Bullwhip effect in Supply Chains

Bullwhip effect :

A small movement of the wrist can produce huge wave at the end of whip.Degree of variability, does it matter in supply chain management. Definitely, when a consumer uses some product, its demand order variability in supply chain intensifies as it moves up the supply chain. The mismatch between the variance of inflow to industry and variance in industry's sale can change the inventory-to-sales ratio. This phenomenon is known as bullwhip effect. Larger the company , larger the network of supplier, larger will be the impact of fluctuation in the complex supply chain. For example - a big automobile firm will always have problem in predicting demand which will be extremely different from forecast that could impact flexibility, inventory cost and economies of scale.

Possible causes of bullwhip effect :

(1) Forecasting and demand gap - The planning team forecasts the demand by extrapolating the current demand. When extrapolations are stretched over long lead time then small fluctuations can have large effect.

(2)Batch orders - These kind of orders can be used over frequent and small orders to reduce the logistics or storage cost but the batch orders can create high degree of variability in demand.

(3) Fluctuation in price - Most of the times industries anticipates that price will increase and they tend to stock up items to take advantage of current low price. Same thing can happen in reverse and hence the variation can occur.

(4) Demand- supply gap - When demand exceeds supply , manufacturers  allot a part of inventory for consumers. May be customers order more than they need to gain more profit. When supply caters to normal demand and customers cancel the order, the unwanted inventories can lead to this problem.

Why it is important to identify this effect:

This phenomenon can impact demand information which can be transmitted up in the supply chain. On a larger scale relying on sales orders, companies decide product forecast, plan capacity, inventory and schedule production. Big variation in demand or order cancellation can lead to excess inventory, insufficient or excessive capacity. Cisco systems incurred more than US$ 2 billion inventory cancellation, due to a strong inventory built up followed by a drastic decrease in retailer orders. If mobile phone retailer orders 300,000 new order with 100,000 in stock and suddenly consumer demand decreases by 5% , the retailer will have 5000 extra mobiles in store and 15,000 arriving in next few months. When retailer reduced order by 20%  and then the manufacturer will have to further reduce its supply by 40% and raw material manufacturer will realize this difference by 70%.  

How supply chain can be aligned to mitigate bullwhip effect :

(1) Understanding demand pattern : Frequent and accurate communication with partners can help collaborative partnering and wastage reduction. Using better information systems and tools can improve information sharing. This collaboration can help getting past overestimating rather than ordering to avoid shortage.

(2) Increase in visibility about the cost of supplies from partners throughout the entire supply chain is imperative. For ex- some OEM(original equipment manufacturers) set up the small in-house operation to understand the reasonable estimates of the material needed to be procured from the suppliers.

(3)Monitoring incentives and distributing among the managers who estimate demand accurately is another way to encourage due diligence. Unless firms are ready to share the profit of improved supply chain till then managers will not work diligently to gather information to predict accurate demand. Shared savings and bonuses can help in improving operational efficiency.

(4)A strong leader in supply chain management will be specific about coordination and compliance as per industry specific standards. This practice with effective utilization of information and resources in-hand to reduce wastage. A cross-organizational structure can help in better response planning based on processes.

References -

http://opim.wharton.upenn.edu/~cachon/pdf/bwv2.pdf

http://hbr.org/product/bullwhip-effect-in-supply-chains/an/SMR029-PDF-ENG?Ntt=bullwhip