Plunging commodity prices are unnerving many companies to a point where they are implementing drastic cuts to their operations and workforce. Adjusting to market shifts is sound management practice, but not when the course changes are so extreme that the company becomes too debilitated to take advantage of an eventual market upturn.
Thinking about a turnaround in commodities prices might seem naive at best at this time, but it’s easy to underestimate how quickly markets can rebound and catch companies flat-footed.
In the supply chain sphere, this phenomenon is known as the bullwhip effect, and numerous companies have become ensnared in its coils.
Falling commodity prices are reverberating through many industries. For example, the fracking industry in the US has been laid low by declining oil prices; heavy machinery manufacturers are being hit by a fall-off in demand for mining equipment.
Some companies are responding with deep cuts. One of the more extreme examples is mining conglomerate Anglo American PLC. As the Wall Street Journal reported recently[1], the company intends to cut 85,000 jobs over the next several years in response to the prolonged slump in raw materials prices. The restructuring plan also includes asset sales and the suspension of dividend payments. Company CEO Marl Cutifani said that Anglo American will be “a very different company” after the plan is implemented.
Other enterprises are going through similar transformations – albeit not as swinging as Anglo American’s.
How will these enterprises perform when a rebound occurs, as surely it will?
China’s economic downturn is one of the main drivers of the bust in global commodity prices, but the country will start to pull out of its malaise at some point. The Chinese government simply can’t afford to renege on its unofficial compact with citizens to maintain economic growth in return for tolerating an autocratic regime.
But it isn’t just a turnaround in economic performance that can catch companies unawares when they are severely weakened by over-enthusiastic cost cutting during a downturn. The consequences of actions like these tend to get amplified as you move upstream in the supply chain. This is the essence of the bullwhip effect.
Here is a hypothetical example of the phenomenon as described in a recentSupply Chain @ MIT blog post:
A mining company experiences an X% drop in sales owing to some external event such as a sudden fall off in prices. It reasons that future sales will be low, too, because most forecasts are based on past experience. In addition, the enterprise decides that its current inventories are too high if future sales continue to be low. Consequently, the mining company cuts orders to an equipment maker by, say, 2X% (reflecting both its expectations of lower future sales and its desire to reduce its current inventory).
The equipment maker, seeing the 2X% drop in orders from the mining company, also prepares for future lower sales and too much inventory on hand by cutting orders to its parts supplier by 4X%. The parts supplier, in turn, cuts orders to its suppliers by an even larger amount, and so on.
At each tier of the supply chain, the decline in demand sparks a bigger decline in orders from suppliers — each company reasoning that it needs to quickly cut production (to adjust to declining sales) and work off its seemingly bloated inventory.
The end result is that companies have shed so much production capacity in response to market signals, and have failed to properly maintain the assets they’ve kept, that when orders pick up, they simply can’t fill them. Stronger rivals, or opportunistic newcomers, are all too eager to step in.
Undoubtedly, tumbling commodity prices warrant a reaction from companies that are in the firing line. But it’s easy to get carried away when market sentiment becomes as negative as it is at present. And excessive reactions can be life-threatening for companies when the business cycle changes.

[1] Anglo American to Slash Assets, Cut 85,000 Jobs, Scott Patterson and Alex Macdonald, Wall Street Journal, December 8 2015