Cloudonomics: The Business Value of Cloud Computing, + Website

Whips and Chains

Peter Senge, director of the Systems Thinking and Organizational Learning program at MIT’s Sloan School of Management, has run a business school simulation called “the beer game” thousands of times.21 His students play retailers, wholesalers, and brewers and are told to maximize revenues and profits, which means ensuring that there is sufficient product without carrying excess inventory. To keep things manageable, there is only one brand of beer offered by one brewer.

Things run well for a while, until a slight uptick in demand causes the craziness to begin. The retailer orders more beer from the wholesaler, who orders more from the brewer. When it doesn’t arrive quickly enough, the retailer orders even more. The wholesaler, seeing increased demand, orders even more. As stock-outs ensue, players keep ordering, and the brewery keeps ramping up production.

Finally, all the beer arrives downstream, and the retailers, now inundated with too much, cut their orders back to zero. The brewery, meanwhile, has been ramping up production, until the messages that orders have been cut to zero work their way through the distributors back to the brewer. Money is lost throughout the entire system, due to the opportunity costs of lost sales due to unfulfilled customer demand, excess inventory and its carrying costs, and capital expenditures as the brewer expanded.

Moreover, not only is there variability, but MIT’s Fine pointed out that firms that are farther upstream in the supply ...