Bullwhip Effect in Supply Chain

The problem of  Bullwhip effect in supply chain management has always been a concern for many years. Due to its non industry specific nature, it has grabbed the attention of many professionals from diverse industries and business schools. Bullwhip effect as its name suggests is an oscillation in the chain or pipeline. In supply chain this effect occurs when there is a constant fluctuation in the demand. In-congruence in the information leads to its distortion thereby creating a bullwhip.

The expression “Bullwhip Effect” was termed by executives of P&G, the company that manufactures Pamper brand of diapers. These executives observed that while the consumer demand for Pamper’s Diapers was fairly constant over time, the orders for diapers placed by retailers to their wholesalers or distributors were quite variable i.e., exhibited significant fluctuations over time. In addition, even larger variations in order quantities were observed in the orders that P&G received from its wholesalers. This increase in the variability of the orders seen by each stage in a supply chain was called the bullwhip effect.

Bullwhip Effect in Supply Chain

This situation of misalignment in supply chain can be termed as ‘Asymmetric Information’ where different parties having different states of private information about demand conditions, products, and the chain operations. The problem of this asymmetry arises because participating firms generally lack the knowledge required about each other’s plans and intentions to adequately harmonize their services and activities. Supply chain members often do not wish to share their private information completely and faithfully with all others due to the profitability of that actual or perceived information. Thereby the whole supply chain suffers from sub-optimal and opportunistic behavior. These decisions occur when the members don’t have sufficient visibility to resolve various trade-offs in decision making because lack of information causes decisions to be made in a narrow scope that cannot ensure that products flow properly to end customers. Moreover, with limited information sharing, members don’t have consistent perceptions of market needs and visibility over performance at the other levels of the supply chain. As a consequence, decisions are made based on either the best estimation of the available data or an educated guess. Such decisions can be biased and prevent the individual member from attaining the optimal solution of the supply chain. For example, the manufacturer often uses incoming orders with larger variance and not sales data from the retailer as a signal about the future product demand. Asymmetric information also produces problems of vulnerability of opportunistic behavior. Specifically, adverse selection and moral hazard manifest themselves in the relationship among the supply chain members. The negative selection of adverse selection, for example, is that the member firms cannot optimize supply chain performance because they don’t possess the required capability to meet the predetermined customer service level.

To explain this effect a very simple example of two tier supply chain, a retailer and a manufacturer, can be taken into account. The retailer observes customer demand and places orders to the manufacturer. For determination of the order quantity to place with the manufacturer, retailer will use the observed demand data of customer and a demand forecasting technique. In the 2nd stage, the manufacturer plays his role of forecasting by observing the retailers demand to place order to his suppliers. In many supply chains, the manufacturer doesn’t have access to customer’s demand data thereby making him rely on the retailer’s data to forecast. As the bullwhip effect implies (the orders placed by the retailer are significantly more variable than the customer demand observed by the retailer), the manufacturer’s forecasting and inventory control problem will be much more difficult than the retailer’s forecasting and inventory control problem. In addition, the increased variability will force the manufacturer to carry more safety stock or to maintain higher capacity than the retailer in order to meet the same service level as the retailer.

Causes of  Bullwhip Effect in Supply Chain

There are four main causes behind building up of bullwhip effect in supply chain. These causes are:

  1. Demand Forecasting:  Every company in a supply chain usually does a product forecasting for its production scheduling, capacity planning, inventory control and material requirement planning. This forecast is often done on the basis of previous orders placed by the customers. A very common method of demand forecast is exponential smoothing in which future demands are continuously updated as the real demand data becomes available. The order placed reflects the amount needed to replenish the future demands as well as safety stock. Due to long lead times the safety stock days surge resulting in greater order quantity fluctuations. Moving a level up, to the manufacturers stage if the method of forecasting is same i.e. exponential smoothing then the demand variability is even more, eventually creating a bullwhip.
  2. Order Batching:  In supply chain most of the organizations place orders with their upstream suppliers after the accumulating them. The frequency of these orders is weekly, biweekly or at times monthly depending on the product. There are several cost related and demand related reasons for this practice. This can be demystified by an example of a company that places an order once a month because of the nature of the product it deals in. The supplier faces a highly erratic stream of orders. There is a spike in demand at one time during the month, followed by no demands for the rest of the month. This variability is higher than the demands the company itself faces. This practice amplifies variability leading to bullwhip effect. Transportation economics also plays a major role in the frequency of order placements. If the truck load is not enough then the order is not released as the cost is same irrespective of the load. Therefore companies prefer to order only when accumulated requirements are enough for a truck load to fill. This period batching causes surges in demand at a particular time period, followed by the periods of time with no or little orders, and other time periods with huge demands.
  3. Price Fluctuation:  Price variation is a crucial factor that impacts the buying behavior of a person. The customer buys in quantities that don’t reflect their immediate needs. They buy in bigger quantities and stock up when the prices are low and reduce the purchase when the pieces are normal, thereby creating a forward buy pattern in the chain. As a result the customers buying pattern doesn’t reflect the consumption pattern and variation between the 2 grows which leads to the bullwhip effect.
  4. Rationing and Shortage Gaming:  When the product demand exceeds its supply the manufacturer is forced to ration them to the customers. Knowing that manufacturer will ration the goods, customers exaggerate their real needs at the time of ordering. Later when the variation between demand and supply plummets down, orders suddenly start to fade and cancellations pour in. This overreaction of the customer is an outcome of anticipation due to lack of information and interaction between the relevant parties. As the customer doesn’t get 100% delivery of the goods required, he exaggerates the demand in order to receive the desired amount of goods.

From the above information it is clear enough that all the factors or elements resulting in bullwhip effect originate from a common ground i.e. information sharing. It is evident enough that the lack of information and interaction between different stages evolve bullwhip in the system thereby plaguing the whole Supply Chain.

Eliminating Bullwhip Effect in Supply Chain

Following are a set of efficient countermeasures that were designed to minimize the negative effects of the Bullwhip effect;

  1. Avoid multiple demand forecast updates: Since the main reason of existence of the Bullwhip effect is the fact, that every member of the supply chain makes its own demand forecasting based on the data provided to it by its immediate downstream member, the one evident way to avoid this repetitive processing of demand data in a supply chain is to make the real consumption data (that is known at a downstream site) available at all of the upstream sites. This would allow all of the enterprises in a supply chain (from downstream to upstream) to make and update their forecasts based on the same raw data. Data sharing can be implemented, for instance, by the use of the electronic data interchange (EDI) systems. But the practice shows that in some cases even though all of the organizations in a supply chain use the same demand data to make their forecasts, the differences in forecasting methods and/or buying practices may still lead to fluctuations in the orders placed with the upstream sites.
  2. Break order batches:  The main idea here is to avoid another reason of appearance of the Bullwhip effect – order batching – by developing the strategies that lead to smaller batches and thus more frequent supply. One of the reasons of large order batches and low order frequencies is the high cost of processing the orders, which can be avoided, for example, by the use of electronic document circulation instead of paper-based. The other reason of large order batches is the transportation costs: the differences in the costs of full truckloads and less-than-truckloads are very high, and this makes companies to “wait” for the full truckloads and thus stretch the replenishment times, which also creates order batching. This problem can also be avoided by inducing by the manufacturers their distributors to order assortments of different products at a time (a truckload from the same producer may contain different products instead of full load of the same product) and thus significantly increase the order frequency. This can be stimulated by offering discounts by manufacturers to their distributors if they order mixed loads. The other effective way to solve the problem of order batching is the use of third-party logistics companies: these companies allow economies of scale by combining loads from different suppliers situated near each other and delivering these loads to different companies, what is especially very useful for small companies, for which full truckload replenishment times are very long.
  3. Stabilize prices:  A very straightforward way of eliminating the Bullwhip effect caused by forward buying is for the manufacturers to reduce the levels and frequencies of wholesale discounts. One of the most effective ways of doing it is implementing the everyday low price (EDLP) pricing strategy. The practice shows that this strategy is effective both for the suppliers and for the customers since it helps to decrease costs of inventory, storage, transportation etc. for every participant. Though with use of the conventional accounting systems the benefits of the EDLP strategy compared to wholesale price discounting strategy are not evident for the buyer, ABC systems in most cases explicitly show the advantages of EDLP strategy.
  4. Eliminate gaming in shortage:  The aim of this measure is to deprive buyers of the incentives to exaggerate their orders in hope of the partial satisfaction of these orders by the suppliers. One of the simple ways to get rid of this reason of Bullwhip effect appearance is as following: in case of shortage the supplier can allocate products to the customers not based on their orders, but in proportion to past sales records. Also the buyers’ desire for gaming may be lessened if the supplier shares its capacity and inventory information with them. The other way of fighting with buyers’ “gaming desire” is to use strict supply contracts that restrict buyer’s flexibility in ordering unlimited quantities of goods and free cancelling of orders.

However, we have to admit that the above mentioned measures of reduction of the Bullwhip effect are not exhaustive and cannot fully eliminate the existence of this effect.

Countermeasures of Bullwhip Effect in Supply Chain

Actual demand for a product is influenced by several factors such as competition, prices, weather conditions, technological developments, and consumers’ general confidence. These would be considered external and unmanageable factors. There are other uncertainties involved as well that can have an effect on the supply chain such as problems in delivery time due to production machine failures. Techniques to lessen or curtail the bullwhip effect would be to understand and recognize who or what is suggesting the variations in demand. Is it the retailer, manufacturer, the customer, or the distributor? The key element to eliminating this setback is being aware of where the demand changes are beginning.

Techniques that can be used or put into place to reduce the bullwhip effect is sharing information along the supply chain, Vendor Managed Inventory (VMI), and managing e-business. The most obvious way to reduce the bullwhip effect is to improve communication and forecasting along the supply chain. Master Data Management (MDM) is can be looked at to integrate all data in an organization at the highest level, both internally and externally. One of the most notable examples of information sharing is between large manufacturers and retailers. Inventory if properly managed, it can increase profits and efficiency. The implementation of a Vendor-Managed Inventory (VMI) initiative would be a key factor in improving and controlling the bullwhip effect. VMI indicates that the vendor, usually a distributor, maintains the inventories for manufacturer or buyer and in turn will reduce warehouse costs for suppliers. VMI alleviates uncertainty of demand and replenishment decisions can be made according to operating needs, and also has heightened awareness of trends in demand.

E-commerce brings about new opportunities to improve the performance of the supply chain. The primary advantages of internet utilization are speed, decreased costs, the potential to shorten the supply chain, and flexibility. Electronic marketplaces provide for more efficient resource allocation, better information flow and dissemination on products and services in the supply chain. Electronic data interchange (EDI) can be implemented to help supply chain mangers in reducing misleading signals sent from sales and marketing (distribution).

Enterprise resource planning (ERP) is one of the most successful tools for managing supply chains. ERP is software that integrates the planning, management, and use of all sources in the entire enterprise. The major objective is to integrate all departments and functional information flow across a company onto a single computer system that can serve all of the enterprise’s needs. A plan created from an SCM system that allows companies to quickly assess the impact of their actions on the entire supply chain, including customer demand, can only be done with the integration of ERP software. ERP and SCM can help alleviate the bullwhip effect across the supply chain by having a shared understanding of what needs to get done, managing the variations in the organization, communication among all that’s involved especially top management, and having single control of replenishment or VMI can overcome inflated demand forecasts. Long lead times should also be reduced where it is reasonably beneficial.

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