The more echelons exist between the customer and the supplier, the bigger the variation is:
In 1997, Hau L. Lee, V. Padmanabhan and Seungjin Whang published a research paper- “The bullwhip effect in Supply Chain” and explained-
1. Demand forecast updating. As each entity along the chain places an order, it replenishes stock and includes some safety stock. With long lead times, there may be weeks of safety stocks, which make the fluctuation in demand more significant.
2. Order batching. Companies may place orders in batches, often to avoid the cost of processing orders more frequently or the high transportation costs for less-than-truckload orders. Suppliers, in turn, face erratic streams of orders, and the bullwhip effect occurs. When order cycles overlap, the effect is even more pronounced.
3. Price fluctuation. Special promotions and price discounts result in customers buying in large quantities and stocking up. When prices return to normal, customers stop buying. As a result, their buying pattern does not reflect their consumption pattern.
4. Rationing and shortage gaming. If product demand exceeds supply, a manufacturer may ration its products. Customers, in turn, may exaggerate their orders to counteract the rationing. Eventually, orders will disappear and cancellations pour in, making it impossible for the manufacturer to determine the real demand for its product.
The authors suggest several ways in which companies can counteract the bullwhip effect:
1. Avoid multiple demand forecast updates. Companies can make demand data from downstream available upstream. Or they can bypass the downstream site by selling directly to the consumer. Also, they can improve operational efficiency to reduce highly variable demand and long resupply lead times.
2. Break order batches. Companies can use electronic data interchange to reduce the cost of placing orders and place orders more frequently. And they can ship assortments of products in a truckload to counter high transportation costs or use third-party logistics companies to handle shipping.
3. Stabilize prices. Manufacturers can reduce the frequency and level of wholesale price discounting to prevent customers from stockpiling. They can also use activity-based costing systems so they can recognize when companies are buying in bulk.
4. Eliminate gaming in shortage situations. In shortages, suppliers can allocate product based on past sales records, rather than on orders, so customers don’t exaggerate their orders. They can also eliminate their generous return policies, so retailers are less likely to cancel orders.
Only by thoroughly understanding the underlying causes of the bullwhip effect, say the authors, can companies counteract and control it.
Causes of bullwhip effect:
Demand Forecast Updating
- Forecast Errors
- Adjustment of inventory control parameters with each demand observation
- Consolidation of demands
- Transaction motive
- Quantity discount
- Allocation rule of suppliers
- Shortage gaming
- Lean and JIT style management of inventories and a chase production strategy
Counter measures
Investment in information technology, creation of a corporate culture of flexibility, focus on customer demand, trustful collaboration and information sharing are the keys and in order to achieve the objective the following methods are proven to be effective:
- Reduce minimum batch sizes
- Smaller and more frequent replenishment
- Every day low price policy
- Restrict returns and order cancellations
- Order allocation based on past sales instead of current size in case of shortage
Sina’s blog explains –
Demand Forecast Updating
One way to avoid inaccuracies is by reducing the lack of demand visibility by providing access to point of sale (POS) data. Also it is possible to overcome exaggerated demand forecasts by single control of replenishment or vendor Management Inventory (VMI).
Order Batching
Price Fluctuation
High-low pricing can be replaced with everyday low prices. This way, special purchase contracts can be implemented in order to specify ordering at regular intervals to better synchronize delivery and purchase.
Rationing and Shortage Gaming
One solution is to allocate units based on past sales. Unrestricted ordering capability can be addressed by reducing the order size flexibility and implementing capacity reservations. For example, one can reserve a fixed quantity for a given year and specify the quantity of each order shortly before it is needed, as long as the sum of the order quantities equals to the reserved quantity.