Wednesday, August 6, 2008

The Bullwhip Effect in Supply Chain

(The article is a summary from the paper written by Hau L. Lee, V. Padmanabhan and Seungjin Whang and taken from sloan management review/spring 1997)

Distorted information from one end of a supply chain to the other can lead to tremendous inefficiencies excessive inventory investment, poor customer service, lost revenues, misguided capacity plans, ineffective transportation, and missed production schedules. The article deals with how do exaggerated order swings occur? What can companies do to mitigate them?

The bullwhip effect results from rational decision making by members in the supply chain. Companies can effectively conteract the effect by thoroughly understanding its underlying causes. Industry leaders like P&G are implementing innovative strategies that pose new challenges: integrating new information system, defining new organizational relationships, and implementing new incentive and measurement systems. The choice for companies is clear: either let the bullwhip effect paralyze you or find a way out.

What is Bullwhip effect in supply chain?
This effect first came to my knowledge while my professor was of SCM was trying to teach us the reason for extremely high inventory by making us play the ‘Beer Game’. Here each of the four participants are given the role of ‘retailer’, ‘wholesaler’, ‘distributor’ and ‘manufacturer’. The retailer is randomly given a customer demand based on which the retailer try to forecast future demand and gives the order to wholesaler with some built in ‘safety stock’. Now as the process moves upward, from wholesaler to distributor to manufacturer, to my utter surprise, even if all the decision seems perfectly rational the inventory kept on increasing at each level. You will not believe the end result, the retailers fluctuation in demand only varied from some 8 to 16 over a period of 24 turns (that we played) and the total inventory and total backorder in entire supply chain was running in excess of 2000!!!
This is what is called ‘Bullwhip effect’. Here are some of the real life examples of this effect in play. It was observed by executives of P&G that the sales patterns for one of their best-selling products pampers fluctuates in retail stores, but the variabilities were certainly not excessive. However, as they examined the distributor’s orders, the degree of variability increased. When they further looked at P&G’s orders of materials to their suppliers, such as 3M, they discovered that the swings were even greater. This did not make sense. While the consumers, in this case the babies, consumed diapers at a steady rate, the demand order variabilities in the supply chain were amplified as they moved up the supply chain. This effect is called the bullwhip effect / whiplash effect / whipsaw effect.
As per wiki, the bullwhip effect is because customer demand is rarely perfectly stable, businesses must forecast demand in order to properly position inventory and other resources. Forecasts are based on statistics, and they are rarely perfectly accurate. Because forecast errors are a given, companies often carry an inventory buffer called "safety stock". Moving up the supply chain from end-consumer to raw materials supplier, each supply chain participant has greater observed variation in demand and thus greater need for safety stock. In periods of rising demand, down-stream participants will increase their orders. In periods of falling demand, orders will fall or stop in order to reduce inventory. The effect is that variations are amplified as one moves upstream in the supply chain (further from the customer)
In short, Bullwhip effect is the magnification of demand fluctuations, not the magnification of the demand. This could be really costly to any company.

(The beer game could be made available on request. If required, please send a mail to with subject line “request for beer game”. The game is also available online…just try to google a bit!!)

Consequence of Bullwhip Effect
· Excessive inventory quantities : Various studies have found that the total supply chain, from when products leave the manufacturers production lines to when they arrive on the retailers shelves, has more than 100 days of inventory supply. Also, various reports estimates a potential $30 billion opportunity from streamlining the inefficiencies of the grocery supply chain.
· Poor customer service
· Lost revenue
· Unsatisfactory quality
Causes of Bullwhip Effect
People generally believe that the amplified order variability is the case cause of players irrationally decision making within the supply chain’s infrastructure. On the contrary, the fact is that bullwhip effect is the consequence of rational behavior of various players involved in the supply chain. This implies that the companies should try to modify the chains infrastructure and related processes rather than the decision makers behavior.
· Demand forecast updating: Forecasting is often based on order history from the company’s immediate customers. When a downstream operation places an order, the upstream manager processes the piece of information as a signal about future demand. Based on this forecast, the upstream manager readjusts his or her demand forecast and, in turn, the order placed with the suppliers of the upstream operation. This demand signal processing is the major contributor to the bullwhip effect. It is intuitive that, when the lead times between the resupply of the items along the supply chain are longer, the fluctuations is even more significant

· Order batching: There are two forms of order batching, a) Periodic ordering and b) Push ordering. Instead of ordering frequently, companies may order weekly, biweekly, or even monthly. The order batching is generally done to minimize the cost of ordering or to use the economies of transportation. This causes sudden increase in demand of the product thereby amplifying variability. For companies, the ordering pattern from their customers is more erratic than the consumption patterns that their customer experience. However, if all customers order cycles were spread out evenly throughout the ordering cycle, the bullwhip effect would be minimal. The periodic surges in demand by some customers would be insignificant because not all would be ordering at the same time. Unfortunately, such an ideal situation rarely exists. Orders are more likely to be overlapping towards let say end of the month or year. As a result, the surge of demand is even more pronounced, and the variability from the bull-whip effect is at its highest.

· Price fluctuations: Manufacturers and distributors periodically have special promotions like price discounts, quantity discounts, rebates etc. All these promotions results in price fluctuations. The result is that customers buy in quantities that do not reflect their immediate needs; they buy in bigger quantities and stock up for the future. The problem is it could be costly if forward buying becomes the norm? When a products price is low (due to offers), a customer buys in bigger quantities then needed. When the products price return to normal, the customer stops buying until it has depleted its inventory. As a result, the customer’s buying pattern does not reflect its consumption pattern, and the variation of the buying quantities is much bigger than the variation in the consumption rate – the bullwhip effect. This practice of giving regular discounts is sometimes called ‘the dumbest marketing ploy ever’.

· Rationing and shortage gaming: When product demand exceeds supply, the manufacturers often ration its product to customers. Generally, the manufacturer allocates the amount in proportion to the amount ordered. Knowing that the manufacturer will ration when the product is in short supply, customers exaggerate their real needs when they order. Later, when demand cools, order will suddenly disappear and cancellation pours in. In short, the customers try to ‘game’ the rationing system adopted by the seller. The effect of ‘gaming’ is that customers orders give the supplier little information on the products real demand, a particularly vexing problem for manufacturers in a products earlier stages.
How to counteract the Bullwhip Effect
Innovative companies in various industries have found that they can control the bullwhip effect and improve their supply chain performance by coordinating information and planning along the supply chain. Understanding the causes of the bullwhip effect can help managers find strategies to mitigate it.
· Avoid multiple demand forecast updates: Ordinarily, every member of a supply chain conducts some sort of forecasting in connection with its planning. Bullwhip effects are created when supply chain members process the demand input from their immediate downstream member in producing their own forecasts. Demand input from the immediate downstream member, of course, results from that member’s forecasting, with input from its own downstream member. Hence the best remedy to this is that to avoid repetitive processing of consumption data in a supply chain and instead to make available the demand data at a downstream site available to the upstream site. Hence, both sides can update their forecasts with the same raw data. In short share the POS data with the manufacturer. Hence, either by having mechanism (EDI) to share data or by bypassing the supply chain can counteract the ‘Bullwhip Effect’

· Back order batches: Since order batching contributes to the bullwhip effect, companies need to devise strategies that lead to smaller batches or more frequent resupply.

· Stabilize Prices: The best way to control bullwhip effect is to reduce both the frequency and the level of wholesale price discounting, establish a uniform wholesale pricing policy.

· Eliminate gaming is shortage situation: When a supplier faces a shortage, instead of allocating products based on orders, it can allocate in proportion to past sales record.

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