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-:SUPPLY-CHAIN MODELLING:-

The traditional objective of supply chain management is to minimize total


supply chain cost to meet fixed and given demand. The total cost may be
composed of:
• Raw materials and other acquisition costs.
• Inbound transportation costs.
• Facility investment costs.
• Direct and indirect manufacturing costs.
• Direct and indirect distribution centre cost.
• Inventory holding costs.
• Interfacility transportation costs.
• Outbound transportation costs.

Total supply chain costs minimization may boil down to maximization of


net revenues, which is defined as follows:

Net Revenues = Gross Revenues – Total Cost

Optimization models can be developed which can assist management in


evaluating the trade-offs among objectives. A typical trade-off analysis may
be depicted as below:
Between customers services, measured in days of delivery time, and supply
chain costs.

Our analysis considers the trade-off of supply chain cost versus delivery
times in the range of 1 to 4 days, which are the limits of interest to the
management. The curved line containing point ‘A’ is called the efficient
frontier. Any supply chain strategy on the efficient modeling system by
reversing these disaggregations. The schedules reflect short-term
commitments that the higher-level system teats as fixed and given.

Strategic and Tactical Optimization Modeling System:


The strategic optimization modeling system assists senior management in
determining the most effective long-term configuration of the company’s
supply chain network. Its models analyze decision about major resource
acquisitions and divestments and the manufacture and distribution of new
and existing products over the coming years. The implications of these
decision to next year’s tactical plans are passed to the tactical optimization
modeling system, as depicted in fig. 2.7.
Frontier is undominated in the sense that no achievable strategy exists that is
at least as good as it is with respect to customer service and cost, and strictly
better on one criteria. The efficient frontier can be generated by iteratively
solving an optimization model that minimizes the supply chain costs subject
to constraints on the maximum delivery time. Strategy ‘A’ corresponds to a
least-cost strategy with a maximum delivery time of 2 days.

Suppose that the company currently has a customer service policy


guaranteeing delivery within 3 days and that the current supply chain cost
corresponds to that of strategy B, which is off the efficient frontier. By
using an optimization model, management has the opportunity to identify
and implement strategy B2 on the efficient frontier that lowers cost while
maintaining the same customer service policy. Alternatively, the company
could consider spending the same amount of money on supply chain
management but using it more effectively to improve customer service by
implementing the undominated strategy B1. A third choice would be to
reduce delivery time to 2 days and reduce cost to that of strategy A.

The selection of a specific strategy on the efficient frontier is left to


managerial judgment, perhaps with the assistance of tools that help
individual managers, or, group of managers, assess their preferences. Our
assumption in promoting the use of models is that the company’s supply
chain is not grossly inefficient, and therefore, global analysis is needed to
make improvements. The strategy corresponding to B represents such a
situation in that we assume an optimization model is needed to identify the
superior strategies corresponding to B1, A and B2. by contrast, the strategy
corresponding to C is so distant from the efficient frontier that significant
improvements can be realized by obvious modifications of inefficient supply
chain procedures.

For example, suppose that, due to sloppy management, cross-docking and


dispatching at the company’s distribution centers take much longer than
industry norms. Suppose, further that, tightening these practices will
eliminate the inefficiencies and allow max. Delivery time to be reduced to 4
days at little, or, no increase in cost. Such improvements are clearly
important, but they can be identified without recourse to a supply chain
model.
Overview of Supply Chain Models & Modeling Systems:
The information revolution has accelerated significantly in recent years.
Competitive advantage in supply chain management is not gained simply
through faster and cheaper communication of data. Many managers have
come to realize, ready access to transactional data does not automatically
lead to better decision making. A guiding principle is as follows:

“To effectively apply IT in managing its supply chain, a company must


distinguish between the form and function of Transactional IT and
Analytical IT.”

Manufacturing and distribution companies in a wide range of industries have


begun to appreciate this distinction. As a result, they are seeking to develop,
or, acquire systems that analyze their corporate databases to identify plans
for redesigning their supply chains and operating them more efficiently their
supply chains and operating them more efficiently. Essential components of
these systems are ‘optimization models.’ The application of an optimization
model in a company requires the construction of an optimization modeling
system. A key element in such a system is the supply chain decision
database, which is derived from, but is significantly different from, the
company’s corporate database.

Analytical IT involves the implementation and application of two types of


mathematical models. First, there are descriptive models that modeling
practitioners develop to better understand functional relationships in the
company and the outside world. Descriptive models include the following:
(a) Forecasting models that predict demand for the company’s finished
products, the cost of raw materials or, other factors, based on
historical data.
(b) Cost relationships that describe how direct and indirect costs vary as
functions of cost drivers.
(c) Resource utilization relationships that describes how manufacturing
activities consume scarce resources.
(d) Simulations models that describe how all, or, parts of the company’s
supply chain will operative over time as a function of parameters and
policies.
This list is representative of the wide range of descriptive models that the
modeling practitioner might create to better understand a company’s supply
chain.

Second, there are normative models that modeling practitioners develop to


help managers make better decisions. The term normative refers to
processes for identifying norms that the company should strive to achieve.
Normative models and optimization models are synonyms.

Supply chain managers should realize that the development of accurate


descriptive models is necessary but not sufficient for realizing effective
decision making. For example, accurate demand forecasts must be
combined with data in constructing a global optimization model to
determine which plants should make which products to serve which
distribution centres and markets so that demand is met at the minimal supply
chain cost. Similarly, an accurate management accounting model of
manufacturing process costs in necessary but not sufficient to identify an
optimal production schedule.

SUPPLY CHAIN MODELING INCORPORATES CONCEPTS FROM


SEVERAL MANAGEMENT DISCIPLINES:

Fig.1 Value Chain: Michael Porter.

COMPONETS OF SUPPLY-CHAIN SYSTEM HIERARCHY:


Fig. 2 displays the supply chain system hierarchy comprising six types of
optimization modeling systems and four transactional systems responsible
for intertemporal, functional and geographical integration of supply chain
activities in a manufacturing and distribution company that has multiple
plants and distribution centres. Six, types of optimization modeling systems
are Analytical IT, and the four other systems are Transactional IT. Strictly
speaking, the demand forecasting and order management system is a hybrid
with analytical capabilities for forecasting demand and transactional
capabilities for handling customer orders.

Fig.2 Supply Chain System Hierarchy


There exists and important linkage between external data management
systems maintained by the company’s customers and suppliers and the
company’s enterprise transactional data. Recent advances in e-commerce
offer the promise to streamline and enhance such communication. They also
increase the need for modeling systems, especially to support operational
decision making across multiple firms.

The Supply Chain System Hierarchy in Fig. 2. is hypothetical. No company


has implemented and integrated all nine types of systems, although many
companies have implemented several of them. Moreover, the components
and structure of the hierarchy may appear arbitrary, and this may be
modified for specific applications. The hierarchy represents the most likely
configurations needed to analyze strategic, tactical and operational supply
chain planning problems in a firm that both manufactures and distributes
products.

The transactional and scheduling systems in the system hierarchy represent


the bottom-up thrust in supply chain management. IT developments are the
driving force for innovations in this area, with business process redesign as a
natural consequence. This area is red hot, with annual sales of software in
the hundred of millions of dollars, and it is growing rapidly.

Modeling is essentially an analytical IT system. Distinctions among the


transactional and scheduling systems displayed in Fig.2 have become
blurred. Software companies offering ERP systems have either acquired, or,
entered into alliances with companies offering operational modeling
systems. Similarly, some distribution requirements planning (DRP) systems
include modules for vehicle scheduling and forecasting. For our analysis
and discuss we maintain separation between the form and function of the
modeling and transactional systems.

When seeking to better manage its operations, a company must decide if it


wishes to acquire off-the-shelf systems, or to develop customized systems
implemented by its internal IT staff, or, by outside developers.
Most off-the-shelf scheduling systems to support Materials Requirement
Planning (MRP) and DRP decision making use heuristics less effective
in identifying good operational plans. They rely on graphical user and
the judgement of a human scheduler to extract a good operational plan
from a complex data set.

Strategic Optimisation Modeling Systems in the hierarchy reflect


the top-down thrust in supply chain management.
Starting from the bottom up, the following are synopsis of the
capabilities of each system type:

 (1) ERP System: The ERP System manages the company’s


transactional data on a continuous real- time basis.
This system standardizes the company’s data and
information systems for order entry, financial accounting,
purchasing and many other functions.

 (2) MRP-I (Materials Requirement Planning System): Analysis


with the MRP system begins with a Master Production
Schedule of finished products to meet demand in each period
of a planning horizon. Using a balance on hand of raw
materials, work-in-progress and finished goods, a Bill of
Materials description of the product structures, and machine
production data, this system develops net requirements of raw
materials to be manufactured, or, ordered from vendors.
Products at all stages of manufacturing are analysed by the
MRP system at the SKU level (Standard Keeping
Units).

 (3) DRP (Distribution Requirements System Planning:Analysis


with a DRP system begins with forecasts of finished products to be
transported, a balance on hand of inventories of products, and
inventory management data. DRP system schedules inbound,
inter-facility and outbound shipments through the company’s
logistics network, taking into account transportation factors.
Products throughout the logistics network are analysed by the
DRP system at the SKU level (Standard Keeping Units).
 (4) Demand Forecasting and Order Management System: This
system combines current orders data with historical data to
produce requirements of finished products.

 (5) Production Scheduling Optimisation Modeling Systems: These


are located at each plant in the company’s supply chain that
address operational decisions such as sequencing of orders on a
machine, timing of major and minor changeovers.

 (6) Distribution Scheduling Optimisation Modeling Systems:The


manufacturing and distribution company faces a variety of
vehicle and other scheduling and operational planning problems.
This system helps companies to decide as to which distribution
centre should serve each market based on inventory availability.

 (7) Production Planning Optimisation Modeling Systems: Each


part in the company’s supply chain uses this system to determine
a master production for the next quarter. The model determines
work-in-progress inventories, major machine changeovers and
other decisions.

 (8) Logistics Optimisation Modeling System: This determines a


logistics master plan that analyses how demand in markets will be
met over the next quarter. Its goal is to minimize avoidable
transportation, handling, warehousing, and inventory costs across
the entire logistics network.

 (9) Tactical Optimisation Modeling System: This integrates


supply / manufacturing / distribution / inventory plan for the next
12 months. It minimizes total cost of fixed demand, and,
minimizes net revenues if the product mix varies.
 (10) Strategic Optimisation Modeling System:
This system analyses resource acquisition and other strategic
decisions such as the construction of a new manufacturing facility,
the break-even price for an acquisition, or, the design of a supply
chain for a new product.

 Frequency of Analysis, Cycle Times, and Run Times of Supply Chain


Systems:

Table 2.1 reviews several timing features of each system:

 Communication among Supply Chain Systems of Data and Decisions:

In effecting the interactions, decisions determined by the


modeling systems become input data to other systems with which they
communicate.

 ERP, MRP, DRP, and Forecasting and Order Management Systems:


(1, 2, 3 & 4 in Fig.2)

Fig.2.3 below depicts interaction among the ERP, MRP, DRP and
Forecasting and Order Management Systems.

 The MRP (Materials Requirement Planning) and DRP systems


that are one level up from the ERP system develop and
disseminate detailed production & distribution schedules. A
separate MRP system is employed in each plant, whereas the DRP
system addresses distribution operations across the entire
company. The typical planning horizon for these schedules is 7 to
28 days.

 The ERP system provides the MRP and DRP systems with
detailed data about costs, capacities and equipment. It also passes
data about orders to the forecasting and order management
system, which in turn passes orders and forecasts to the MRP and
DRP systems.
 MRP and Production Scheduling Optimisation Modeling system:
In using the MRP system without the production scheduling
optimisation modeling system, production managers can only muddle
through the scheduling process by using trial-and-error methods. For
this reason, the company needs a modeling system that employs
optimisation on models and methods to determine an effective
production schedule over a 13-Week planning horizon, with particular
attention paid to the next 4 weeks, which span the 28-Day horizon of the
MRP system.

 As shown in Fig2.4, the optimisation model determines production


setups, production runs, discretionary resource levels, work-in-process,
and finished goods inventories to minimize avoidable costs associated
with attempting to meet customer orders.

 The links between the production scheduling optimisation


modeling system and the MRP system involves aggregation when data
are fed upward from the MRP system to the modeling system and
disaggregation when data are fed downward. Upward aggregation
entails detailed time-dependent data, such as scheduled maintenance,
or, machine changeovers, into aggregate time-dependent data, such as
the week in which these events will take place. Downward
disaggregation entails translation of production schedules and
inventories of products families into details regarding individual
products.

 These systems analyse decisions across the company’s entire


logistics network, which might include several plants and
distribution centers and several hundred markets.

 Without such a system, distribution managers using the DRP


system must muddle through the short-term scheduling of
transportation movements and the operations of distribution
centers to support them.
 The logistics optimization modeling system determines a master
transportation schedule that includes inbound shipments of raw
materials and parts to the plants, interplant shipments of
intermediate and finished products, shipments of finished
products to distribution centres, and outbound shipments to the
markets of finished products. This system also makes modal
choices for large shipments based on timing considerations.

 Production Scheduling, Logistics and Tactical Optimisation Modeling


Systems:

The tactical optimisation modeling system is the lowest-level


system in the hierarchy that analyses decisions across the company’s
entire supply chain. As shown in Fig.2.6, it passes aggregate details
about the optimal supply chain plan for each of the 3 months of the
immediate quarter to the production scheduling optimisation modeling
systems, one in each plant, and to the logistics optimization modeling
system.

 The details of this plan are disaggregated. Disaggregation may


entail refinement of product families and the timing of resource
planning decisions. Schedules developed by the lower-level systems are
fed back to the tactical optimization supply chain modeling system by
reversing these disaggregations.

 Strategic and Tactical Optimisation Modeling System:


The strategic optimisation modeling system assists senior
management in determining the most effective long-term configuration
of the company’s supply chain network. The implications of these
decisions to next year’s tactical plans are passed to the tactical
optimisation modeling system, as depicted in Fig.2.7.

 The tactical optimization modeling system provides detailed


feedback to the strategic system about how these facilities will be used
and how market demand will be met over the first year of a strategic
planning horizon.
 The demand forecasting and order management system provides
medium- and long-term demand forecasts. Conversely, the strategic
optimization modeling system provides the demand forecasting system
with feedback about the profitability of existing and new product line.

 Balancing Centralised and Decentralised Decision Making:


An important underlying purpose of the system hierarchy is to
resolve management to make supply chain decisions in both a
centralised and decentralised manner. Centralised decision-making is
needed for rapid, detailed execution of operations. Decentralised
decision-making is need for rapid, detailed execution of operations.

MANUFACTURING COST:
The bullwhip effect increases manufacturing cost in the supply chain. As a
result of the bullwhip effect, P&G and its suppliers try to satisfy a stream of
orders that is much more variable than customer demand. P&G can respond
to the increased variability by either building excess capacity, or, holding
excess inventory, both of which increase the manufacturing cost per unit
produced.

INVETORY COST:
The bullwhip effect increases inventory cost in the supply chain. To handle
the increase in demand, P&G has to carry a higher level of inventory than
would be required in the absence of the bullwhip effect. As a result,
inventory costs in the supply chain increases. The high levels of inventory
also increase the warehousing space required and thus the warehousing cost
incurred.
REPLENISHMENT LEAD TIME:
The bullwhip effect increases replenishment lead times in the supply chain.
The increased variability as a result of the bullwhip effect makes scheduling
at P&G and supplier plants much more difficult compared with a situation
with level demand. There are times when the available capacity and
inventory cannot supply the orders coming in. This results in higher
replenishment lead times within the supply chain from both P&G and its
suppliers.

TRANSPORTATION COST:
The bullwhip effect increases transportation cost within the supply chain.
The transportation requirements over time at P&G and its suppliers are
correlated with the orders being filled. As a result of the bullwhip effect,
transportation requirements will also fluctuate significantly over time. This
has the impact of raising transportation cost because surplus transportation
capacity needs to be maintained to cover high demand periods.

LABOUR COST FOR SHIPPING AND RECEIVING:


The bullwhip effect increases labour costs associated with shipping and
receiving in the supply chain. Labour requirements for shipping at P&G and
its suppliers will fluctuate with orders. A similar fluctuation will occur for
the labour requirements for receiving at distributors and retailers. The
various stages have the option of carrying excess labour capacity, or, varying
labour capacity in response to the fluctuations in orders. Either option
increases total labour cost.

LEVEL OF PRODUCT AVAILABILITY:


The bullwhip effect hurts the level of product availability and results in more
stock outs within the supply chain. The large fluctuations in orders make it
less likely that P&G will be able to supply all distributor and retailer orders
on time. This increases the likelihood that retailers will run out of stock,
resulting in lost sales for the supply chain.
RELATIONSHIP ACROSS THE SUPPLY CHAIN:
The bullwhip effect negatively affects performance at every stage and thus
hurts the relationships between different stages of the supply chain. There is
a tendency to assign blame to other stages of the supply chain because
people involved at each stage feel they are doing the best they can. The
bullwhip effect thus leads to a loss of trust between different stages of the
supply chain and make any potential coordination efforts more difficult.

Fig. IMPACT OF BULLWHIP EFFECT ON SUPPLY CHAIN


PERFORMANCE:

Performance Measure Impact On Bullwhip Effect


Manufacturing Cost: Increases.
Inventory Cost: Increases.
Replenishment Lead Time: Increases.
Transportation Cost: Increases.
Shipping and Receiving Cost: Increases.
Level of Productivity: Decreases.
Profitability: Decreases.

Key point: The bullwhip effect reduces the profitability of a supply chain
by making it more expensive to provide a given level of product availability.

OBSTACLES TO COORDINATION IN A SUPPLY CHAIN:


Any factor that leads to either local optimization by different stages of the
supply chain, or, an increase in information distortion and variability within
the supply chain is an obstacle to coordination. If managers in a supply
chain are able to identify the key obstacles, they can then take suitable
actions that help, achieve coordination. We divide the manor obstacles into
five categories:
(a) Incentive Obstacles.
(b) Information Processing Obstacles.
(c) Operational Obstacles.
(d) Pricing Obstacles.
(e) Behavioural Obstacles.
(a) INCENTIVE OBSTACLES: Incentive obstacles refer to situations in
which incentives offered to different stages, or, participants in a
supply chain lead to actions that increase variability and reduce total
supply chain profits.
(a1) Local Optimization Within Functions, or, Stages of a Supply
Chain:
Incentives that focus only on the local impact of an action result in
decisions that do not maximize total supply chain profits. For
example, if a transportation manager’s compensation is linked to the
average transportation cost per unit, she is likely to take actions that
lower transportation costs even if they increase inventory costs, or,
hurt customer service. It is natural for any participant in the supply
chain to take actions that optimize performance measures along which
he, or, she is evaluated. For example, managers at a retailer such as
K-Mart make all their purchasing and inventory decisions to
maximize K-Mart profits, not total supply chain profits.

Evaluating a function in the supply chain based only on that function


costs also leads to actions that reduce supply chain profits. For
example, transportation policies that minimize transportation costs
rarely minimize total cost in the supply chain, or, even in the
company.

(a2) Sales Force Incentives:


Improperly structured sales force incentives are a significant obstacle
to coordination in the supply chain. In many companies, sales force
incentives are based on the amount of sale a salesman makes during
an evaluation period, viz, a month, or, a quarter. The sales typically
measured by a manufacturer are the quantity sold to distributors, or,
retailers (sell-in), not the quantity sold to final customers (sell-
through). Measuring performance based on sell-in is often justified
on the grounds that the manufacturer’s sales force does not control
sellthrough.
For example, ‘Barilla’ offered its sales force incentives based on the
quantity sold to distributors during a four-to-six week promotion
period. To maximize their bonuses, the Barilla sales force urged
distributors to buy more pasta toward the end of the evaluation period,
even if distributors were not selling as much to retailers. The sales
force offered discounts they controlled to spur end-of-period sales.
This increased variability in the order pattern with a jump in orders
towards the end of the evaluation period followed by very few orders
at the beginning of the next evaluation period. Order sizes from
distributors to Barilla fluctuated by a factor of upto 70 from one week
to the next. A sales force incentive based on sell-in thus results in
order variability being larger than customer demand variability.

(b) INFORMATION PROCESSING OBSTACLES: Information


processing obstacles refer to situations in which demand information
is distorted as it moves between different stages of the supply chain,
leading to increased variability in orders within the supply chain.

(b1) Forecasting Based on Orders, Not Customer Demand:


When forecasts are based on orders received, any variability in
customer demand is magnified as orders move up the supply chain to
manufacturers and suppliers. In supply chains that exhibit the
bullwhip effect, the fundamental means of communication between
different stages are the orders that are paced. Each stage views its
primary role within the supply chain as one of filling orders placed by
its downstream partner. Thus, each stage views its demand to be the
stream of orders received and produces a forecast based or this
information.

In such a scenario, a small change in customer demand becomes


magnified as it moves up the supply chain in the form of customer
orders. Consider the impact of a random increase in customer demand
at the retailer. The retailer may interpret part of this random increase
to be a growth trend. This interpretation will lead the retailer to order
more than the observed increase in demand because the retailer
expects growth to continue into the future and thus orders to cover for
future anticipated growth. The increase in the order placed with the
wholesaler is thus larger than the observed increase in demand at the
retailer. Part of the increase is a one-time increase. The wholesaler,
however, has no way to interpret the order increase correctly. The
wholesaler simply observes a jump in the order size and infers a
growth trend. The growth trend inferred by the wholesaler will be
larger than that inferred by the wholesaler will be larger than that
inferred by the retailer. (Recall that the retailer had increased the
order size to account for future growth). The wholesaler will thus
place an even larger order with the manufacturer. As we go further up
the supply chain, the order size will be magnified.

Now assume that periods of random increase are followed by periods


of random decrease in demand. Using the same forecasting logic just
described, the retailer will now anticipate a declining trend and reduce
order size. This reduction will also become magnified as we move up
the supply chain.

Key Point: The fact that each stage in a supply chain forecasts
demand based on the stream of orders received from the downstream
stage results in a magnification of fluctuations in demand as we move
up the supply chain from the retailer to the manufacturer.

(b1) Lack of information sharing:


The lack of information sharing between stages of the supply chain
magnifies the bullwhip effect. For example, a retailer such as Wal-
Mart may increase the size of a particular order because of a planned
promotion. If the manufacturer is not aware of the planned
promotion, it may interpret the larger order as a permanent increase in
demand and place orders with suppliers accordingly. The
manufacturer and suppliers thus have a lot of inventory right after
Wal-Mart orders return to normal, manufacturer orders will be smaller
than before. The lack of information sharing between the retailer and
manufacturer thus leads to large fluctuation in orders placed by the
manufacturer.

(c) OPERATIONAL OBSTACLES:


Operational obstacles refer to actions taken in the course of placing
and filling orders that lead to an increase in variability.
(c1) Ordering in Large Lots: When a firm places orders in lot sizes
that are much larger than the lot sizes in which demand arises,
variability of orders in magnified up the supply chain. Firms may
order in large lots because there is a significant fixed cost associated
with placing, receiving, or, transporting an order, or, because the
supplier offers quantity discounts based on lot sizes. Ordering in large
lots results in an order stream that in far more erratic than the demand
stream. Fig 2.10 shows both the demand and the order stream for a
firm placing an order every five weeks.
Fig 2.10: Demand and Order Stream With Orders Every Five Weeks.

Because orders are batched and placed every five weeks, the order
stream has four weeks without orders followed by a large order that
equals five weeks of demand. A manufacturer supplying several
retailers who batch their orders will face an order stream that is much
more variable than the demand the retailers experience. If the
manufacturer further batches their orders to suppliers, the effect is
further magnified. In many instances there are certain focal point
periods like the first, or, last week of a month when a majority of the
orders arrive. This concentration of orders further exacerbates the
impact of batching.

(c2) Large Replenishment Lead Times:


The bullwhip effect is magnified if replenishment lead times between
stages are long. Consider a situation in which a retailer has
misinterpreted a random increase in demand as a growth demand. If
the retailer faces a lead time of two weeks, it will incorporate the
anticipated growth over two weeks when placing the order. If, in
contrast, the retailer faces a lead time of two months, it will
incorporate into its order anticipated growth over two months (which
will be much larger). The same applies when a random decrease in
demand is interpreted as a declining trend.

(c3) Rationing and Shortage Gaming:


Rationing schemes that allocate limited production in proportion to
the orders placed by retailers lead to a magnification of the bullwhip
effect. A situation in which a high-demand product is in short supply
often arises within the supply chain. HP, for example, has faced
several situations in which its newest product has demand that for
exceeds supply. In such a situation, manufacturers come up with a
variety of mechanism to ration the scarce supply of product among
various distributions, or, retailers. One commonly used rationing
scheme is to allocate the available supply of product based on orders
placed. Under this rationing scheme, if the supply available is 75% of
the total orders received, each retailer receives 75% of its order.

This rationing scheme results in a game in which retailers try to


increase the size of their orders to increase the amount supplied to
them. A retailer needing 75 units will order 100 units in the hope that
75 will then be made available. The net impact of this rationing
scheme is to inflate orders for the product artificially. What is worse,
a retailer ordering based on what it expects to sell will get less and, as
a result, lose sales, whereas a retailer inflating its order is rewarded.

If the manufacturer is using orders to forecast future demand, it will


interpret the increase in orders as an increase in demand, even though
customer demand is unchanged. The manufacturer may respond by
building enough capacity to be able to fill all orders received. Once
sufficient capacity becomes available, orders return to their normal
level because they were inflated in response to the rationing scheme.
The manufacturer is now left with a surplus of product and capacity.
These boom and burst cycles then tend to alternate.

This phenomenon is fairly common in the computer industry, in


which alternating periods of component shortages followed by a
components surplus are often observed. In particular, memory chip
manufacturing has experienced several such cycles during the 1990s.

(d) PRICING OBSTACLES: Pricing obstacles refer to situations in


which the pricing policies for a product lead to an increase in
variability of orders placed.

(d1) Lot Size Based Quantity Discounts: Lot size-based quantity


discounts increase the lot size of orders placed within the supply
chain.
(d2) Price Fluctuations: Trade promotions and other short-term
discounts offered by a manufacturer result in forward buying, in
which a wholesaler, or, retailer purchases large lots during the
discounting period to cover demand during future periods. Forward
buying results in large orders during the promotion period followed by
very small orders after that, as shown in the figure given below:

Fig: Retailer Sales & Manufacturer’s Shipments for a FMCG


Product:

(e) Behavioural Obstacles: Behavioural obstacles refer to problems in to


the bullwhip effect. These problems are often related to the way the
supply chain is structured and the communication between different
stages. Some of the behavioural obstacles follow:

(1) Each stage of the supply chain views its actions locally and
is unable to see the impact of its actions on other stages.
(2) Different stages of the supply chain react to the current local
situation rather than identify the root causes.
(3) Based on local analysis, different stages of the supply chain
blame each other for the fluctuations, with successive stages
in the supply chain becoming enemies rather than partners.
(4) No stage of the supply chain learns from its actions over
time because the most significant consequences of the
actions any one stage takes occur elsewhere.
(5) A lack of trust between supply chain partners causes them to
be opportunistic at the expense of overall supply chain
performance.

MANAGERIAL LEVERS TO ACHIEVE COORDINATION:


The following managerial actions in the supply chain increase total
supply chain profits and moderate the bullwhip effect:
(a1) Aligning goals and incentives.
(b1) Improving information accuracy.
(c1) Improving operational performance.
(d1) Designing pricing strategies to stabilize orders.
(e1) Building partnership and trust.
(a1) ALIGNING GOALS AND INCENTIVES:
Managers can improve coordination within the supply chain by
aligning goals and incentives such that every participant in supply
chain activities works to maximize total supply chain profits.

(a1.0) ALIGNING INCENTIVES ACROSS FUNCTIONS:


One key to coordinated decisions within a firm is to ensure that the
objective any function uses to evaluate a decision is aligned with the
firm’s overall objective. All facility, transportation, information, and
inventory decisions should be evaluated based on their impact on
profitability, not total costs, or, even worse, just local costs. This
helps avoid situations such as a transportation manager making
decisions that lower transportation cost but increase overall supply
chain costs.

(a1.1) PRICING FOR CORDINATION:


A manager can use lot size-based quantity discounts to achieve
coordination for commodity products if both the retailer and the
manager have large fixed costs associated with each lot. For products
for which a firm has market power, a manager can use two-part tariffs
and volume discounts to help achieve coordination. Given demand
uncertainty, manufacturers can use buyback contracts and quantity
flexibility contracts to spur retailers to provide levels of product
availability that maximize supply chain profits.

(a1.2) ALTERING SALES FORCE INCENTIVES FROM SEELL-


IN TO SELL-THROUGH: Any change that reduces the incentive for
a salesperson to push product to the retailer will reduce the bull-whip
effect. If sales force incentives are based on sales over a rolling
horizon, the incentive to push product is reduced. This helps reduce
forward buying and the resulting fluctuations in orders. Another
action that managers can take is to link incentives for the sales staff to
sell-through by the retailer rather than sell-in to the retailer. This
action eliminates any motivation that sales staff may have to
encourage forward buying. The elimination of forward buying helps
reduce fluctuations in the order stream.
(b1) IMPROVING INFORMATION ACCURACY:
Managers can achieve coordination by improving the accuracy of
information available to different stages in the supply chain.

(b1.1) SHARING POINT-OF-SALE DATA:


Sharing point-of-sale (POS) data across the supply chain can help
reduce the bull-whip effect. A primary cause for the bull-whip effect
is the fact that each stage of the supply chain uses orders to forecast
future demand. Given that orders received by different stages vary,
forecasts at different stages also vary. In reality, the only demand that
the supply chain needs to satisfy is from the final customer. Sharing
POS data helps reduce the bull-whip effect because all stages now
respond to the same change in customer demand.

Dell shares demand data as well as current inventory positions of


components with many of its suppliers on the internet, thereby helping
to avoid unnecessary fluctuations in supply and orders placed. Given
that orders received by different stages vary, forecasts at different
stages also vary. In reality, the only demand that the supply chain
needs to satisfy is from the final customer. Sharing POS data helps
reduce the bull-whip effect because all stages now respond to the
same change in customer demand.

Dell shares demand data as well as current inventory positions of


components with many of its suppliers on the internet, thereby helping
to avoid unnecessary fluctuations in supply and orders placed.

(b1.2) IMPLEMENTING COLLABORATIVE FORECASTING


AND PLANNING: Once POS data does not guarantee coordination
is to be achieved. Without collaborative planning, sharing POS data
does not guarantee coordination. A retailer may have observed large
demand in the month of January because it ran a promotion. If no
promotion is planned in the following January, the retailer’s forecast
will differ from the manufacturer’s forecast even if both have past
POS data. The manufacturer must be aware of the retailer’s
promotion plans to achieve coordination. The key is to ensure that the
entire supply chain is operating to a common forecast.
(b1.3) DESIGNING SINGLE STAGE CONTROL OF
REPLENISHMENT:
Designing a supply chain in which a single stage controls
replenishment decisions for the entire supply chain can help diminish
the bull-whip effect. As mentioned earlier, a key cause for the bull-
whip effect is the fact that each stage of the supply chain uses orders
from the previous stage as its historical demand. As a result, each
stage views its role as one of replenishing order5s placed by the next
stage.

When sales occur directly from manufacturer to customers, like Dell,


single control of replenishment is automatic as there is no
intermediary. When sales occur through retailers, there are several
industry practices that result in single point control of replenishment.
In continuous replenishment programs (CRP), the wholesaler, or,
manufacturer replenishes a retailer regularly based on POS data.

In vendor-managed inventories (VMI), the distributor, or,


manufacturer monitors and manages at the wholesaler, or, retailer.
This centralizes the replenishment decision for all retailers at the
upstream distributor, or, manufacturer. This practice existed in
retailing before the growth of enabling technologies. K-mart has seen
inventory turns on seasonal items increase from 3 to between 9 and
11, and for nonseasonal items for 12-15 to 17-20. Fred Meyer has
seen inventories reduce by 30% to 40% and fill rates increase to 98%.

In each of the instances cited here, the single forecast and control of
replenishment by a single stage are what help eliminate the increased
fluctuations because of the bull-whip effect.

(C1) IMPROVING OPERATIONAL PERFORMANCE:


Managers can help dampen the bull-whip effect by improving
operational performance and designing appropriate product rationing
schemes in case of shortages.
(C1.1) REDUCTING REPLENISHMENT LEAD TIME:
By reducing the replenishment lead time, managers can decrease the
uncertainty of demand during the lead time. A reduction in lead time
is especially beneficial for several items, because it allows for
multiple orders to be placed in the season with a significant increase
in the accuracy of the forecast:-
QR(Quick Response): QR can be in the supply chain implemented
through EDI establishing real-time connectivity across the supply
chain and ASN (Advanced Shipment Notices). ASN can be used to
reduce the lead time as well as effort associated with receiving. Cross
docking can be used to reduce the lead time associated with moving
the product between stages in the supply chain. Wal-mart has
successfully used many of these approaches to significantly reduce
lead time within its supply chain.

(C1.2) REDUCING LOT SIZES: Managers can dampen the bull-


whip effect by implementing operational improvements that reduce lot
sizes. Reducing lot sizes decrease the amount of fluctuation that can
accumulate between any pair of stages of a supply chain, thus
decreasing the bull-whip effect – establishing CR (continuous
replenishment) will automatically reduce lot sizes.

(C1.3) RATIONING BASED ON PAST SALES AND SHARING


INFORMATION TO LIMIT GAMING: To diminish the bull-whip
effect, managers can design rationing schemes that discourage
retailers from artificially inflating their orders in case of a shortage.
One approach, referred to as turn and earn, is to allocate the available
supply based on past retailer sales rather than current retailer orders.
HP have historically allocated based on retailer orders but are now
switching to past sales.

(d1) DESIGNING PRICING STRATEGIES TO STABILIZE


ORDERS:
Managers can diminish the bull-whip effect by devising pricing
strategies that encourage retailers to order in smaller lots and reduce
forward buying.
(d1.1) MOVING FROM LOT SIZE-BASED TO VOLUME-BASED
QUANTITY DISCOUNTS: As a result of lot-size-based quantity
discounts, retailers increase their lot size to take full advantage of the
discount. Offering volume-based quantity discounts eliminates the
incentives to increase the size of a single lot because volume based
discounts consider the total purchases during a specific period (say a
year) rather than purchases in a single lot. Offering discounts over a
rolling time horizon helps dampen this effect. HP is experimenting
with a move away from lot-size-based discounts to volume-based
discounts.

(d1.2) STABILIZING PRICING:


Managers can dampen the bull-whip effect by eliminating promotions
and charging an every day low pricing (EDLP). The elimination of
promotions removes forward buying by retailers and results in orders
that match customer demand.

Managers can place limits on the quantity that may be purchased


during a promotion to decrease forward buying. This limit should be
retailer specific and linked to historical sales by the retailer.

BUILDING STRATEGIC PARTNERSHIP AND TRUST:


Managers find it easier to use the levers discussed above to diminish
the bull-whip effect and are built within the supply chain.

Managerial levers that help a supply chain achieve better coordination


fall into two broad categories: Action-Oriented Levers include
information sharing, changing of incentives, operational
improvements, and stabilizing of pricing, and relationship-oriented
levers involve the building of cooperation and trust within the supply
chain.