than expected in kitchen appliances, TVs, outdoor furniture, sporting goods, and apparel.
Walmart’s earnings call transcript states “we knew that we were up against stimulus dollars from last year, but the rate of inflation in food pulled more dollars away from GM than we expected as customers needed to pay for the inflation in food.” This statement indicates that Walmart believes that general merchandise sales are being negatively impacted by increased food prices (assumedly without a corresponding amount of money to spend.).
Conclusion: Whiplash not Bullwhip Effect
It appears from these sources that retailers’ excess inventory is due to a rapid shift in demand patterns along with a reduction in purchasing power at the same time that inflation is discouraging some discretionary spending. The traditional definition of the bullwhip effect (The Bullwhip Effect in Supply Chains MIT Sloan Management Review”, 1997) was that of demand order variabilities in the supply chain being amplified as they go up the supply chain. This does not seem to be the case with Target and Walmart. It appears to mostly be “whiplash” from a drastic and sudden change in demand patterns. So let’s call it “demand whiplash”. Unfortunately, I am unsure about the order of magnitude or the duration of these inventory mismatches. But as I previously discussed, optimal order quantities go up when inflation is high with respect to the cost of capital, as is the case today. Therefore, it is likely that retailers and distributors have been ordering larger quantities and holding more inventory than they would in a low inflation environment (all else equal). And this doesn’t bode well when demand shifts are volatile.