Monday, February 24, 2014

Taming the "Bull"whip Effect

In recent years, the size of the supply chain network has increased, dependencies among entities and functions have shifted, the speed of change has accelerated, and the level of transparency has decreased. Overall, developing a product and getting it to the market requires more complex supply chains needing a higher degree of coordination.
This has resulted in issues like:
  • Manufacturers producing 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 finding 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.
  • The bullwhip effect: Ordering/producing in large lots can also increase the safety stock of suppliers and its corresponding carrying cost.  It can also create what’s called the bullwhip effect.

The Bullwhip Effect:

The bullwhip effect is the phenomenon of orders and inventories getting progressively larger (more variable) moving backwards through the supply chain.  Because customer demand is rarely perfectly stable, businesses 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".
Some of the causes of variability that leads to the bullwhip effect includes:
  •  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 and hence 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.

Coping with the bullwhip effect:

Centralizing demand information occurs when customer demand information is available to all members of the supply chain.  This information can be used to better predict what products and volumes are needed and when they are needed such that manufacturers can better plan for production.  However, even though centralizing demand information can reduce the bullwhip effect, it will not eliminate it.  Therefore, other methods are needed to cope with the bullwhip effect which include:
  • 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 EDI (electronic data interchange).
  • Strategic partnerships.  The use of strategic partnerships can change how information is shared and how inventory is managed within the supply chain.  

Techniques for improving inventory management include:
  • 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, and has been used very successfully by WalMart and Xerox among others.
  •  Delayed differentiation.  This involves adding differentiating features to standard products late in the process.  For example, Bennetton decided to make all of their wool sweaters in undyed yarn and then dye the sweaters when they had more accurate demand data.  Another term for delayed differentiation is postponement.
  • 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.  Companies such as Dell use this approach. 

These challenges provide a huge scope for the executives to improve in the above-discussed areas where supply chain managers are looking for quicker response to fast and ever-changing market conditions.


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