Bullwhip effect

The Bullwhip Effect (or Whiplash Effect) is an observed phenomenon in forecast-driven

distribution channels. The concept has its roots in J Forrester's Industrial Dynamics
(1961) and thus it is also known as the Forrester Effect. Since the oscillating demand
magnification upstream a supply chain reminds someone of a cracking whip it became
famous as the Bullwhip Effect.

Causes

Behavioural causes

• misuse of base-stock policies

• misperceptions of feedback and time delays
• panic ordering reactions after unmet demand
• perceived risk of other players' bounded rationality

Operational causes

• dependent demand processing

o Forecast Errors
o adjustment of inventory control parameters with each demand observation
• Lead time Variability (forecast error during replenishment lead time)
• lot-sizing/order synchronization
o consolidation of demands
o transaction motive
o quantity discount
• trade promotion and forward buying
• anticipation of shortages
o allocation rule of suppliers
o shortage gaming
o Lean and JIT style management of inventories and a chase production
strategy

[edit] Consequences

In addition to greater safety stocks, the described effect can lead to either inefficient
production or excessive inventory as the producer needs to fulfil the demand of its
predecessor in the supply chain. This also leads to a low utilization of the distribution
channel. In spite of having safety stocks there is still the hazard of stock-outs which result
in poor customer service. Furthermore, the Bullwhip effect leads to a row of financial
costs. Next to the (financially) hard measurable consequences of poor customer services
and the damage of public image and loyalty an organization has to cope with the
ramifications of failed fulfillment which can lead to contract penalties. Moreover the
hiring and dismissals of employees to manage the demand variability induce further costs
due to training and possible pay-offs.

[edit] Countermeasures

Theoretically the Bullwhip effect does not occur if all orders exactly meet the demand of
each period. This is consistent with findings of supply chain experts who have recognized
that the Bullwhip Effect is a problem in forecast-driven supply chains, and careful
management of the effect is an important goal for Supply Chain Managers. Therefore it is
necessary to extend the visibility of customer demand as far as possible. One way to
achieve this is to establish a demand-driven supply chain which reacts to actual customer
orders. In manufacturing, this concept is called Kanban. This model has been most
successfully implemented in Wal-Mart's distribution system. Individual Wal-Mart stores
transmit point-of-sale (POS) data from the cash register back to corporate headquarters
several times a day. This demand information is used to queue shipments from the Wal-
Mart distribution center to the store and from the supplier to the Wal-Mart distribution
center. The result is near-perfect visibility of customer demand and inventory movement
throughout the supply chain. Better information leads to better inventory positioning and
lower costs throughout the supply chain. Barriers to the implementation of a demand-
driven supply chain include the necessary investment in information technology and the
creation of a corporate culture of flexibility and focus on customer demand. Another
prerequisite is that all members of a supply chain recognize that they can gain more if
they act as a whole which requires trustful collaboration and information sharing.

Methods intended to reduce uncertainty, variability, and lead time:

• Vendor Managed Inventory (VMI)

• Just In Time replenishment (JIT)
• Strategic partnership
• Information sharing
• smooth the flow of products
o coordinate with retailers to spread deliveries evenly
o reduce minimum batch sizes
o smaller and more frequent replenishments
• eliminate pathological incentives
o every day low price policy
o restrict returns and order cancellations
o order allocation based on past sales instead of current size in case of
shortage
Introduction

A SUPPLY CHAIN refers to a network of suppliers, manufacturing, assembly,

distribution, and logistics facilities that perform the functions of procuring of
materials, transformation of these materials into intermediate and finished products,
and the distribution of these products to customers. Supply chains arise in both
manufacturing and service organizations. It is a systems approach to managing the
entire flow of information, materials, and services from raw materials suppliers
through factories and warehouses to the customers.

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 : 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 errors

a) 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 orders

a) 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 variability

i. 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.

The bullwhip effect is mainly caused by three underlying problems: 1) a lack of

information, 2) the structure of the supply chain and 3) a lack of collaboration.

The three causes can be identified in an interactive session with the students by
discussing the beergame experiences and then be corroborated with insights from practice
and the literature.

1) Lack of information

In the beergame no information except for the order amount is perpetuated up the supply
chain. Hence, most information about customer demand is quickly lost upstream in the
supply chain.
With these characteristics the beergame simulates supply chains with low levels of trust,
where only little information is being shared between the parties.

Without actual customer demand data, all forecasting has to rely solely on the incoming
orders at each supply chain stage. In reality, in such a situation traditional forecasting
methods and stock keeping strategies contribute to creating the bullwhip effect.

2) Supply chain structure

The supply chain structure itself contributes to the bullwhip effect. The longer the lead
time, i.e. the longer it takes for an order to travel upstream and the subsequent delivery to
travel downstream, the more aggravated the bullwhip effect is likely to be.

With traditional ordering, the point in time where an order is typically placed (the order
point) is usually calculated by multiplying the forecasted demand with the lead time plus
the safety stock amount, so that an order is placed so far in advance as to ensure service
level during the time until the delivery is expected to arrive.

Hence, the longer the lead time is, the more pronounced an order will be as an reaction to
an increase in forecasted demand (especially in conjunction with updating the safety
stock levels, see above), which again contributes to the bullwhip effect.

3) Local optimisation

Local optimisation, in terms of local forecasting and individual cost optimisation, and a
lack of cooperation are at the heart of the bullwhip problem.

A good example for local optimisation is the batch order phenomenon. In practice,
ordering entails fix cost, e.g. ordering in full truck loads is cheaper then ordering smaller
amounts. Furthermore, many suppliers offer volume discounts when ordering larger
amounts.

Hence, there is a certain incentive for individual players to hold back orders and only
place aggregate orders. This behaviour however aggravates the problem of demand
forecasting, because very little information about actual demand is transported in such
batch orders.

And batch ordering, of course, contributes directly to the bullwhip effect by unnecessarily
inflating the orders.