Bullwhip Effect: Information Distortions in Supply Chains

The Genesis

The ‘bullwhip effect’ refers to increasing variability of demand further upstream in a supply chain. The term – ‘bullwhip effect’ – is said to have first been used by Procter & Gamble, when they experienced extensive demand amplifications for their diaper product ‘Pampers’.

In the literature this effect is described as a result of information distortion in a supply chain, where companies upstream do not have information on actual consumer demand. Consequently, their ordering decisions are based on incoming orders from the next downstream company. This leads to amplified order variability: demand coming in from a downstream company has a lower variability than demand to an upstream company.

Causes of Bullwhip Effect

This effect is ascribed to a few particular causes as discussed below:

Demand Forecast Updating: Links in the supply chain base the expectations about future demand on orders they receive from the succeeding link. An increase in orders leads to higher demand forecasts, which is transferred to the next link by increased order quantity. That link also sees an increase in demand, updates its forecasts and distorts information for the subsequent link. It works in the reverse way when end customer demand decreases.

Because amount of safety stock contributes to the bullwhip effect, when the lead-time between resupply of items along the supply chain is longer, the fluctuation is more significant.

Order Batching: Demand comes in, depleting inventories but the company may not immediately place an order with its suppliers. It often accumulates demands before issuing an order due to considerations of fixed order costs or optimum distribution efficiency.

Consider a company that receives orders daily but places orders with its suppliers once a week. Variability of orders placed with suppliers is higher than the demands the company itself faces.

Price Fluctuations: Because of promotions and trade deals, the price of a product fluctuates, which increases variability of demand. When the price of a product is low, a customer buys larger quantities than needed. When the price returns to normal, the customer buys less than needed to deplete her inventory.

Rationing and Shortage Gaming: When product demand exceeds supply, a supplier may ration its product to customers. For example, a producer may allocate only half the quantity demanded downstream, in case of a shortage. The problem is, customers are prompted to order more than they need in the expectation that they may finally get as much as they need. Later, when there are no shortages, orders disappear.

Possible RemediesMeasuring the total bullwhip effect does not tell which of the different causes contributes most and which solutions are most relevant. However, for each of the above causes, several possible remedies are suggested in literature. Some of them are:

Data on consumer demand may be made directly available to companies further upstream in the supply chain. However, benefits of transferring EPOS data must be clear before a system is set up to make this possible. In many cases a

significant investment in information systems is needed to collect and process the data. Further more, EPOS data is very valuable marketing information, that retailers may not want to make available to the manufacturer.

In a particular supply chain, to assess the possible benefits of exchanging demand information, it is important to be able to measure which part of ‘bullwhip effect’ is due to incomplete demand information. By specifying at which level of aggregation the information is useful, the various companies may find that a particular level of aggregation data may be exchanged to dampen the bullwhip effect and to improve operations, while detailed EPOS data may not be exchanged if retailers want to protect that for marketing purposes.

Further, a single source of forecasting needs to be determined for the entire supply chain.

Common reasons for inventory systems based on order cycles, are

Companies place purchase orders with their suppliers when they run their MRP systems. Since most MRP system runs are monthly, it results in monthly ordering with suppliers.

Economics of transportation: Normally there are substantial differences between Full-Truck-Load (FTL) rates and less than Full-Truck-Load rates. Thus there’s a strong incentive to wait till full truckloads can be ordered.

However, reducing batch sizes can be enabled by using EDI to reduce administrative ordering costs and using third party logistics service providers to make less than full truckloads economically viable.Also, a company may order assortment of different products. A truckload may contain different products from the same manufacturer instead of a full truckload of the same product. The effect is that for each product, the order frequency is much higher, the frequency of deliveries to the distributors remains unchanged, and the transportation efficiency is preserved.Owing to price deals, the consumer engages in forward buying. Here, consumer’s buying pattern does not reflect her consumption pattern, and the variation of the buying quantity is much bigger than the variation in the consumption rate – the bullwhip effect. Stabilizing prices and reducing the number of promotions is a way of reducing this effect.Rationing methods based on past sales rather than on orders placed can take away the incentive for customers to inflate order sizes.

Complications in Source Identification & Implementation of RemediesNotwithstanding the efficacy of the aforesaid remedies, what makes any of these difficult to implement, is the inherent difficulty of segregating the particular cause responsible for observing such an effect. Any supply chain is part of a larger supply web. For instance, a manufacturer of butter may supply grocery chain A, where a project is started to reduce the bullwhip effect. Variation in demand at the manufacturer is however influenced by his other customers. It is difficult, in this case, to obtain insight into a particular supply chain, namely the chain with grocery chain A. Thus for the grocery chain A, the source of bullwhip effect may be upstream rather than downstream.As of date, the theory of measurement of the bullwhip effect in practical settings has received very limited attention. However, further research is required in this field for effective Supply Chain Management.By Anjan Datta of IIM, Lucknow.