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Bullwhip Effect
BUSM 361 Sec. 2 November 28, 2005,Jeremy Leishman, Jed Robison, Chris Rogers, Sarajane ZarbockWhat is the Bullwhip Effect?
Original text on www.freequality.org
The bullwhip effect is the magnification of demand
fluctuations, not the magnification of demand.
The bullwhip effect is evident in a supply chain when demand increases
and decreases. The effect is that these
increases and decreases are exaggerated up the supply chain.
The essence of the bullwhip effect is that orders to suppliers tend to have larger variance than sales to the buyer. The more chains in the supply chain the more complex this issue becomes. This distortion of demand is amplified the farther demand is passed up the supply chain.
Proctor & Gamble coined the term “bullwhip
effect” by studying the demand fluctuations for Pampers (disposable
diapers). This is a classic example of
a product with very little consumer demand fluctuation. P&G observed that
distributor orders to the factory varied far more than the preceding retail
demand. P & G orders to their material suppliers fluctuated even more.
Babies use diapers at a very predictable rate, and
retail sales resemble this fact.
Information is readily available concerning the number of babies in all
stages of diaper wearing. Even so
P&G observed that this product with uniform demand created a wave of
changes up the supply chain due to very minor changes in demand.
Example of the Bullwhip Effect
The graphical
representations above show the bullwhip effect between two supply chain
partners. It can be seen that the
Distributor orders to the factory experience demand fluctuate far more
drastically than the retail demand.
Over time as the Distributor builds inventory and fulfills orders, it
communicates very different demand levels to the upstream factory by the order
amounts it requests. This becomes more
complicated the farther up the supply chain we go. Some of the reasons that the bullwhip effect occurs include the
following:
- Over reacting to the backlog orders.
- Little or no communication between
supply chain partners.
- Delay times between order processing,
demand, and receipt of products.
- Order batching: method for reduction
of ordering costs due to price discounts for bulk ordering, transportation
expense decrease by ordering full-truck loads, etc.
- Limitations on order size (i.e.
retailers can order products in cases of 10 from wholesaler; however,
distributors receive orders in cases of 1,000)
- Inaccurate demand forecasts.
- Free return policies.
How do costs increase?
Excess raw materials costs arise from the last minute
purchasing decisions made to accommodate an unplanned increase in demand. The
result of these panicked buying periods is an inventory of unused
supplies. As these unused supplies
grow, so do the associated costs.
Excess capacity during periods of low volume of
demand is followed by inefficient utilization and overtime expenses incurred
during high demand periods. This is
made worse by the excess warehousing expenses that are incurred because of
unused storage space, as well as increases in shipping costs caused by premium
rates paid for last minute orders..
How to remedy the Bullwhip Effect
When the bullwhip effect is first
identified in a supply chain, it is important to identify the problem
areas. The following areas are places
in the supply chain that should be considered when trying to decrease the
bullwhip effect. Although many of these
areas many seem like proper business practices, the reality is that they
diminish the efficiency of the supply chain.
Once changes are made in these areas, the productivity and timeliness of
the supply chain will increase greatly and the bullwhip effect will be
dramatically lessened.
1. Demand Signal
Processing
·
Retailers
often use realized demand as an indicator of future demand.
·
Inference
and data dependency problems.
2. Rationing
Gaming
·
Used when
demand outstrips supply.
·
Rationing
might indicate internal problems that limit meeting supply goals.
3. Order Batching
·
Used because
organizations are attempting to obtain benefits from large-volume pricing
discounts and reduced costs of transportation.
·
Can lead to
large inventory volumes and misleading demand figures for upstream suppliers.
4. Price Variations
·
Used to
position suppliers that are involved in market share wars with other suppliers.
·
Might cut
off established relationships in efforts to “shop around” for a better price.
Where to get more information
An extensive amount of research has been completed on
what causes the bullwhip effect and how to remedy the problems it causes. The following is a list of resources where
more information can be found on this topic:
Baganha, M. and M.
Cohen (1998) “The Stabilizing Effect of Inventory in Supply Chains,” Operations Research.
Baljko, J. (1999a)
“Expert Warns of ‘Bullwhip Effect’,” Electronic
Buyers’ News, July 26.
Cachon, G. (1999) “Managing supply chain demand
variability with scheduled ordering policies,” Management Science.
Cachon, G. and M. Fisher (2000) “Supply
Chain Inventory Management and the Value of Shared Information,” Management Science.
Cachon, G. and M. Lariviere (1999)
“Capacity Choice and Allocation: Strategic Behavior and Supply Chain
Performance,” Management Science.
Bibliography
Lee, H., P. Padmanabhan and S. Whang
(1997) “Information Distortion in a Supply Chain: The Bullwhip Effect,” Management Science, 43, 546-558.
Croson, Rachel;
Donohue, Karen; Katok, Elena; Sterman, John (2003) “Supply Chain
Management: A Teaching Experiment,” Second Asian Conference on Experimental
Business Research.