Supply Chain Management

Chapter 5

The Value of Information

Professor Ayman Abdallah

4-1
 5.1 Introduction
 This chapter deals with the availability of
information throughout the supply chain
and how this information can enhance
supply chain integration

 Implications this availability on effective

design and management of the integrated
supply chain

5-2
 Information Types
Shared information among supply chain
partners may include:

 Inventory levels
 Orders
 Production
 Delivery status

5-3
 Value of more Information
Some advantages of information sharing with
supply chain members:

 Helps reduce variability in the supply chain.

 Helps suppliers make better forecasts,
accounting for promotions and market changes.
 Enables the coordination of manufacturing and
distribution systems and strategies.
 Enables retailers to better serve their customers
by offering tools for locating desired items.
 Enables retailers to react and adapt to supply
problems more rapidly.
 Enables lead time reductions.
5-4
 Potential obstacles to
information sharing

 Some SC partners may not agree to share

information

 Some SC partners may inflate their orders

 Some SC partners may abuse the information

shared

5-5
 5.2 Bullwhip Effect
 Bullwhip effect: Fluctuations in orders increase
as they move up the SC from retailers to
wholesalers to manufacturers to suppliers.
 While customer demand for specific products
does not vary much
 Inventory and back-order levels fluctuate
considerably across their supply chain

5-6
 5.2 Bullwhip Effect
 To explain the bullwhip effect:
Almost always there is a variability in customer demand (for
example: one week the demand is 200 units, next week: 240;
third week: 140; fourth week: 210, and so on). This variability in
customer demand is seen only by the retailer. So, based on the
current customer demand, the retailer will submit an order to the
wholesaler. The wholesaler, who sees only the retailer’s order
and does not know any thing about actual customer demand,
will submit an order to the distributor and he (the wholesaler) will
increase his safety stock to be responsive. The distributor, who
sees only the wholesaler’s order (does not know anything about
actual customer demand), will submit an order to the
manufacturer, and he will also order more quantity to enhance
his safety stock (more quantity than that in the wholesaler’s
order).
5-7
 5.2 Bullwhip Effect
 To explain the bullwhip effect:
The manufacturer (who sees only the order received from the
distributor) thinks that the distributor’s order reflects the actual
customer demand, and he will submit an order to the supplier to
produce more quantity than he received from the distributor (to
have safety stock and to be responsive).

 The main reason for this effect is lack of information sharing

among supply chain members.

 The ideal situation: actual customer demand is seen by all

supply chain members

5-8
Effect of Order Variability

FIGURE 5-6: The bullwhip effect

5-9
Factors that Contribute to the Variability (to the
bullwhip effect)
1. Demand Forecasting
 Different demand techniques used by
deferent parties
 Certain percentage is often added to the
estimated demand
 Safety stock is estimated differently at
each stage
 Forecasting is based on past data

5-10
 Factors that Contribute to the Variability (to
the bullwhip effect)
2. Lead Time

 Longer lead time results in more variability

as customers tend to increase their safety
stock combined with increased uncertainty

5-11
Factors that Contribute to the Variability (to the
bullwhip effect)
3. Batch Ordering
 Some SC parties apply economic order quantity
(EOQ) to reduce inventory cost
 Some SC parties take advantage of transportation
discounts and quantity discounts (so they order
more than needed)
 Batch ordering (ordering more than needed to get a
discount or reduce transportation cost) does not
reflect the actual demand from the customers, so
the upstream party will receive large orders in some
weeks, and no orders in other weeks. [Note: the
upstream party for the retailer is the wholesaler. For
the wholesaler is the distributor. For the distributor is
the manufacturer].
5-12
Factors that Contribute to the Variability (to the
bullwhip effect)
4. Price Fluctuations

 When prices are low: the retailer tends to

purchase more than needed to stock up
 When prices are high: low quantities are
ordered.
 Forward buying: retailers purchase large
quantities during distributor’s and
manufacturer’s discount and promotion
time, and order relatively small quantities
at other time periods
5-13
Factors that Contribute to the Variability (to the
bullwhip effect)
5. Inflated Orders
 Inflated orders (ordering more, or much
more, than needed) happen during
shortage periods when some SC parties
suspect that a product will be in short
supply
 When shortage period is over, they go
back to standard orders, causing
variations in demand estimates

5-14
Impact of Centralized Information on
Bullwhip Effect
 Centralized information (or centralized supply chain):
all supply chain parties receive complete information
on the actual customer demand. This means full
information sharing
 In this case, all supply chain parties will share and
use the same:
 Demand information
 Forecasting techniques
 Inventory policy
 Centralized demand information can significantly
reduce the bullwhip effect, but will not completely
eliminate it.
5-15
Impact of Centralized Information on
Bullwhip Effect
 Decentralized supply chain: Supply chain parties do
not receive complete information on the actual
customer demand. Each party estimates the
demand based on the orders received from the
previous party (not based on actual customer
demand). This means no information sharing

 Decentralized supply chain will cause the bullwhip

effect

5-16
Methods for Coping with the Bullwhip
Effect
1. Reducing uncertainty: By centralizing
demand information
 Use the same demand data
 Use the same forecasting methods
 Use the same ordering policy and buying
practices

5-17
Methods for Coping with the Bullwhip
Effect
2. Reducing variability.

 Reducing variability in the customer demand

 This can be done by avoiding promotions

which result in dramatic shifts in demand.
Retailer may use every day low prices (EDLP)
strategy to ensure that product price will be
consistent (stable).

5-18
Methods for Coping with the Bullwhip
Effect

3. Lead-time reduction
 High lead times lead to increased variability
(bullwhip effect)
 Two types of lead times that can be reduced:
 order lead times : The time it takes to produce and
ship the item
 Information lead times: time it takes to process an
order. [can be reduced through the use of
electronic data interchange (EDI).]

5-19
Methods for Coping with the Bullwhip
Effect
4. Strategic partnerships
 Changing the way information is shared and
inventory is managed
 Cooperation, coordination, and trust will
enable strategic partnership
 Strategic partnership will enhance information
sharing
 Example: Vendor managed inventory (VMI)
 Manufacturer manages the inventory of its product
at the retailer store. In this case, the manufacturer
does not rely on the orders placed by a retailer,
thus avoiding the bullwhip effect entirely. 5-20
 5.3 Information Sharing And Incentives
 Centralizing information will reduce variability
 Upstream stages would benefit more
 Unfortunately, information sharing is a problem in
many industries
 Inflated forecasts are a reality
 Similar situation to asymmetric information may arise
(suppliers take the whole risk)
 Risk sharing may be required to encourage the
information sharing
 Two supply contracts (were discussed in chapter 4)
enable the risk sharing: Capacity Reservation Contract
and Advance Purchase Contract
5-21
Contractual Incentives to Get True
Forecasts from Buyers
 Capacity Reservation Contract
 Buyer pays to reserve a certain level of capacity at
the supplier
 A menu of prices for different capacity reservations
provided by supplier
 Buyer signals true forecast by reserving a specific
capacity level
 Advance Purchase Contract
 Supplier charges special price before building
capacity
 When demand is realized, price charged is different
 Buyer’s commitment to paying the special price
reveals the buyer’s true forecast

5-22
 5.7 Lead-Time Reduction
 Many firms actively look for suppliers with shorter
lead times
 Many potential customers consider lead time a very
important criterion for vendor selection.
 Much of the manufacturing revolution of the past 20
years led to reduced lead times

Benefits of lead time reduction:

1. The ability to quickly fill customer orders that
can’t be filled from stock.
2. Reduction in the bullwhip effect.
3. More accurate forecasts due to a decreased
forecast horizon.
4. Reduction in finished goods inventory levels
5-23