'Bullwhip' Hits Firms as Growth Snaps Back

Wall Street Journal (Aeppel) - Caterpillar Inc. recently told its steel suppliers that it will more than double its purchases of the metal this year—even if the company's own sales don't rise one iota. In fact, the heavy-equipment maker has been boosting orders to suppliers for everything from big tires and hydraulic tubes to shatterproof glass.

How is that possible? Chalk it up to the "bullwhip effect," which is reverberating across the U.S. economy. This phenomenon occurs when companies significantly cut or add inventories. Economists call it a bullwhip because even small increases in demand can cause a big snap in the need for parts and materials further down the supply chain.


But inventory bullwhips can become too much of a good thing, especially in today's unusual economic environment. That's because the recession created lingering problems that could hamper the ability of suppliers to respond to a sudden jump in orders.

Many are smaller companies hurt by the credit crunch as they continue to have difficulty obtaining loans.

A flow of new orders to suppliers could encourage banks to start lending to them more freely. But if that doesn't happen quickly, there could be bottlenecks and shortages as suppliers miss shipments or turn away orders because they can't afford to buy the materials or hire more workers to do the job. Prices could spike.

Inventory swings also inspire less confidence than actual demand growth. Some business leaders are likely to fear the uptick will fade once inventories are restored, so they put off adding workers or making other investments until they are certain underlying demand is growing. "This is not going to go smoothly," predicts William Strauss, senior economist at the Federal Reserve Bank of Chicago. "I'd be very surprised if everyone could grow at the rate they desired."

One factor that could complicate things is China. Caterpillar, like many big companies, is counting on continued growth there to fuel a global rebound. But some analysts caution that China could slow if Beijing tries to cool down inflation.