BULLWHIP EFFECT

25 04 2010

Bullwhip effect, also referred as the Whiplash Effect, is a phenomenon noticed in the forecast driven distribution channel. We find the reference of the said effect in the J Forrester’s Industrial Dynamics (1961). The effect refers to the fact that the variation in demand increases as we move further upward in the chain from customer to the manufacturer.  This effect leads to inefficiencies in supply chains, since it increases the cost for logistics and lowers its competitive ability. A variation in demand causes variation in the usage of capacities. The varying demand leads to variation in inventory levels at each level of the supply chain. As a result the safety stock that is required to maintain apt service level increases with the variation of demand.

There is always an unstable demand from the customers, which blurs the estimation of the businesses. If we segregate two aspects as demand forecast and demand fulfillment then demand forecast deals with customer contracts/sales forecast, MRP/Production, purchase request, purchase order, receiving, supplier’s invoice and payments while demand fulfillment deals with the sales order, order confirmation, picking and packing, shipping, delivery management, customer invoice and receipts.

                                         Source : http://www.google.com

The above picture clearly depicts the role of information in the supply chain management.

Suppose if there is an original equipment manufacturer and there are three suppliers to him in the downward links of supply chain then the original manufacturer has the lowest variation in demand as compared to the third supplier which has the maximum variations in the process and this distortion in the estimation of demand is referred as Bullwhip Effect.


Source : Human Behavior and Bullwhip Effect Research paper by Joerg Nienhaus, Arne Ziegenbein, Christoph Duijts

At the macro level Bullwhip effect creates inefficiencies in production causing lo capacity extraction or working at low level of output. It also causes sourcing, distribution, revenue generation and realization problems.  

Talking from the point of view of operating level the bullwhip effect add on to the existing inventory level while at the performance level it reduces the velocity of cash, destroys the potential revenue and also drives away the revenue in terms of discounting strategies.

At some point of time it leads to the dilution of the competitive strategy and hampers the market positioning of the products, which ultimately escort with the threat of shut down.

The Bullwhip Effect Impact:

* Increase in manufacturing cost.
* Rise in inventory.
* Increase in the replenishment lead-time.
* High carrying costs.
* Lack of uniformity in demand estimation at each level of supply chain.
* Increase in the transportation cost.
* Decrease in profitability.

Factors contributing to the Bullwhip effect:

* Information processing errors

a) Independent forecasting at each stage based on received orders.
b) The ratio between minimum sales and peak sales and its faulty interpretation.
c) Primitive information systems causing incorrect data inaccuracy and inconsistency.
d) Lack of information sharing among the various stages of the chain.

* Forecast errorsa) Forecast error is the deviation of the forecasted quantity from the actual. Mostly in Supply Chain Management MAPE (Mean Absolute Percentage Error) is used. It is the sum of all Errors divided by the sum of Actuals. But if we are having a perfect fit MAPE is zero but it has no limits in regard to its upper limits.
b) The figures have an indirect impact of optimistic bias.
c) Inaccurate and biased primary data collections.

* Lead Time Variability

a) A lead-time is the period of time between the initiation of any process of production and the completion of that process. But with reference to Supply chain Management it is the time from the moment the supplier receives an order to the moment it ships it in the absence of finished goods or intermediate (Work In Progress) inventory–it is the time it takes to actually manufacture the order without any inventory other than raw materials or supply parts. The bullwhip effect increases with longer lead times.
b) The higher the lead-time higher would be the need for safety stock and much are the chances of increased BWE.
c) The lower the level of demand the lower is the requirement for safety stock.

* Batch Ordering and dispatch plans

a) Bullwhip effect enlarges the chances for large order size for materials and other inputs.
b) In order to reduce order-processing costs the respondents inflate the order size, which contributes to the BWE.
c) Companies subsume demand in batches in order to reduce set up costs and fixed order costs.
d) The dispatch plans prepared does addicts errors on stock available in central warehouse, the immediate dispatch and the truck dispatches, leakages and other wastages.

* Price fluctuations

a) It generally results in over-reactions from customer’s viewpoint.
b) Companies lower the price of the commodities (temporarily) for the basic marketing and market positioning strategies.
c) Consumers start speculating about the price behaving to purchase at low prices and postponing the demand at times of high prices.
d) This variation flows in the chain as a microscopic view and BWE increases.

* Inflated ordersa) In case of demand exceeding supply the suppliers often ration their products.
b) The customers in anticipation of price fluctuation in their favor inflate the orders to the suppliers.
c) The time the bottleneck is arrived the excess orders are cancelled which compel to realize the increased Bullwhip effect.
d) The ordering is done in large lots in order to reduce fixed costs associated with the order placement and transportation.

* Human Behavior

a) The human behavior, a slightly neglected aspect in the supply chain process does have a strong impact on the supply chain management.
b) The value of information for the upward link in the chain is under-estimated.
c) The under-estimation of the information increases the lead-time of information and the bullwhip effect is amplified.

To manage BWE it has to be the strategic initiative rather than the tactical one. Single isolated efforts cannot do much to restrain the BWE. The Bullwhip effect is the result of rational response by the member of supply chain management.

The Way Out:

* Check in the demand variabilityi. There should be regular vigilance at each process of demand estimation and demand fulfillment.
ii. The demand forecasting should reduce the bias of optimism.
iii. There should be a regular practice of low scheduled price not based on only quantum of order and not only at the occasion of product promotion.
iv. Avoid multiple demand forecasts.
v. Use EDI+POS+VMI
– Where EDI mean Electronic Data Interchange
– POS means Point of Sale
– VMI means Vendor Managed Inventory
vi. Moving from decentralized dispatch mode to a centralized planning in order to improve control on inventories.

* Ordering solutions

i. Increase in the order frequencies.
ii. Operating costs to be reduced by EDI.
iii. Reducing safety stocks by cutting lead times.
iv. There should be aggregation of stocks across retail outlets with a systematic warehousing.
v. There should be standardization to reduce Order Processing costs.
vi. Computer assisted ordering.
vii. Moving from lot size-based to volume-based quantity discounts considering total purchase over a specific period.
viii. Limiting the ordering quantity during promotions.

* Eliminate shortage gaming

i. There should be honest sharing of information.
ii. The capacity and demand responses should not carry any optimistic bias.
iii. There should be a standardization of pricing in order to make customers spell less variation of demand.
iv. There should be fewer tendencies to bend for panic or safe harbor approach.
v. Ration based on past sales and information sharing to limit gaming.
vi. Aligning incentives across functions.
vii. Building strategic partnerships and trust.
viii. Altering sales force incentives from sell-in to sell-through approach.

* Eliminate information processing errors

i. Sharing point of sale data
ii. Collaborative forecasting and planning
iii. Single stage control of replenishment
iv. Continuous replenishment programs (CRP)
v. Vendor managed inventory (VMI)

Conclusion

The Indian retail industry, which today has over ninety five percentage of the outlets just spacing below five hundred square feet, accounting for eight percentage of employment and estimated at growth rate of 25 % annually, the knowledge of supply chain, its processes are still to be said in the incubation stage. The much in number are unaware of the Bullwhip effect.

There is always an optimistic bias in respondents if the economy is at boom and the per capita consumption is at positive trends. But the contradictions inundate the already existing ordering and stocking in response of variation in the demand. As revealed by the Beer Distribution Game developed by the Systems Dynamics Group at Massachusetts Institute of Technology in 1960, the respondents behave in two extreme sets of behavior. At the first to be said as Safe harbor and second as Panic approach. Safe harbor approach leads to hold more stocks than needed while panic criteria leads to empty the stock before there is a variation in the end consumer’s demand.

There should be proper sharing and reporting of information, which can be very effective in reducing the bullwhip effect. On the edge of being a dominant player, in the retail sector, where top of the notch company like Wal-Mart considering the pitch of India to match it on with the already existing big giants of the Indian companies, time has come where the perspective of supply chain management should change from the old traditional process of warehousing, distribution to a much more wider segment of collaborations between various links of merchandisers and OEM in the supply chain. The ERP should be refined and a microscopic analysis should be made for the various financial and non-financial planning at the end of the suppliers.

References:

[1] Forrester, J. W.: Industrial Dynamics. A major breakthrough for decision makers. Harvard
Business Review, 36 (1958) 4, pp. 37-66.
[2] Lee, L. H.; Padmanabhan, V.; Whang, S.: The Bullwhip Effect in Supply Chains, Sloan
Management Review, Spring 1997, pp. 93-102.
[3] Lee, L. H.; Padmanabhan, V.; Whang, S.: Information Distortion in a Supply Chain:   The Bullwhip Effect, Management Science, 43 (1997) 4, pp. 546-558.
[4] Joerg Nienhaus, Arne Ziegenbein, Christoph Duijts : How Human behavior amplifies the bullwhip effect, a study based on the beer distribution game online.
[5] N. Ravichandran, working paper on Managing Bullwhip effect- Two case Studies

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