Bullwhip Effect in Supply Chain

byAnoop Kumar Gupta

MAIT1

Supply Chain Management and Uncertainty

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► Inventory and back-order levels fluctuate considerably across the supply chain even when customer demand doesn’t vary

► The variability worsens as we travel “up” the supply chain► Forecasting doesn’t help!

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Wholesale Distributor

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Bullwhip Effect

Traditional supply chain information flow3

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Bullwhip Effect4

► Sharing product demand information between members of a supply chain is critical.

► However, inaccurate or distorted information can travel through the chain like a bullwhip uncoiling.

► The bullwhip effect, as this is called, causes erratic replenishment orders placed on different levels in the supply chain that have no apparent link to final product demand.

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Bullwhip Effect5

► The results are excessive inventory investment, poor customer service levels, ineffective transportation use, misused manufacturing capacity, and lost revenues.

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Bullwhip Effect6

► An extreme change in the supply position upstream in a supply chain generated by a small change in demand downstream in the supply chain.

► The retailer’s orders to the wholesaler display greater variability than the end-consumer sales; the wholesaler’s orders to the manufacturer show even more oscillations; and, finally, the manufacturer’s orders to its suppliers are the most volatile.

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Bullwhip Effect7

► This phenomenon of variability magnification as we move from the customer to the producer in the supply chain is often referred to as the bullwhip effect.

► The effect indicates a lack of synchronization among supply chain members.

► Even a slight change in consumer sales ripples backward in the form of magnified oscillations upstream, resembling the result of a flick of a bullwhip handle.

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Bullwhip Effect8

► Because the supply patterns do not match the demand patterns, inventory accumulates at various stages, and shortages and delays occur at others.

► This bullwhip effect has been observed by many firms in numerous industries, including Campbell Soup and Procter & Gamble in consumer products; Hewlett-Packard, IBM, and Motorola in electronics; General Motors in automobiles; and Eli Lilly in pharmaceuticals.

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Bullwhip Effect9

► The bullwhip effect was first discovered and noted by an economist named Forrester, so it is also sometimes called the Forrester Effect.

► Forrester noted that when there were small perturbations in demand, parties in the supply chain held extra inventory as a precaution, and the further one went back in the chain, the higher the inventory buildup.

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Bullwhip Effect10

► A major limitation of the EOQ model is that it considers the impact on costs for only a single firm.

► No consideration is given to how order quantity decisions for one firm affect other members of the supply chain.

► Therefore, even though the EOQ minimizes costs for a particular firm, it can cause problems for other partners and may actually increase overall supply chain costs.

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Bullwhip Effect11

► What causes this? Quite simply, if a distributor reaches its reorder point, it places a large order. Otherwise, it does nothing.

► Therefore, a single unit change in demand may determine whether or not the distributor places an order.

► So even though the distributors may be following good inventory practice by ordering in quantities of 1500, the impact on the supply chain is to increase demand variability at the plant.

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Bullwhip Effect12

► Ultimately, this demand variability will drive up costs at the plant, which will then be forced to pass at least some of these costs on to the distributors.

► In order to reduce the bullwhip effect, many supply chain partners are working together to reduce order quantities by removing volume discount incentives and reducing ordering costs.

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Increasing Variability of Orders up the Supply Chain

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Causes of the Bullwhip Effect14

► The causes of the bullwhip effect are demand forecast updating, order batching, price fluctuation, and rationing and gaming.

► Each member in the supply chain, beginning with the retailers, does demand forecast updating with every inventory review. Based on actual demand, the retailers update their demand forecast.

► The retailers review their current inventory level and, based on their inventory policies, determine whether a replenishment order is needed.

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Causes of the Bullwhip Effect15

► The wholesalers repeat the process. Note that the demand is from the retailers’ inventory replenishments and may not reflect actual customer demand at the retail level.

► The wholesalers update their demand forecast and place appropriate replenishment orders with the distribution centers.

► The distributors repeat the process, updating their demand forecasts based on demand from the wholesalers.

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Causes of the Bullwhip Effect16

► The distributors review their inventory levels and place the appropriate orders with the manufacturer. These orders are determined by the inventory policies at the distributors.

► Orders placed with the manufacturer end up replenishing each level in the supply chain rather than being directly linked to end-customer demand.

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Causes of the Bullwhip Effect17

► A company does Order Batching when, instead of placing replenishment orders right after each unit is sold, it waits some period of time, sums up the number of units sold, and then places the order.

► This changes constant product demand to lumpy demand—a situation where certain levels in the supply chain experience periods of no demand.

► Order batching policies amplify variability in order timing and size.

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Causes of the Bullwhip Effect18

► Price fluctuations cause companies to buy products before they need them. Price fluctuations follow special promotions like price discounts, quantity discounts, coupons, and rebates.

► Each of these price fluctuations affects the replenishment orders placed in the supply system.

► When prices are lower, members of the supply chain tend to buy in larger quantities.

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Causes of the Bullwhip Effect19

► When prices increase, order quantities decrease.► Price fluctuations create more demand

variability within the supply chain.► Rationing and shortage gaming result when

demand exceeds supply and products are rationed to members of the supply chain.

► Knowing that the manufacturer will ration items, customers within the supply chain often exaggerate their needs.

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Causes of the Bullwhip Effect20

► For example, if you know the company is supplying only 50 percent of the order quantity, you double the order size.

► If you really need 100 pieces, you order 200 so you are sure to get what you need.

► Such game-playing distorts true demand information in the system.

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Counteracting the Bullwhip Effect21

Here are four ways of counteracting the bullwhip effect:►Change the way suppliers forecast product demand by making this information from the final-seller level available to all levels of the supply chain. This allows all levels to use the same product demand information when making replenishment decisions. Companies can do this by collecting point-of-sale (POS) information, a function available on most cash registers.

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Counteracting the Bullwhip Effect22

► Eliminate order batching: Companies typically use large order batches because of the relatively high cost of placing an order.

► Supply chain partners can reduce ordering costs by using electronic data interchange (EDI) to transmit information.

► Lower ordering costs eliminate the need for batch orders.

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Counteracting the Bullwhip Effect23

► Stabilize prices: Manufacturers can eliminate incentives for retail forward buying by creating a uniform wholesale pricing policy.

► In the grocery industry, for example, major manufacturers use an everyday low-price policy or a value-pricing strategy to discourage forward buying.

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Counteracting the Bullwhip Effect24

► Eliminate gaming: Instead of filling an order based on a set percentage, manufacturers can allocate products in proportion to past sales records.

► Customers then have no incentive to order a larger quantity to get the quantity they need.

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Factors Contributing to the Bullwhip 25

► Demand forecasting practices۞ Min-max inventory management (reorder points to bring inventory up to

predicted levels)► Lead time

۞ Longer lead times lead to greater variability in estimates of average demand, thus increasing variability and safety stock costs

► Batch ordering۞ Peaks and valleys in orders۞ Fixed ordering costs۞ Impact of transportation costs (e.g., fuel costs)۞ Sales quotas

► Price fluctuations۞ Promotion and discount policies

► Lack of centralized information

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Taming the Bullwhip 26

Four critical methods for reducing the Bullwhip effect:►Reduce uncertainty in the supply chain

۞ Centralize demand information۞ Keep each stage of the supply chain provided with up-to-date customer

demand information۞ More frequent planning (continuous real-time planning the goal)

►Reduce variability in the supply chain۞ Every-day-low-price strategies for stable demand patterns

►Reduce lead times۞ Use cross-docking to reduce order lead times۞ Use EDI techniques to reduce information lead times

►Eliminate the bullwhip through strategic partnerships۞ Vendor-managed inventory (VMI)۞ Collaborative planning, forecasting and replenishment (CPFR)

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