The Bullwhip Effect

Whats covered?Bullwhip effect definedResults of the bullwhip effectCauses of the bullwhip effectAn exampleReducing the bullwhip effectYour firm and the bullwhip effectSummary

Bullwhip Effect DefinedThe bullwhip effect is the uncertainty caused from distorted information flowing up and down the supply chain.

Who is affected?Nearly all industries are affected!Firms that experience large variations in demand are at risk.Firms that depend on suppliers upstream or distributors and retailers downstream may be at risk.

Results of the bullwhip effectExcess inventoriesProblems with qualityIncreased raw material costsOvertime expensesIncreased shipping costs

Results of the bullwhip effect - continued.Lost customer serviceLengthened lead timeLost salesUnnecessary adjusted capacity

Causes of the bullwhip effectUn-forecasted sales promotionsSales incentivesLack of customer confidenceCustomers turning back sales ordersFreight incentives

Bullwhip effect - an exampleChronology of company Xs supply chain problem.Company X produces widgets for sale on the open market.Customer demand for Company Xs widgets become stagnantRetailers offer a sales promotion to boost sales of Company X widgets

Example continuedRetailers fail to notify manufacturers of sales promotionCompany X recognizes that demand for widgets has increased.Company X increases inventory to allow for increased manufacturing of widgets.

Example - continuedCompany X notifies part suppliers of increased demand.Suppliers increase inventory to meet demand.

Moral of the storyDistorted information along the supply chain caused inventory levels to increase along the supply chain which may result in increased inventory costs, poor customer service, adjusted capacity and many other problems associated with the bullwhip effect.

Supply Chain in EquilibriumCustomer demand forecast = 10 units

SuppliersProducersDistributorsRetailersProducts & ServicesProducts & ServicesProducts & ServicesInformationCashKey: =Inventory Levels10 Units10 Units10 Units10 Units10 Units10 UnitsRetailers are selling product at a constant rate and price. Firms along the supply chain are able to set their inventory to meet demand.

Supply Chain DisruptedCustomer Demand forecast = 20 units

SuppliersProducersDistributorsRetailersProducts & ServicesProducts & ServicesProducts & ServicesInformation FlowCash FlowKey: =Inventory Levels160 Units80 Units40 Units80 Units40 Units20 UnitsAs demand increases, the distributor decides to accommodate the forecasted demand and increase inventory to buffer against unforeseen problems in demand. Each step along the supply chain increases their inventory (double in this example) to accommodate demand fluctuations. The top of the supply chain receives the harshest impact of the whip effect.

Solving the Bullwhip dilemmaImprove communication along the supply chain. Retailers notifying firms upstream of sales promotions will help clarify demand signals from consumers Improved information will improve demand forecasts upstream in the supply chain.

Solving the Bullwhip dilemma - continuedImprove sources of forecast dataFirms can use data from Point of Sale computer systems to derive data from forecastingFirms along the supply chain can use EDI systems to retrieve data on items that are legitimately being purchased by customers

Solving the Bullwhip dilemma - continuedWork with firms upstream and downstream in the supply chain Create smaller order increments to decrease time between orders. Order processing will become closer to real-time. Work to develop consistent pricing of products to avoid demand fluctuations from the sale of inexpensive products.

Reducing the bullwhip effect in your firmAre prices in your supply chain stable?Is information between firms along the supply chain accurate and timely?

Reducing the bullwhip effect in your firmIs sales being forecasted on projected data?Are you forecasting sales using data from EDI or Point of Sale computer systems.Are incentives for sales representatives along the supply chain at minimum?

Reducing the bullwhip effect in your firmAre orders being placed in small increments?Are batch orders reduced to minimum levels?

Reducing the bullwhip effect in your firmIf you answered no to any of the previous questions regarding your firm and the bullwhip effect, then you may have an opportunity to reduce costs to your individual firm.

SummaryBullwhip effect is caused from distortions in information along the supply chainResults of the bullwhip effect can include: excess inventories, problems with quality, increased costs, overtime expenditures, lost customer service, lost sales and more.

Summary - ContinuedCauses of the bullwhip effect may include: poor forecasting of sales, incorrect information along the supply chain, sales incentives, sales promotions and lack of customer confidence.

Summary - ContinuedSolutions to the bullwhip effect include: improved information flow between firms along the supply chain, stable pricing, small order increments, focused demand on EDI or POS systems and removal of sales incentives.

***The bullwhip effect is caused by fluctuations in information supplied to firms further up the supply chain. Distorted information causes firms to forecast demand incorrectly. Thereby, many unnecessary costs are put upon each of the firms along the supply chain. *Most firms are affected by the bullwhip effect. The bullwhip effect used to be considered a normal phenomenon. However, recently, many firms have been trying to focus on how to improve communication along the supply chain.

*The bullwhip effect can inflict many unnecessary costs on business firms. Inventory costs from stored inventory, problems with quality caused from rapid production, overtime expenses for increased employee labor, and increased units being shipped create costs far and beyond normal levels of production.*Customers can also lose faith in a firms ability to deliver products. This is because firms are having trouble meeting demand. Likewise, firms often must lengthen lead time for finished goods, which also may discourage customers, which in turn leads to lost sales. In a worst case, incorrect forecasts may entice a company to adjust capacity which could be detrimental to the overall success of the company.*To reduce stocked product, retailers may offer sales promotions to customers. If retailers fail to notify firms upstream in the supply chain, these firms may forecast increased sales as legitimate demand. Thereby producing product that was not wanted by the customer in the first place. Furthermore, sales incentives for salesman may entice salesman to sell products to firms to meet incentives. This may cause large inventories for the firm, or the firm may cancel the orders, which causes demand fluctuations in the supply chain.*In this example is only one of many that may occur for firms. A retailer of a good may indeed offer lower prices so as to reduce the amount of inventory sitting on store shelves. A problem may occur if the retailer fails to notify other firms upstream in the supply chain. *Firms upstream in the supply chain may feel that the increased demand may be legitimate and increase production and inventory levels to produce more. However, in reality, the product hardly moved and required a drop in price to be moved off of retailers shelves. Each firm upstream in the supply chain will feel the whip effect.***Each of the firms along the supply chain are producing at a constant rate because demand is easily forecasted; the supply chain is in equilibrium. Each of the firms are forecasting demand accurately.*In this example, demand has increased by 10 units over equilibrium. To meet the demand, the distributor doubles inventory to meet production and to meet any other demand fluctuations. The producer further up the chain also notices the increased demand of the distributor and doubles their demand forecast to 40 units and hold 80 units in inventory to meet demand and hedge against any other demand fluctuations. The supplier (or top of the supply chain) receives the blunt of the whip effect. Costs for individual firms, in this example, increase the further you move up the supply chain,*Improved communication from retailers will assist firms upstream in the supply chain in determining what is actual product demand. Improved communication and reliable information helps firms to develop forecasts that are effective and accurate.*Determining product demand from actual data entered into point of sale (POS) computer systems and electronic data interchange (EDI) systems will result in accurate sales forecasts. In contrast, determining sales forecasts on experience or hunches may be risky.*Ordering products up and down the supply chain in smaller increments reduces the time between orders and allows for timely information to be available to your firm. Receiving information in real-time is a great advantage to a firm when forecasting data is essential to reducing costs.*Some keys to reducing costs to your firm: stabilize prices along the supply chain and be sure your information along the supply chain is timely and accurate. This will enhance decision making and allow your company to be responsive to customer demand.*Reduce the speculative decisions in your firm by using actual sales of product entered into point of sale or EDI computer systems. This will help your firm base their decisions on actual demand and not on demand based upon speculation or demand derived from a zealous salesman reaching a sales quota.*Small orders and reduced batch orders increase information quality and contact with vendors up and down the supply chain.*Every firm should look to reduce costs and help them gain competitive advantage. Reducing costs along the supply chain is a new phenomenon. Perhaps your firm can gain a competitive edge by reducing fluctuations in the information along your supply chain.***