The Bullwhip Effect

P&G
Procter & Gamble (P&G) examined order patterns
for Pampers.
Its sales at retail stores were fluctuating, but the variability
was not excessive.
For the distributors' orders, P&G was surprised by the
greater degree of variability.
When they looked at P&G's orders of materials to their
suppliers, such as 3M, the swings were even greater.
While babies consumed diapers at a steady rate, the
demand order variability in the supply chain was
amplified as we move up the supply chain. P&G
called this phenomenon the "bullwhip" effect.

Bullwhip
As we move further away from the
end-customer in the supply chain,
1. Distortion in demand information,
2. Increase in variance of orders
Information Coordination: The
Bullwhip Effect
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Causes of the Bullwhip
Effect
Best illustration of the bullwhip effect is "beer game."
Participants play the roles of customers, retailers, wholesalers,
and suppliers of a popular brand of beer.
They cannot communicate with each other and must make
order decisions based only on orders from the next downstream
player.
The ordering patterns share a common, recurring theme: the
variability of an upstream site is always greater than
those of the downstream site, a simple, yet powerful
illustration of the bullwhip effect.
the bullwhip effect is a consequence of the players' rational
behavior within the supply chains infrastructure.
Customer
Retailer
Manufact.
Supplier
Distributor
So What?
When a supply chain is plagued with a
bullwhip effect and demand information
is distorted,
It results in
excessive inventory
poor product forecasts
insufficient or excessive capacities
poor customer service
Uncertain and costly production
high costs for corrections (expedited shipments
and overtime)
General Techniques for Over-
coming the Bullwhip Effect
Electronic linkages
Information sharing
Better forecasts
Real-time updates
Lower costs of procurement
More frequent deliveries
Use of cheap electronic procurement
Consolidation of loads through 3rd party logistics
Stable prices
Eg, Everyday Low Pricing (EDLP)
Four major causes of the
bullwhip effect:
1. Demand forecast updating
2. Order batching
3. Price fluctuation
4. Rationing and shortage
gaming

1. Demand Forecast
Updating
Companies in a supply chain usually do their own
product forecasting
Forecasting is often based on the order history from
the company's immediate customers.
When a downstream operation places an order,
the upstream manager processes that information as a
signal about future product demand.
readjusts his/her demand forecasts and, in turn,
the orders with the upstream suppliers
The order sent to the supplier reflects
the amount needed to replenish the stocks to
meet the requirements of future demands,
as well as the necessary safety stocks.
With long lead times, it is not uncommon to have
weeks of safety stocks.
The result is that the fluctuations in the order
quantities to suppliers over time can be much greater
than the fluctuations in the demand data
2. Order Batching
In a supply chain, each company places
orders with an upstream organization using
some inventory monitoring or control.
Demands come in, depleting inventory, but the
company may not immediately place an
order with its supplier.
It often batches or accumulates demands before
issuing an order.
There are two forms of order batching:
economies of ordering and transport
push ordering
High Cost of Order Processing
Companies may order weekly, biweekly,
or even monthly.
the time and cost of processing an
order. P&G estimates customer ordering
to cost $35 - $75 to process.
Many manufacturers place purchase orders
with suppliers when they run their material
requirements planning (MRP) systems.
MRP systems are often run monthly.
slow-moving items may be ordered infrequently
Economics of Transportation
There are substantial differences
between full truckload (FTL) and
less-than-truckload (LTL) rates,
strong incentive to fill a truckload
when ordering from a supplier.
Full truckload could be a month or
more product

Salespeople are measured
quarterly or annually
Sales people fill sales quotas by
"borrowing" ahead.
Sign orders prematurely
company experiences regular surges in
demand.
orders "pushed" on it from customers
3. Price Fluctuation
forward buy constituted 80
percent of transactions between
manufacturers and distributors in
the grocery industry
due to attractive price.
Resulted in $75 billion to $100 billion
of inventory
Promotions
Manufacturers and distributors periodically
have special promotions and trade deals like
price discounts, quantity discounts, coupons,
rebates, etc.
The result is that customers buy in bigger
quantities that do not reflect their
immediate needs and stock up for the
future.
Results of Promotions
Factories run overtime at certain times and are
idle at others.
Companies pile huge inventories to anticipate big
demand swings.
With a surge in shipments, they may pay premium
freight rates.
Damage also increases due to larger-than-normal
volumes and stocking inventories for long periods.
Problems are self imposed
4. Rationing and Shortage
Gaming
When demand exceeds supply,
manufacturers may ration its product to
customers.
One method: allocates amounts amount in
proportion to the amount ordered.
For example, if the total supply is only 50 percent of the
total demand, all customers receive 50 percent of what
they order.
Knowing that, customers may exaggerate
their real needs.
If and when demand cools, orders will suddenly
be cancelled
How to
Counteract the
Bullwhip Effect
1. Avoid Multiple Demand
Forecast Updates
make downstream demand data available to the
upstream sites. Both sites can update their forecasts
with the same raw data.
IBM, HP, and Apple require sell-through data on
withdrawn stocks from their resellers' central
warehouse.
Not as complete as point-of-sale (POS) store data.
Electronic Data Interchange
(EDI)
Supply chain partners use electronic data
interchange (EDI) to share data.
In the consumer products industry, EDI is growing
in 1990, 20 percent of orders by retailers transmitted via
EDI.
In 1992, 40 percent and,
in 1995, nearly 60 percent.
The increasing use of EDI
facilitate information transmission
sharing among chain members
Now moving to the internet
Vendor-managed inventory (VMI) or
Continuous replenishment program (CRP)
Manufacturer or wholesaler has access to the demand and
inventory information at retailing sites (either POS or retail
warehouses)
Updates forecasts and resupplies the retail sites.
Retailers become a passive partners in supply chain.
Inventory reductions of up to 25 percent are common.
Many companies such as Campbell Soup, M&M/Mars,
Nestle, Quaker Oats, Nabisco, P&G, and Scott Paper use CRP
with some or most of their customers. P&G uses VMI in its
diaper supply chain, starting with its supplier, 3M, and
its customer, Wal-Mart.
Consumer direct" program
Apple Computer has a "consumer
direct" program
sells directly to consumers without
going through the reseller
Allows Apple to see directly the
demand patterns.
Dell does the same.
2. Break Order Batches
Devise strategies that lead to
smaller batches
more frequent resupply
Lower cost of ordering
EDI can reduce the cost of the paperwork in
generating an order.
Using EDI, Nabisco perform paperless, computer-assisted
ordering (CAO) and customers order more frequently.
McKesson uses EDI to lower the transaction costs from
orders by drugstores and other retailers.
P&G has introduced standardized ordering terms
across all business units to simplify the process and
dramatically cut the number of invoices.
General Electric is electronically matching buyers
and suppliers.
A paper purchase order that typically cost $50 to process is
now $5.
Transportation alternatives
Differences in the costs of full truckloads and
less-than- truckloads are great
Improvements in order efficiency are wasted due to the full-
truckload constraint.
Now some manufacturers induce their distributors to
order assortments of different products. Hence
a truckload may contain different products from the
same manufacturer instead of a full load of the same
product.
P&G has given discounts to distributors that are willing to
order mixed-SKU loads of any of its products.
Third-party logistics
Consolidate loads from multiple
suppliers located near each other
a company can realize full truckload
economies without the batches coming
from the same supplier.
3. Stabilize Prices
Reduce the frequency and the level of
wholesale price discounting.
The manufacturer can reduce the incentives
for retail forward buying by establishing a
uniform wholesale pricing policy.
P&G, Kraft, and Pillsbury have moved to an
everyday low price (EDLP) or value
pricing strategy
4. Eliminate Gaming in
Shortage Situations
Instead of allocating products based on
orders, allocate in proportion to past
sales.
Customers then have no incentive to
exaggerate their orders.
General Motors uses this method of
allocation in cases of short supply.