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Bullwhip EffectBUSM 361 Sec. 2 November 28, 2005,Jeremy Leishman, Jed Robison, Chris Rogers, Sarajane Zarbock
What 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.
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.