Bullwhip effect
Encyclopedia
The Bullwhip Effect is an observed phenomenon in forecast-driven distribution channels. It refers to a trend of larger and larger swings in inventory in response to changes in demand, as one looks at firms further back in the supply chain
for a product. The concept first appeared 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
is reminiscent of a cracking whip, it became known as the Bullwhip Effect.
demand is rarely perfectly stable, business
es must forecast demand to properly position inventory and other resources. Forecasts are based on statistics, and they are rarely perfectly accurate. Because forecast errors are a given, companies often carry an inventory
buffer called "safety stock
".
Moving up the supply chain
from end-consumer to raw material
s supplier, each supply chain participant has greater observed variation in demand and thus greater need for safety stock
. In periods of rising demand, down-stream participants increase orders. In periods of falling demand, orders fall or stop, thereby not reducing inventory. The effect is that variations are amplified as one moves upstream in the supply chain (further from the customer). This sequence of events is well simulated by the Beer Distribution Game
which was developed by Prasad Ligade MIT Sloan School of Management
in the 1960s.
The causes can further be divided into behavioral and operational causes:
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.
. 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:
Supply chain
A supply chain is a system of organizations, people, technology, activities, information and resources involved in moving a product or service from supplier to customer. Supply chain activities transform natural resources, raw materials and components into a finished product that is delivered to...
for a product. The concept first appeared in J Forrester
Jay Wright Forrester
Jay Wright Forrester is a pioneer American computer engineer, systems scientist and was a professor at the MIT Sloan School of Management. Forrester is known as the founder of System Dynamics, which deals with the simulation of interactions between objects in dynamic systems.- Biography :Forrester...
's Industrial Dynamics (1961) and thus it is also known as the Forrester Effect. Since the oscillating demand magnification upstream a supply chain
Supply chain
A supply chain is a system of organizations, people, technology, activities, information and resources involved in moving a product or service from supplier to customer. Supply chain activities transform natural resources, raw materials and components into a finished product that is delivered to...
is reminiscent of a cracking whip, it became known as the Bullwhip Effect.
Causes
Because customerCustomer
A customer is usually used to refer to a current or potential buyer or user of the products of an individual or organization, called the supplier, seller, or vendor. This is typically through purchasing or renting goods or services...
demand is rarely perfectly stable, business
Business
A business is an organization engaged in the trade of goods, services, or both to consumers. Businesses are predominant in capitalist economies, where most of them are privately owned and administered to earn profit to increase the wealth of their owners. Businesses may also be not-for-profit...
es must forecast demand to properly position inventory and other resources. Forecasts are based on statistics, and they are rarely perfectly accurate. Because forecast errors are a given, companies often carry an inventory
Inventory
Inventory means a list compiled for some formal purpose, such as the details of an estate going to probate, or the contents of a house let furnished. This remains the prime meaning in British English...
buffer called "safety stock
Safety stock
Safety stock is a term used by logisticians to describe a level of extra stock that is maintained to mitigate risk of stockouts due to uncertainties in supply and demand. Adequate safety stock levels permit business operations to proceed according to their plans...
".
Moving up the supply chain
Supply chain
A supply chain is a system of organizations, people, technology, activities, information and resources involved in moving a product or service from supplier to customer. Supply chain activities transform natural resources, raw materials and components into a finished product that is delivered to...
from end-consumer to raw material
Raw material
A raw material or feedstock is the basic material from which a product is manufactured or made, frequently used with an extended meaning. For example, the term is used to denote material that came from nature and is in an unprocessed or minimally processed state. Latex, iron ore, logs, and crude...
s supplier, each supply chain participant has greater observed variation in demand and thus greater need for safety stock
Safety stock
Safety stock is a term used by logisticians to describe a level of extra stock that is maintained to mitigate risk of stockouts due to uncertainties in supply and demand. Adequate safety stock levels permit business operations to proceed according to their plans...
. In periods of rising demand, down-stream participants increase orders. In periods of falling demand, orders fall or stop, thereby not reducing inventory. The effect is that variations are amplified as one moves upstream in the supply chain (further from the customer). This sequence of events is well simulated by the Beer Distribution Game
Beer Distribution Game
The Beer Distribution Game is a simulation game created by a group of professors at MIT Sloan School of Management in early 1960s to demonstrate a number of key principles of supply chain management. The game is played by teams of at least four players, often in heated competition, and takes from...
which was developed by Prasad Ligade MIT Sloan School of Management
MIT Sloan School of Management
The MIT Sloan School of Management is the business school of the Massachusetts Institute of Technology, in Cambridge, Massachusetts....
in the 1960s.
The causes can further be divided into behavioral and operational causes:
Behavioural causes
- misuse of base-stock policies
- misapplication of trinomial theorem
- misperceptions of feedback and time delays
- panic ordering reactions after unmet demand
- perceived risk of other players' bounded rationality
Operational causes
- dependent demand processing
- Forecast ErrorsCalculating Demand Forecast AccuracyCalculating demand forecast accuracy is the process of determining the accuracy of forecasts made regarding customer demand for a product.-Importance of forecasts:...
- adjustment of inventory control parameters with each demand observation
- Forecast Errors
- Lead timeLead timeA lead time is the latency between the initiation and execution of a process. For example, the lead time between the placement of an order and delivery of a new car from a manufacturer may be anywhere from 2 weeks to 6 months...
Variability (forecast error during replenishment lead time) - lot-sizing/order synchronization
- consolidation of demands
- transaction motive
- quantity discount
- trade promotion and forward buying
- anticipation of shortages
- allocation rule of suppliers
- shortage gaming (including dereliction under Benford's Law)
- Lean and JIT style management of inventories and a chase production strategy
Consequences
In addition to greater safety stocks, the described effect can lead to either inefficient production or excessive inventory as the producer needs to fulfill 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.
Counter Measures
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 ManagersSupply chain management
Supply chain management is the management of a network of interconnected businesses involved in the ultimate provision of product and service packages required by end customers...
. 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
Manufacturing
Manufacturing is the use of machines, tools and labor to produce goods for use or sale. The term may refer to a range of human activity, from handicraft to high tech, but is most commonly applied to industrial production, in which raw materials are transformed into finished goods on a large scale...
, this concept is called Kanban
Kanban
, also spelled kamban, and literally meaning "signboard" or "billboard", is a concept related to lean and just-in-time production. According to Taiichi Ohno, the man credited with developing Just-in-time, kanban is one means through which JIT is achieved.Kanban is not an inventory control system...
. This model has been most successfully implemented in Wal-Mart
Wal-Mart
Wal-Mart Stores, Inc. , branded as Walmart since 2008 and Wal-Mart before then, is an American public multinational corporation that runs chains of large discount department stores and warehouse stores. The company is the world's 18th largest public corporation, according to the Forbes Global 2000...
's distribution system. Individual Wal-Mart stores transmit point-of-sale (POS) data from the cash register
Cash register
A cash register or till is a mechanical or electronic device for calculating and recording sales transactions, and an attached cash drawer for storing cash...
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
Information technology
Information technology is the acquisition, processing, storage and dissemination of vocal, pictorial, textual and numerical information by a microelectronics-based combination of computing and telecommunications...
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 InventoryVendor Managed InventoryVendor-managed inventory is a family of business models in which the buyer of a product provides certain information to a supplier of that product and the supplier takes full responsibility for maintaining an agreed inventory of the material, usually at the buyer's consumption location .A...
(VMI) - Just In Time replenishment (JIT)
- Strategic partnershipStrategic partnershipA strategic partnership is a formal alliance between two commercial enterprises, usually formalized by one or more business contracts but falls short of forming a legal partnership or, agency, or corporate affiliate relationship....
- Information sharing
- smooth the flow of products
- coordinate with retailers to spread deliveries evenly
- reduce minimum batch sizes
- smaller and more frequent replenishments
- eliminate pathological incentives
- every day low price policy
- restrict returns and order cancellations
- order allocation based on past sales instead of current size in case of shortage
Literature
- Cannella S., and Ciancimino E. (2010). On the bullwhip avoidance phase: supply chain collaboration and order smoothing. International Journal of Production Research, 48 (22), 6739-6776
- Chen, Y. F., Z. Drezner, J. K. Ryan and D. Simchi-Levi (2000), Quantifying the Bullwhip Effect in a Simple Supply Chain: The Impact of Forecasting, Lead Times and Information. Management Science, 46, 436—443.
- Chen, Y. F., J. K. Ryan and D. Simchi-Levi (2000), The Impact of Exponential Smoothing Forecasts on the Bullwhip Effect. Naval Research Logistics, 47, 269—286.
- Chen, Y. F., Z. Drezner, J. K. Ryan and D. Simchi-Levi (1998), The Bullwhip Effect: Managerial Insights on the Impact of Forecasting and Information on Variability in a Supply Chain. Quantitative Models for
- Disney, S.M., and Towill, D.R. (2003). On the bullwhip and inventory variance produced by an ordering policy. Omega, the International Journal of Management Science, 31 (3), 157-167.
- Lee, H.L., Padmanabhan, V., and Whang, S. (1997). Information distortion in a supply chain: the bullwhip effect. Management Science, 43 (4), 546-558.
- Lee, H.L. (2010). Taming the bullwhip. Journal of Supply Chain Management 46 (1), pp. 7–7.
- Supply Chain Management, S. Tayur, R. Ganeshan and M. Magazine, eds., Kluwer, pp. 417–439.
- Selwyn, B. (2008) Bringing Social Relations Back In: (re)Conceptualising the 'Bullwhip Effect' in global commodity chains. International Journal of Management Concepts and Philosophy, 3 (2)156-175.
- Tempelmeier, H. (2006). Inventory Management in Supply Networks—Problems, Models, Solutions, Norderstedt:Books on Demand. ISBN 3-8334-5373-7.