The Bullwhip Effect

P&G

Procter & Gamble (P&G) examined order patterns for Pampers.

Its sales at retail stores were fluctuating, but the variability was not excessive.

For the distributors' orders, P&G was surprised by the greater degree of variability.

When they looked at P&G's orders of materials to their suppliers, such as 3M, the swings were even greater.

While babies consumed diapers at a steady rate, the demand order variability in the supply chain was amplified as we move up the supply chain. P&G called this phenomenon the "bullwhip" effect.

Bullwhip

As we move further away from the end-customer in the supply chain,

1. Distortion in demand information,

2. Increase in variance of orders

Information Coordination: The Bullwhip Effect

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Causes of the Bullwhip Effect Best illustration of the bullwhip effect is "beer game." Participants play the roles of customers, retailers,

wholesalers, and suppliers of a popular brand of beer. They cannot communicate with each other and

must make order decisions based only on orders from the next downstream player.

The ordering patterns share a common, recurring theme: the variability of an upstream site is always greater than those of the downstream site, a simple, yet powerful illustration of the bullwhip effect.

the bullwhip effect is a consequence of the players' rational behavior within the supply chains infrastructure.

Customer

Retailer

Manufact.

Supplier

Distributor

So What? When a supply chain is plagued with a

bullwhip effect and demand information is distorted,

It results in excessive inventory poor product forecasts insufficient or excessive capacities poor customer service Uncertain and costly production high costs for corrections (expedited

shipments and overtime)

General Techniques for Over-coming the Bullwhip Effect

Electronic linkages Information sharing Better forecasts Real-time updates Lower costs of procurement

More frequent deliveries Use of cheap electronic procurement Consolidation of loads through 3rd party logistics

Stable prices Eg, Everyday Low Pricing (EDLP)

Four major causes of the bullwhip effect:

1. Demand forecast updating

2. Order batching 3. Price fluctuation 4. Rationing and shortage

gaming

1. Demand Forecast Updating Companies in a supply chain usually do their

own product forecasting Forecasting is often based on the order history

from the company's immediate customers. When a downstream operation places an

order, the upstream manager processes that information as

a signal about future product demand. readjusts his/her demand forecasts and, in turn, the orders with the upstream suppliers

The order sent to the supplier reflects the amount needed to replenish the stocks to

meet the requirements of future demands, as well as the necessary safety stocks.

With long lead times, it is not uncommon to have weeks of safety stocks.

The result is that the fluctuations in the order quantities to suppliers over time can be much greater than the fluctuations in the demand data

2. Order Batching

In a supply chain, each company places orders with an upstream organization using some inventory monitoring or control. Demands come in, depleting inventory, but the

company may not immediately place an order with its supplier.

It often batches or accumulates demands before issuing an order.

There are two forms of order batching: ‘economies’ of ordering and transport push ordering

High Cost of Order Processing Companies may order weekly, biweekly,

or even monthly. the time and cost of processing an

order. P&G estimates customer ordering to cost $35 - $75 to process.

Many manufacturers place purchase orders with suppliers when they run their material requirements planning (MRP) systems.

MRP systems are often run monthly. slow-moving items may be ordered infrequently

Economics of Transportation There are substantial differences

between full truckload (FTL) and less-than-truckload (LTL) rates, strong incentive to fill a truckload

when ordering from a supplier. Full truckload could be a month or

more product

Salespeople are measured quarterly or annually

Sales people fill sales quotas by "borrowing" ahead. Sign orders prematurely

company experiences regular surges in demand.

orders "pushed" on it from customers

3. Price Fluctuation

forward buy constituted 80 percent of transactions between manufacturers and distributors in the grocery industry due to attractive price. Resulted in $75 billion to $100

billion of inventory

Promotions Manufacturers and distributors

periodically have special promotions and trade deals like price discounts, quantity discounts, coupons, rebates, etc.

The result is that customers buy in bigger quantities that do not reflect their immediate needs and stock up for the future.

Results of Promotions

Factories run overtime at certain times and are idle at others.

Companies pile huge inventories to anticipate big demand swings.

With a surge in shipments, they may pay premium freight rates.

Damage also increases due to larger-than-normal volumes and stocking inventories for long periods.

Problems are self imposed

4. Rationing and Shortage Gaming When demand exceeds supply,

manufacturers may ration its product to customers. One method: allocates amounts amount in

proportion to the amount ordered. For example, if the total supply is only 50 percent

of the total demand, all customers receive 50 percent of what they order.

Knowing that, customers may exaggerate their real needs.

If and when demand cools, orders will suddenly be cancelled

How to Counteract the Bullwhip Effect

1. Avoid Multiple Demand Forecast Updates

make downstream demand data available to the upstream sites. Both sites can update their forecasts with the same raw data.

IBM, HP, and Apple require sell-through data on withdrawn stocks from their resellers' central warehouse. Not as complete as point-of-sale (POS) store data.

Electronic Data Interchange (EDI)

Supply chain partners use electronic data interchange (EDI) to share data.

In the consumer products industry, EDI is growing in 1990, 20 percent of orders by retailers transmitted

via EDI. In 1992, 40 percent and, in 1995, nearly 60 percent.

The increasing use of EDI facilitate information transmission sharing among chain members

Now moving to the internet

Vendor-managed inventory (VMI) or Continuous replenishment program (CRP)

Manufacturer or wholesaler has access to the demand and inventory information at retailing sites (either POS or retail warehouses)

Updates forecasts and resupplies the retail sites. Retailers become a passive partners in supply chain. Inventory reductions of up to 25 percent are common. Many companies such as Campbell Soup,

M&M/Mars, Nestle, Quaker Oats, Nabisco, P&G, and Scott Paper use CRP with some or most of their customers. P&G uses VMI in its diaper supply chain, starting with its supplier, 3M, and its customer, Wal-Mart.

”Consumer direct" program Apple Computer has a

"consumer direct" program sells directly to consumers without

going through the reseller Allows Apple to see directly the

demand patterns. Dell does the same.

2. Break Order Batches

Devise strategies that lead to smaller batches more frequent resupply

Lower cost of ordering EDI can reduce the cost of the paperwork in

generating an order. Using EDI, Nabisco perform paperless, computer-

assisted ordering (CAO) and customers order more frequently.

McKesson uses EDI to lower the transaction costs from orders by drugstores and other retailers.

P&G has introduced standardized ordering terms across all business units to simplify the process and dramatically cut the number of invoices.

General Electric is electronically matching buyers and suppliers.

A paper purchase order that typically cost $50 to process is now $5.

Transportation alternatives Differences in the costs of full truckloads

and less-than- truckloads are great Improvements in order efficiency are wasted due to the

full-truckload constraint. Now some manufacturers induce their

distributors to order assortments of different products. Hence a truckload may contain different products from the same manufacturer instead of a full load of the same product.

P&G has given discounts to distributors that are willing to order mixed-SKU loads of any of its products.

Third-party logistics

Consolidate loads from multiple suppliers located near each other a company can realize full truckload

economies without the batches coming from the same supplier.

3. Stabilize Prices

Reduce the frequency and the level of wholesale price discounting.

The manufacturer can reduce the incentives for retail forward buying by establishing a uniform wholesale pricing policy.

P&G, Kraft, and Pillsbury have moved to an everyday low price (EDLP) or value pricing strategy

4. Eliminate Gaming in Shortage Situations

Instead of allocating products based on orders, allocate in proportion to past sales.

Customers then have no incentive to exaggerate their orders.

General Motors uses this method of allocation in cases of short supply.