The Bullwhip Effect in the Supply Chain

The Bullwhip Effect in the Supply Chain As the name suggests bullwhip effect is an oscillation in the supply pipeline. In supply chain this effect occurs when there is a constant fluctuation in the demand. This effect also known as whiplash effect arises when minute demand fluctuations downstream result in a bigger fluctuation upstream of the supply chain. It describes how inaccurate information, non operational transparency and a disengaged production plan and real time information result in revenue loss, bad customer service, high inventory levels and unrealized profits. Incongruent information across the supply chain leads to overreact to backlog and building of excessive inventory in order to prevent stock outs (Supply Chain Management: Concepts Techniques and Practices-Enhancing Value Through Collaboration, By Ling Li; pp 191) it creates unstable production schedules that cause lead to unnecessary cost in supply chain. Companies have invested in extra capacity to meet the high variable demand. The highly variable dema nd increases the requirements for safety stock in the supply chain. Additionally, companies may decide to produce to stock in periods of low demands to increase productivity. If this is not managed properly it leads to excessive obsolescence. Highly variable demand also increases lead times. These inflated lead times lead to increased stocks and bullwhip effect. Thus this effect can be quite exasperating for the companies; they invest in extra capacity, extra inventory, work over time one week and stand idle the next, whilst at the retail stores the shelves of popular products are empty, and the shelves with products that arent selling are full (Dr. Stephen Disney, Cardiff Business School, Cardiff University) The problem of this effect in supply chain management has been a concernment for many years. Due to its non industry specific nature, it has grabbed the attention of many professionals from diverse industries and business schools. Many firms have observed the bullwhip effect in which the fluctuations in orders increase as they move up the supply chain from retailers to wholesalers to manufacturers to suppliers.(pp 478-479 ; Supply Chain Management Strategy , Planning and Operation , 2nd Edition; Sunil Chopra Peter Meindl) Some of the prominent cases so far noticed have been of an Italian pasta manufacturer Barilla SpA (Hammond 1994) that provides vivid illustrations of bullwhip in its supply chain. Barilla for a very long time had been offering special price discounts to the customers for bulk purchases. Such marketing policies created a highly erratic and spiky demand patterns, leading to high supply chain costs that outstripped the full truckload benefits and mismanaged inventory. Another case is of Campbell Soups chicken noodle soup experience (Cachon and Fisher 1997). The company is into selling only those products that have a stable demand. The manufacturer yet faced extremely variable demand on the factory level, the reason for which was found out to be forward buying practices of the customers. (FIGURE) As pointed out by Lee, Padmanabhan and Whang(1997 a,b) the expression Bullwhip Effect was termed by executives of PG, the company that manufactures Pamper brand of diapers. These executives observed that while the consumer demand for Pampers Diapers was fairly constant over time, the orders for diapers placed by retailers to their wholesalers or distributors were quite variable i.e., exhibited significant fluctuations over time. In addition, even larger variations in order quantities were observed in the orders that PG received from its wholesalers. This increase in the variability of the orders seen by each stage in a supply chain was called the bullwhip effect. As per Simatupang and Sridharan this situation of misalignment in demand understanding can be termed as Asymmetric Information where different parties have different states of private information about product demand, and the chain operations. The problem of this as ymmetry arises because participating firms generally lack the knowledge required about each others plans and intentions to adequately harmonize their services and activities. Supply chain members often do not wish to share their private information completely and faithfully with all others due to the profitability of that actual or anticipated information. Thereby the whole supply chain suffers from suboptimal and opportunistic behavior. These decisions occur when the members donot have sufficient visibility to resolve various tradeoffs in decision making because lack of information causes decisions to be made in a narrow scope that cannot ensure the products flows properly to end customers. Moreover, with limited information sharing, members donot have consistent perceptions of market needs and visibility over performance at the other levels of the supply chain. As a consequence, decisions are made based on either the best estimation of the available data or an educated guess. Such decisions can be biased and prevent the individual member from attaining the optimal solution of the supply chain. For example, the manufacturer often uses incoming orders with larger variance and not sales data from the retailer as a signal about the future product demand. Asymmetric information also produces problems of vulnerability of opportunistic behavior. Specifically, adverse selection and moral hazard manifest themselves in the relationship among the supply chain members. The negative selection of adverse selection, for example, is that the member firms cannot optimize supply chain performance because they donot possess the required capability to meet the predetermined customer service level. ( Semchi levi, David, Philip Kaminsky and Edith Simichi Levi, Designing and Managing the Supply Chain, London: Mc Graw Hill, 1999, pp. 103-107)(Lee, Hau L., V Padmanabhan and Seugjin Whang, The Bullwhip Effect in Supply Chains, Sloan Management Review, Vol. 38, No. 3 (1997), pp 93-102 ) To explain this effect a very simple example of two tier supply chain, a retailer and a manufacturer, can be taken into account. The retailer observes customer demand and places orders to the manufacturer. For determination of the order quantity to place with the manufacturer, retailer will use the observed demand data of customer and a demand forecasting technique. In the 2nd stage, the manufacturer plays his role of forecasting by observing the retailers demand to place order to his suppliers. In many supply chains, the manufacturer doesnt have access to customers demand data thereby making him rely on the retailers data to forecast. As the bullwhip effect implies (the orders placed by the retailer are significantly more variable than the customer demand observed by the retailer), the manufacturers forecasting and inventory control problem will be much more difficult than the retailers forecasting and inventory control problem. In addition, the increased variability will force t he manufacturer to carry more safety stock or to maintain higher capacity than the retailer in order to meet the same service level as the retailer. Longer the supply chain of a company more the impact of bullwhip effect can be observed. This also leads to increase in amount of the inventory across the chain. The rules of ordering such as timing of order placement, the acceptance of or refusal of back orders, order quantities and lot sizes, and cancellation rights and penalties, can have an enormous impact on the total system inventory and the bullwhip effect. To understand these challenges better a simulation of beer distribution game was created by the professors of MIT, Sloan School of Management. This simulation helps to understand the challenges faced by putting the participant in a real life supply chain situation. In this exercise, students enact a four stage supply chain. The task is to produce and deliver units of beer: the factory produces and the other three stages delive r the beer units until it reaches the customer at the downstream end of the chain. The aim of the players is rather simple: each of the four groups has to fulfill incoming orders of beer by placing orders with the next upstream party. Communication and collaboration are not allowed between supply chain stages, so players invariably create the bullwhip in the pipeline or chain. Sterman (1950a) was the first one to actually test the beer game to experience the bullwhip effect to experiment the causes that result to it. He (Sterman) experienced (1) Inventory Rationing (2) order bathing and (3)Price Fluctuations. He also provides evidence on bullwhip effect that occurs due to customers tendency of underweighting the inventory in supply line. The customer does not keep in the account the unreceived inventory at the time of placing a new order. Due to this the orders in backlog are underweighed in the decision to order more. Peter et. al.(1940) identify 4 main causes behind building up of bull whip effect. These causes are:- Demand Forecasting Every company in a supply chain usually does a product forecasting for its production scheduling, capacity planning, inventory control and material requirement planning. This forecast is oftenly done on the basis of previous orders placed by the customers. A very common method of demand forecast is exponential smoothing in which future demands are continuously updated as the real demand data becomes available. The order placed reflects the amount needed to replenish the future demands aswell as safety stock. Due to long lead times the safety stock days surge resulting in greater order quantity fluctuations. Moving a level up, to the manufacturers stage if the method of forecasting is same i.e. exponential smoothing then the demand variability is even more, eventually creating a bullwhip. Order Batching In supply chain most of the organizations place orders with their upstream suppliers after the accumulating them. The frequency of these orders is weekly, biweekly or at times monthly depending on the product. There are several cost related and demand related reasons for this practice. This can be demystified by an example of a company that places an order once a month because of the nature of the product it deals in. The supplier faces a highly erratic stream of orders. There is a spike in demand at one time during the month, followed by no demands for the rest of the month. This variability is higher than the demands the company itself faces. This practice amplifies variability leading to bullwhip effect. Transportation economics also plays a major role in the frequency of order placements. If the truck load is not enough then the order is not released as the cost is same irrespective of the load. Therefore companies prefer to order only when accumulated requirements are enough for a truck load to fill. This period batching causes surges in demand at a particular time period, followed by the periods of time with no or little orders, and other time periods with huge demands. Price Fluctuation Price variation is a crucial factor that impacts the buying behavior of a person. The customer buys in quantities that donot reflect their immediate needs. They buy in bigger quantities and stock up when the prices are low and reduce the purchase when the prices are normal, thereby creating a forward buy pattern in the chain. As a result the customers buying pattern doesnt reflect the consumption pattern and variation between the 2 grows which leads to the bullwhip effect. Rationing and Shortage Gaming When the product demand exceeds its supply the manufacturer is forced to ration them to the customers. Knowing that manufacturer will ration the goods, customers exaggerate their real needs at the time of ordering. Later when the variation between demand and supply plummets down, orders suddenly start to fade and cancellations pour in. This overreaction of the customer is an outcome of anticipation due to lack of information and interaction between the relevant parties. As the customer doesnt get 100% delivery of the goods required, he exaggerates the demand in order to receive the desired amount of goods. The above mentioned literature is comprehensible enough that all the factors or elements resulting in bullwhip effect originate from a common ground i.e. information sharing. It is evident enough that the lack of information and interaction between different stages evolve bullwhip in the system thereby plaguing the whole Supply Chain. Therefore it calls for supply chain integration where different stages upstream and downstream need to combine their operational practices by sharing information and work together towards a common objective. In this collaborative manner firms are likely to have less risk factor and more benefits to reap. Multiple researches have been done in order to prove the impact of inter firm collaboration on the performance of supply chain and attenuate the bull whip effect. Supply Chain Collaboration Intensive competition in the market place has forced companies to respond more quickly to customer needs through faster product development and shorter delivery time. Increasing customer awareness and preferences have led to companies that are able to deliver products with excellent quality, and on time. However the demand of customers for product variety, especially in the case of short life-cycle products such as food, apparel, toys and computers, makes it difficult for manufacturers and retailers to predict which particular variety of the products the markets will accept. To be effective in matching demand with supply, manufacturers and retailers need to collaborate in the supply chain. Each form of collaboration varies in its focus and objectives. Regardless of the collaborative approach taken, however, Simatupang and Sridharan(2003) suggest that the requirements for effective collaboration are mutual objectives, integrated policies, appropriate performance measures, a decision d omain, information sharing and incentive alignment. These requirements demonstrate a need for significant planning and communication to occur between partners, and can require significant resource commitment. Additional studies (Derocher and Kilpatrick, 2000; Mentzer et al., 2000) have affirmed that strong relationships increase the likelihood that firms will exchange critical information as required to collaboratively plan and implement new supply chain strategies. In order for this sharing of critical information to occur, a high degree of trust must exist among the collaborating partners (Frankel et al., 2002). Trust refers to the extent to which supply chain partners perceive each other as credible and benevolent (Ganesan, 1994; Doney and Cannon, 1997). Credibility reflects the extent to which a firm believes their relationship partner has intentions and motives that will benefit the relationship (Ganesan, 1994). One important aspect of information sharing as it relates to colla boration is the delineation of the kind of knowledge, explicit or tactic that results from the exchange of information. Collaborative arrangements involve knowledge transfer that is both explicit (e.g. transactional) and tacit, which resides in social interactions (Lang, 2004). More specifically, explicit knowledge is defined by Lang (2004) and referred to here as knowledge that can be articulated and codified in order to be transmitted easily. Hoover et. al., (2001) identify the benefits of collaboration only when it is done on a larger scale. Therefore they conclude that collaboration cannot be just a solution between close partners, but needs to be implemented with a larger number of business partners. The end goal should be solutions that enable mass collaboration. Darren Peters (six sigma master black belt for Cummins Inc. and also an ex professor of Purdue Universitys College of Technology) in his article on supply chain integration mentioned that a true integration of supply chain calls for a high degree of synchronization and alignment. Peters defines synchronization as information sharing; alignment, the most complex factor, reflects the collective behavior and motives of each partner within an ecosystem. Collaborative Planning Forecasting and Replenishment (CPFR) is the most recent prolific management initiative that provides supply chain collaboration and visibility. It has lately emerged as a new paradigm for the organizations that further want to cut their operational cost and make their supply chain more agile and responsive. Supply chain collaboration involves close work relationship with upstream suppliers and downstream customers. It is a new strategy to make the supply chain more effective and efficient keeping the customer at top priority. The association of Operations Management defines CPFR as follows: Collaboration process whereby supply chain trading partners can jointly plan key supply chain activities from production and delivery of raw materials to production and delivery of final products to end costumers (The Association of Operations Management also known as the American Production and Inventory Control Society, APICS). The complexity of new products, shrinking tim e to market, and capital intensity have led firms to collaborate to improve access to complementary abilities (Scott 2000) to help meet competitive challenges (Kanter 1994) and to address increasing competition due to market globalization, product diversity and technological breakthroughs ( Simatupang, Wright and Sridharan 2002). A greater interconnectedness and trend of outsourcing have led to a greater need for supply chain professionals to work in alliance with firms possessing complementary skills and capabilities. Lambert et. al. (Lambert, Douglas M., Margaret A. Emmelhainz and John T. Gargner,Building Successful Partnerships, Journal of Business Logistics, Vol. 20, No. 1 (1999), pp. 165-181) suggest a particular degree of relationship among chain members as means to share risks and rewards that result in higher business performance than would be achieved by the forms individually. Bowersox (Bowersox, Donald J., The Strategic Benefits Of Logistics Alliance, Harvard Business Rev iew, Vol. 68, No. 4 (1990), pp. 36-43) reports that logistics alliances offer opportunities to dramatically improve customer service and at the same time lower distribution and storage operating costs. Narus and Anderson (Narus, James A. and James C. Anderson, Rethinking Distribution: Adaptive Channels, Harvard Business Review, Vol. 74, No. 4 (1996), pp. 112-120) define a collaborative supply chain as the cooperation among independent but related firms to share resources and capabilities to meet their customers most extraordinary needs. As per a simplistic definition, Collaboration is nothing but a process in which people, groups and organizations work together to achieve desired results. Therefore supply chain collaboration is a business practice wherein trading partners use IT and a standard set of business procedures to combine their intelligence in planning and fulfillment of customer demand (VICS, 2004). The CPFR model created by Voluntary Interindustry Commerce Standards Assoc iation (VICS) is a promising mechanism for the forecast accuracy by having customers and suppliers participation in the forecasting process. A buyer and a seller work together as collaborators to satisfy the needs of the end customer thereby creating a win win situation. VICS 2004 proposes a model that is applicable to almost all the industries. In case of any discrepancy the vendor and the buyer can come together and rectify it by deciding upon the replenishment quantity. This kind of association or professional acquaintance offers a great potential to drastically improve supply chain performance through collaborative demand planning, synchronized production scheduling, logistics planning and new product development. The VICS Association, CPFR provides templates for supply chain collaboration in 4 stages (VICS 2004): Planning Stage: At this phase the relationship between buyers and vendors is planned and updated. It leads to front end agreement and joint business plan. Variances, w hether plan to plan or plan to actual, are also addressed. Forecasting Stage: At this stage, demand (order)/supply (sales) forecast is created and exceptions or discrepancies are identified and resolved. Forecast accuracy visibly improves by having customer and supplier involvement in the planning process and thereby making the goals compatible for both the parties. Execution: At this stage, the order is generated, shipments are prepared and delivered, products are received and stocked on retail shelves, sales transactions are recorded and payments are made. Analysis: At this stage, monitor planning and execution activities for exceptional situations. If a discrepancy occurs, the two trading partners can get together and share insights and adjust plans to resolve such discrepancies. Collaboration and co-operation between producers and their customers is a key component of a modern successful supply chain. As per Tim Bennett (Former President of National Farmers Union, Texas, USA) it is imperative that the organizations develop these relationships not only to drive improvements in efficiency but to respond more effectively to customer demands. As per Aviv (2005); Schwarz (2004) this initiative not only reduces the inventory but also increases sales for both sides i.e. retailers and suppliers. This also includes sharing of data and coming up with new and innovative ideas to attain a common objective. Supply chain collaboration is oftenly defined as 2 or more chain members working together to create a competitive through sharing information, making joint decisions, and sharing benefits which result from greater profitability of satisfying end customer needs than acting alone.(Simatupang Sridharan, 2005; Whipple and Russell, 2007). Narus and Anderson (1996) define Supply Chain Collaboration as sharing knowledge and skills by independent but related firms to meet extraordinary demands of precious customers. The major reasons for companies to collaborate their supply chain with suppliers and/or customers as the case may be, is to reap a better competitive advantage and improve the overall operational efficiency with improved profit margins. As per Wernerfelt 1984 Resource based view shows how firms develop and utilize their resources. Moreover the ownership of scarce and firm specific resources is the reasoned behind its success. Collaboration in the past has very often been interchangeably used with cooperation. Every professional and expert defines it differently. There are several driving forces that for the exchange of reliable information in the supply chain industry. One of these driving forces is competition. Merchandise retailers such as Wal-Mart and K-Mart have expanded product offerings into food items in order to enhance the value of customer service offerings through one-stop shopping. A second driver is the innovative nature of products, or the length of the life cycle and the duration of retail trends in these industries. In the apparel industry, for example, the life cycle of some garments is 6 months or less. Yet, manufacturers typically require up-front commitments from retailers that may exceed 6 months making long term fashion forecasts risky. General merchandise retailers know this years newest toy has a short product life cycle. It is imperative to get the latest trend in the consumer products to market quickly; otherwise, either tremendous lost revenues or markdown prices will be experienced. Long manufacturing lead times necessitate supply chain planning visibility. A third driving force is the longer, more complex supply chain given moves to offshore production. International sourcing for apparel and general merchandise has lengthened the supply chain and cycle time, and necessitating supply chain planning visibility. A fourth driving force behind CPFR is the nature of the supply chain cost structure. Global markets and more competitors are likely to move the supply chain system towards universal participation by all retailers in CPFR in an effort to cut costs (Raghunathan, 1999). All of these driving forces support the need to respond quickly to volatile demand and other market signals. These forces stimulate the development of supply chain visibility tools such as CPFR (Fisher 1997). Identified benefits of collaboration include: revenue enhancements, cost reductions, operational flexibility to cope with demand uncertainties (Fisher, 1197; Lee, Padmanabhan, and Whang, 1997; Simatupang et al., 2005); increased sales, improved forecasts, more accurate and timely information, reduced inventory, improved customer service, (Barratt and Oliveira, 2001; Whipple et al., 2007); division of labor, exchanges of knowledge about products and processes (Kotabe, Martin, Domoto, 2003) and cost and/or problem avoidance (Whipple, 2007). Companies like Wal mart, Procter Gamble and Dell computers have evidently shown that an anticipatory business model is better able to increase sales revenues and deliver profit margins meeting the shareholder expectations. This model is successful only when there is a cooperation and collaboration amongst all the members, internal aswell as external of the entire supply chain. (Supply Chain Collaboration-How to implement CPFR ;Ronald K Ireland with Colleen Crum, pg2). As per Ronald K Ireland reducing the Bull Whip effect in supply chain is not a program or a monthly initiative. It is a continuous practice to maintain a balance and to keep it to minimal due the inevitable nature. About the collaboration Ronal shares one of his experiences at Wal mart where due to some wrong program installation in the systems, purchase orders used to get blocked that lead the point of sale data to zero. The actual break down of collaborative planning happened when no queries were raised regarding the drastic change in point of sale rate. It was only when a supplier requested a Wal mart analyst to verify the forecast. This incident moralizes that it takes a team approach to eliminate the bull whip in the supply chain. Trust plays a vital role in the whole collaborative setup. Without trust and reliability on partners, supply chain collaboration is of no use. It is very important to have trust and faith in the partners to create supply chain into a value chain. Andraski (1994) reports that CPFR engages the manufacturer and retailer into exchanging the marketplace information in order to come up with a customer specific plan that can substantially reduce inventory. There are various cases or examples of CPFR implementation that prove its success. Various types of partnerships (collaborations) have been tried. Wal-Mart and Warner Lambert embarked on the first CPFR pilot, involving Listerine products. In their pilot scheme, Wal Mart and Warner Lambert used special CPFR software to e xchange forecasts. Supportive data, such as past sales trends, promotion plans and even the weather, were frequently transferred in an iterative fashion to allow them to converge on a single forecast should their original forecasts differ. The pilot scheme was very successful resulting in a tremendous increase in sales, better fill rates and in a reduction of inventory investment (Cooke, 1998; Hill, 1999). Other examples of CPFR pilots include Sara Lees Hanes and Wal Mart, involving 50 SKUs of underwear supplied to almost 2500 Wal Mart stores (Hill, 1999; Parks, 1999, 2001; Songini, 2001). In 1996, Hieneken USA employed CPFR to cut its order cycle time and is currently providing Collaborative planning and replenishment software to its top 100 distributors (Aviv, 2001). Procter and Gamble has several active CPFR pilots underway (Schachtman, 2000). Levi Strauss and Co. incorporates certain aspects of the CPFR business process into its retail replenishment service (e.g. by creating jo int business plans and identifying exceptions) (Aviv, 2001). Additionally, in the ECR report entitled European CPFR Insights several CPFR pilots are described including: Unilever Sainsburys GNX, Condis-Henkel-Cartisa, Kraft-Sainsburys GNX, Carton Scholler, Vandemoortele-Delhaize (ECR Europe, 2002). (Andraski and Haedicke, 2003) cited a major gap of misunderstanding, misuse of greater bargaining power and undue expectations in a collaborative relationship. Such gaps can be avoided if mutual agreements on extensive and timely information sharing were put in place to more precisely predict potential problems of matching supply and demand. At the same time these arrangements call for an effective governance structure to address potential economic incentive problems between contracting parties, thereby leading to more cooperation across firm level boundaries. Information Sharing Information is an essential part of managing operations and supply chain management. The above given review is comprehensible enough for us to realize the magnitude of information in supply chain and the repercussions if not communicated properly. It is the most crucial element in the whole CPFR frame of supply chain. Sridharan and Simatupang (2009) define information sharing as a process that facilitates the chain members to capture and disseminate timely, relevant and accurate information such that the recipient is able to plan, execute and control the supply chain operations. Likewise it should flow along with material and money across the supply chain in order to smoothly operationalize the key functions of supply chain. In the era of globalization where organizations have gone and are going multinational, the need of information sharing becomes vital for the smooth running of business. Some supply chains have the ability to share point of sale data to the end consumer with other members of the supply chain. Sophisticated supermarkets like Wal Mart use barcode scanning at the checkouts. These scanned barcodes populates electronic files that help in determining the patterns of particular products. This data is then offered to suppliers for the purpose of capacity planning activities. Utilization of this data only for the purpose of capacity planning doesnt help to resolve the problem of bullwhip as the suppliers still donot get clarity on the fluctuating orders of retailers. The real benefit availed from this data comes from its usage in replenishment or ordering decisions. The suppliers need to be proficient enough to use this information for forecasting replenishment. Effective sharing of information provides a shared basis for concerted actions by different functions across interdependent firms (Whipple et al. 2002). Increasing the level of integration and information sharing has become a necessary tool to bring a competitive advantage to the modern suppl y chain. Multiple researches have been performed in this context in order to develop a strong foundation in favor of information sharing and its crucial role in the all new Integrated Supply Chain Models. According to A.T. Kearney report(Field 2005), the average manufacturer has enjoyed benefits equivalent to million in savings for every $1billion of sales by synchronizing t