Hyperbolic Discounting, the Supply Chain, and the Marshmallow Test

August 31, 2017

“Hyperbolic discounting” is a cognitive bias where people choose “smaller, immediate rewards rather than larger, later rewards.”

Flexe container trucks web resources 3000x1690

See how that occurs in the supply chain and what it means for your organization.

A recent Nir & Far blog post, “Hyperbolic Discounting: Why You Make Terrible Life Choices,” got me thinking about the supply chain. I don’t usually default to logistics when thinking about cognitive sciences, but this time, I did.

Here’s why.

“Hyperbolic discounting” is a cognitive bias where people choose “smaller, immediate rewards rather than larger, later rewards.” A cognitive bias, summarized, is a “systematic pattern of deviation from norm or rationality in judgment.” It’s based on a person’s subjective view of reality, which can be based on inaccurate judgment. It parallels irrationality.

We’ve all seen the “Marshmallow Test”, right? No? It’s the video of little kids being promised a second marshmallow if they can resist eating the marshmallow in front of them for five minutes. The results are hilarious and shows that it’s virtually impossible to turn down a marshmallow sitting right in front of your face.

But, the struggle is real. And even as adults, we encounter this all the time. It’s difficult to turn down something enticing in the short-term for something more rewarding in the long-term. Think pizza now in spite of training for that marathon.

It’s no different in supply chain.

The supply chain industry is undergoing a massive transformation. That’s not hyperbole. The business of retail has changed as eCommerce grows in popularity. The trouble is, eCommerce consumers can be anywhere—creating a fundamental shift in the supply chain. What was once a linear process is now decentralized and chaotic.

Thanks to Amazon, consumers are accustomed to fast, affordable shipping. eCommerce and omnichannel retailers that want to compete have to improve their delivery promises and that means rethinking supply chain networks and operations.

Fast, affordable shipping requires adding more locations to create a larger fulfillment network that moves inventory closer to end customers. For some, inventory allocation probably feels like a never-ending game of Tetris.

In terms of hyperbolic discounting and the supply chain, it’s clear that amidst the industry chaos, short-term “rewards” could easily eclipse smarter, long-term investments. The problem is the disruption they cause could jeopardize your business as a whole. Consider the following…

Being driven by your competition #

The supply chain has been slow to adopt new tech to improve operations. As eCommerce sales continue to increase, supply chains should be eager to invest in new technologies and capabilities that increase efficiencies and, ultimately, improve the bottom line.

But, speed without precision can get messy. Samsung sped up production of its Galaxy Note 7 so it could compete with Apple’s release of iPhone 7. The result was a phone that could spontaneously combust. It was banned on airplanes and was eventually recalled when the problem couldn’t be sufficiently remedied.

Samsung blamed the issue on the complexity of its supply chain and being unable to pinpoint how and where the issue occurred. The lack of visibility into production cost the company millions of dollars and is a supply chain failure that will be referenced for a very long time.

Samsung was blinded by the short-term reward of thinking it could compete with Apple’s iPhone release. Though enticing, it failed to consider the long-term advantage of creating a good product that didn’t catch on fire.

Going through Amazon #

Amazon is making it hard for other retailers to compete. And, it just so happens to have a solution for that: Fulfillment By Amazon (FBA). Because Amazon was built for eCommerce from day one, it has a built-in supply chain network that is unrivaled. For many retailers, using its services are appealing.

But going through Amazon for fulfillment isn’t without risk. While it may solve a retailer’s fulfillment woes in the short-term, there’s a lot that can be lost by choosing Amazon’s services.

  • It’s really expensive and there are a slew of fees attached to the services, including handling fees and increased storage fees during peak seasons
  • There’s no control over product placement on Amazon’s marketplace—your products can be listed next to your competitors’ and there’s nothing you can do about it
  • Commingling can negatively impact your brand. Commingling is when Amazon finds an exact replica from another seller and sends that on your behalf to ensure fast ship times
  • Your products show up in an Amazon-branded box which diminishes the strength of your brand
  • Amazon has complete access to your manufacturing and sales data and they have been known to replicate successful products

Choosing to use FBA could make the most sense for your business, but does using it as a fulfillment solution to solve a short-term problem disrupt the long-term plans you have for your business?

Doing nothing #

There’s the adage, “If you’re not sure what to do, do nothing.” For retail and the supply chain that isn’t going to work. It may seem like the most appealing option for the short-term, but choosing to wait it out will hurt you in the long-term.

The media is wrought with stories of more retailers going out of business or closing more stores. 2017 is projected to set a record-high for store closures—even beating out 2008—with nearly 9,000 stores closing.

Many of the store closures and bankruptcies are because of retailers’ inability to focus on the customer and create a better shopping experience—both on- and offline. In a recent Bloomberg article, a quote by Oliver Chen, an analyst at Cowen & Co., summed it up, “Management needs to be fixated on speed of delivery, speed of supply chain, and be able to test read and react to new and emerging trends.”

Retailers that have filed for bankruptcy so far this year: The Limited, Wet Seal, Eastern Outfitters, BCBG Max Azria, Vanity, Hhgregg, Radio Shack, Gordmans stores, Gander Mountain, Payless, Rue21, Gymboree, Papaya Clothing, True Religion Apparel Inc., Alfred Angelo, Perfumania… and it’s only Q3.

For retailers that want to survive what some are calling the “Retail Apocalypse”, a new retail strategy that emphasizes the supply chain is necessary. Never before has your delivery promise mattered more.

One major takeaway from Amazon #

It’s no secret that Amazon is the eCommerce trailblazer. It is projected to be the first company to reach a $1 trillion valuation. And it doesn’t appear to be losing any momentum.

But for its size and scale, Amazon chooses to lose money every day to increase its customer base. Amazon Prime, the loyalty program built on the promise of free, two-day shipping, has more than 80 million members in the U.S. However, Amazon lost $7.2 billion in shipping costs in 2016.

For Amazon the choice is simple. Customers love the fast, free shipping that Prime offers and are willing to pay the $99/year for the service. Not only is membership growing—up from 58 million members in 2016—but also Prime members spend 4.6-times more money on Amazon than non-Prime members.

So the takeaway is this: Amazon isn’t succumbing to hyperbolic discounting. It’s willing to sacrifice money in the short-term because it knows today’s sacrifices mean stronger payoffs down the line.

We can’t all be Amazon, but as businesses moving through this disruption, we can make smarter decisions that benefit the long-term over the short-term. The shared economy is changing the global supply chain and technologies that tap into unused assets are helping businesses solve the eCommerce problem.

Alternatives in transportation, real-time visibility into freight forwarding, on-demand warehousing networks. These are the types of solutions that might not save your entire supply chain, but can improve pieces of it, and when used in conjunction can modernize your supply chain without investing in fixed costs or traditional, static solutions.

At times it will be difficult to sacrifice that marshmallow sitting in front of our faces, but if we can, we’ll get another one in five minutes.

You might also be interested in: #