Bullwhip Effect

There is a popular saying in Supply Chain Management, "I wanted one coca-cola, I needed to order one caret, one truck came to deliver one caret"

The bullwhip effect is the phenomenon of orders and inventories getting progressively larger (more variable) moving backwards through the supply chain. Let us understand following:

• Manufacturers would like to produce in large lot sizes because it is more cost effective to do so. The problem, however, is that producing in large lots does not allow for flexibility in terms of product mix.
• Retailers find benefits in ordering large lots such as quantity discounts and more than enough safety stock.
• The downside is that ordering/producing large lots can result in large inventories of products that are currently not in demand while being out of stock for items that are in demand.
• Ordering/producing in large lots can increase the safety stock of suppliers and its corresponding carrying cost. It can also create what’s called the bullwhip effect. The bullwhip effect can be explained as an occurrence detected by the supply chain where orders sent to the manufacturer and supplier create larger variance then the sales to the end customer.

Causes of variability leading to the bullwhip effect

• Demand forecasting: Many firms use the min-max inventory policy. This means that when the inventory level falls to the reorder point (min) an order is placed to bring the level back to the max , or the order-up-to-level. As more data are observed, estimates of the mean and standard deviation of customer demand are updated. This leads to changes in the safety stock and order-up-to level, and hence, the order quantity. This leads to variability.
• Lead time: As lead time increases, safety stocks are increased, and order quantities are increased. More variability
• Batch ordering: Many firms use batch ordering such as with a min-max inventory policy. Their suppliers then see a large order followed by periods of no orders followed by another large order. This pattern is repeated such that suppliers see a highly variable pattern of orders.
• Price fluctuation: If prices to retailers fluctuate, then they may try to stock up when prices are lower, again leading to variability.
• Inflated orders: When retailers expect that a product will be in short supply, they will tend to inflate orders to insure that they will have ample supply to meet customer demand. When the shortage period comes to an end, the retailer goes back to the smaller orders, thus causing more variability.

Methods for coping with the bullwhip effect

• Centralizing demand information: This occurs when customer demand information is available to all members of the supply chain, and, can be used by the manufacturers for better predicting the when/what products/volumes are needed. The better planning for production due to centralizing demand information can reduce the bullwhip effect, it cannot eliminate the same.
• Reducing uncertainty: This can be accomplished by centralizing demand information.
• Reducing variability: This can be accomplished by using a technique made popular by WalMart and then Home Depot called Everyday Low Pricing (EDLP). EDLP eliminates promotions as well as the shifts in demand that accompany them.
• Reducing lead time: Order times can be reduced by using electronic data interchange(EDI).
• Strategic partnerships: The use of strategic partnerships can change how information is shared and how inventory is managed within the supply chain.

Other techniques for improving inventory management

• Cross-docking: This involves unloading goods arriving from a supplier and immediately loading these goods onto outbound trucks bound for various retailer locations. This eliminates storage at the retailer’s inbound warehouse, cuts the lead time.
• Delayed differentiation: This involves adding differentiating features or customization aspects to standard products late in the process. Another term for delayed differentiation is postponement. Modular design is one of the way to achieve this. Modular process, modular services, modular product-parts are few examples that allows mixing and matching.
• Direct shipping: This allows a firm to ship directly to customers rather than through retailers. This approach eliminates steps in the supply chain and reduces lead time. Reducing one or more steps in the supply chain is known as disintermediation.