The bullwhip effect in supply chainThe increase in variability in demand as we move up in the supply chain from customer to retailer to wholesaler to manufacturer to supplier is referred to as the bullwhip effect. (Fig.1)Causes of the bullwhip effect:

1. Demand forecast updating2. Order batching3. Price fluctuation4. Rationing and shortage gaming

• Demand forecast updatingForecasting by each partner is often based on the order history from the chain’s immediate downstream customers. As there is time lag, database for each one is different. Also, each one may use different forecasting methodology. These lead to increased variability as we move up along the supply chain.

• Order batchingOrder is normally placed in batches. There are two forms of order batching: periodic and push orderingIn periodic ordering, orders are more likely to be randomly spread out or, worse, to overlap. When order cycles overlap, the surge in demand is more pronounced and results in more variability.

Economic order quantity and economics of transportation force a company to resort to batch ordering. Rates of full truck load (FTL) and less-than-truck load are significantly different In push ordering, the company has orders “Pushed” on it from customers periodically. This occurs due to seasonal / festive requirements etc.

Price fluctuation Manufacturers and distributors periodically have special

promotions like price discount, quantity discount, coupons, rebates and so on. All these promotions results in price fluctuations, resulting into “Forward buying”.

Additionally, manufacture offers trade deals (e.g. Special discounts, price terms and payment terms) which are indirect form of price discount.

When promotion or trade discount is there buying is more. When price comes to normal, buyers stop buying until it has depleted its inventory. Customers buying pattern does not reflect consumption pattern, and the variation of the buying quantities is much bigger than the variation of the consumption rate – the bullwhip effect

Rationing and shortage gamingwhen product demand exceeds supply, a manufacturer often ration its product to customers. Sometimes manufacturer applies a factor (say 50%). Knowing that the manufacturer will ration, customers exaggerate their real needs when they order. Later, when demand cools, orders will suddenly disappear and cancellations pour in.

Quantifying bullwhip effect

Two stage supply chainVar (Q) / Var (D) >= 1+ 2L / P + 2L2 / P2 ………………………………..(1)Where,Var (D) --- Variance of customer demandVar (Q) --- Variance of order placed by retailerL --- Lead Time, P – No. of observations for forecasting

For L = 2, P = 5, Var (Q) / Var (D) = 2.12And L = 2, P = 10, Var (Q) / Var (D) = 1.48

2. Centralize demand information i.e. demand information is shared with each stage of the supply chainIncrease in variability from retailer to stage K is given as,

Var (QK) / Var (D) >= 1+ 2 Li / P + 2 ( Li )2 /P 2 . …………………..(2)

Here, increase in variability at each stage is an additive function of lead time.

3. Decentralize demand i.e. if demand information is not shared with each stage of the supply chain. Var (QK) / Var (D) >= (1 + 2Li / P + 2 Li

2 /P 2 )k ………..(3) here increase in variability at each stage is multiplicative Example: K=3, P=5, L1= L2 = L3 = 2

Centralize Information

Var (Q3) / Var (D) >= 1+ 2 Li / P + 2 ( Li )2 /P 2

>= 1 + (2*6/5) + (2*36/25) >= 1 + 2.40 + 2.88 >= 6.28

Decentralize Var (Q3) / Var (D) = (1 + 2Li / P + 2 Li

2 /P 2 )3

= 2.123 = 9.5

How to counteract the bullwhip effect? Avoid multiple demand forecast

updates Use same source demand data to perform

forecast update, preferably sell-through data on withdrawn stocks from their retailers central warehouse or ideally point of sale data.

Vender managed inventory Sell products directly to customer without going

through the distribution channel (Amway) Reduce lead time by improving operational

efficiency.

Break order batchesDevise strategy that lead to smaller batches. One reason for large order is high ordering cost. EDI can reduce the cost of the paperwork in generating an order.

Another reason for large order batches is that cost of transportation.

This cost can be minimized by:• Order for mixed – SKU loads• The use of third – party logistics companies also help

make small batch replenishment economical.

Stabilize price Reduce both the frequency and the level of wholesale

price discount. Establish a uniform wholesale pricing policy or everyday low price (EDLP) policy.

Retailers and distributors can aggressively negotiate with their suppliers to give them everyday Low cost (EDLC).

Activity base costing (ABC) system provide explicit accounting of the cost of inventory, storage, special handling, premium transportation and so on that previously were hidden and often outweigh the benefits of promotions.

Eliminates Gaming in shortage situations Allocate in proportion to past sale records. Customers

then have no incentive to exaggerate their orders. Stringent cancellation policy

Table 1 A framework for supply chain coordination initiatives

Causes of Bullwhip

Information Sharing Channel Alignment

Operational

Efficiency

Demand Forecast update

Understanding system dynamics

Vender-managed inventory (VMI)

Lead-time reduction

Use point-of-sale (POS) data

Discount for information sharing

Echelon-based inventory control

Electronic data interchange (EDI)

Consumer direct

Internet

Computer assisted ordering (CAO)

Order Batching

EDI Discount for truck load assortment

Reduction in fixed cost of ordering by EDI or electronic commerce

Causes of Bullwhip

Information Sharing Channel Alignment

Operational

Efficiency

Internet ordering Delivery appointments

CAO

Consolidation

Logistic Outsourcing

Price Fluctuation

Continuous replenishment program (CRP)

Everyday low price (EDLP)

Everyday low cost (EDLC)

Activity based costing (ABC)

Shortage Gaming

Sharing sales, capacity and inventory data

Allocation based on past sales