Supply chain inefficiency

If your company is part of a supply chain then you are probably not maximizing your profits. This post looks at why and in future posts I will look at what can be done to increase profits.

Supply chains can be very complicated and involve a lot of companies, to simplify things I will consider a chain with three elements, a supplier, a retailer, and customers. The supplier supplies goods to a retailer and the retailer sells the goods on to customers.

Let’s make two simple assumptions:

– that as the price goes up the number of sales will go down.

– that the wholesaler sets the price and the retailer decides how many units to buy based on that price.

The wholesaler will set a price that maximizes their profit. They set a price that gives them a greater share of the profits and gives less to the retailer. Although this maximizes the wholesaler’s profit, it doesn’t maximize the profit across the whole supply chain.

The wholesaler and retailer acting in their individual best interests means they don’t end up setting an optimal price in terms of the whole supply chain.

If the wholesaler were to try to set a price that could maximize profits across the supply chain then the retailer would take advantage and set a volume which would increase their profit but reduce the profit of the wholesaler by more.

People often think that competition will result in an optimal situation. This isn’t necessarily the case, here competition leaves everyone worse off than if the wholesaler and retailer worked together.

The wholesaler and retailer at best make the same profit as in a co-ordinated situation and one of them will make less. Customers are also worse off as they end up paying a higher price.

Today’s takeaway: If you’re not co-ordinating with others in your supply chains then you’re probably not maximizing your profits.

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