LESSON 2 The Bullwhip Effect 29 August 2014

Lesson Objectives Upon completion of this lesson, you should be able to: Illustrate a single-product supply chain for a given scenario Predict the impact of the bullwhip effect on a supply chain for a given scenario Identify common causes of the bullwhip effect Differentiate between installation and echelon inventory policies Prepare a collaborative inventory policy among supply chain partners Identify strategies that contractors use to mitigate the bullwhip effect

Lesson Topics This lesson will cover the following topics: Single-Product Supply Chains The Bullwhip Analogy Causes of the Bullwhip Effect Inventory Replenishment Policies Collaborative Inventory Policy Strategies to Mitigate the Bullwhip Effect

Lesson Introduction What is the bullwhip effect and how does it influence supply chains? How can you mitigate it with inventory policies and supply chain management practices?

What’s In It For Me? Your ability to recognize the bullwhip effect and understand methods for mitigation will enable you to effectively monitor your contractors’ supply decisions and their efforts to coordinate their supply chain Consumer Retailer Distributor Wholesaler Producer

Single-Product Supply Chains Lesson Topics: Single-Product Supply Chains The Bullwhip Analogy Causes of the Bullwhip Effect Inventory Replenishment Policies Collaborative Inventory Policy Strategies to Mitigate the Bullwhip Effect

Single-Product Supply Chains Supply chains consist of links through which a product reaches the consumer: Lack of communication, delays, customer uncertainty, etc., ripples along the supply chain … and result in a bullwhip effect Producer Wholesaler Distributor Retailer Consumer Uncertainty Delays Demand Time Orders

Example: Proctor & Gamble Retail sales of Pampers showed minimal variability from the consumer Distributors’ orders showed a lot of fluctuation Orders erratic Orders fluctuated Orders steady Consumer Retailer Distributors Suppliers

Example: Proctor & Gamble (cont.) The variabilities did not make sense If diapers are consumed at a steady rate, why does demand fluctuation increase up the supply chain? Proctor & Gambler (P&G) called this phenomenon of increasing demand fluctuations throughout the supply chain the bullwhip effect

What does the bullwhip phenomenon represent to supply chain members? Question and Answer What does the bullwhip phenomenon represent to supply chain members? Demand fluctuations throughout the supply chain Economies of scale are not being used Reduced order lead times Strategic alliances are occurring

Exercise: The Cotton Ball Game Small Group Exercise: Teams of 4-6 students Refer to Module 7, Lesson 2, Exercise 1 CME130_M7_L2_E1_Exercise_FINAL.docx CME130_M7_L2_Cotton_Ball_Game_Worksheet.xlsx Read directions in the exercise Complete the activity; be prepared to share your responses Time allowed: 1 hour

Frustrated Confused Disappointed Exercise Discussion How did you feel playing the game? Did you and your team feel in control? Did you trust your supply chain? Did you find yourself blaming others for your team’s supply chain problems? Frustrated Confused Disappointed

The Bullwhip Analogy Lesson Topics: Single-Product Supply Chains Causes of the Bullwhip Effect Inventory Replenishment Policies Collaborative Inventory Policy Strategies to Mitigate the Bullwhip Effect

The Bullwhip Analogy Consumer Retailer Distributors Suppliers

Impact of the Bullwhip Effect Likely implications are: Increased need for safety stock to maintain a certain service level Increased costs due to overstocking throughout the system Inefficient use of resources (labor, transportation, etc.)

Customer Demand: Perception Perception of customer demand Week Number of product 12 10 8 6 4 2 2

Supply Chain Members’ Demand Number of product 10 Manufacturer Wholesaler 8 Distributor 6 4 2 Retailer Week 2 12

Exercise Observations Players cut orders to reduce inventory costs Suppliers see reduction as declining demand Suppliers reduce orders Retailers see a jump in consumer demand and order extra in an attempt to fill the pipeline

Exercise Observations (cont.) Suppliers see higher orders as a signal of increasing demand Backlogs develop Impatience sets in Orders increase Backlog situations turn into excess inventory situations

Centralizing Customer Demand Information Reduces the bullwhip effect and its impact on each member of the supply chain Enables each stage of the supply chain to use actual customer demand data to estimate average demand The bullwhip effect still exists even when demand data is centralized

Question and Answer When supply chain members cut orders to reduce inventory or costs, what can this signal to other supply chain members? A jump in consumer demand Backlogs signal increase in orders Reductions signal declining demand Work-In-Process (WIP) inventory costs are declining

What can result from backlog situations? Question and Answer What can result from backlog situations? Excess inventory Lead times decrease Price increases Reduction in inventory

Causes of the Bullwhip Effect Lesson Topics: Single-Product Supply Chains The Bullwhip Analogy Causes of the Bullwhip Effect Inventory Replenishment Policies Collaborative Inventory Policy Strategies to Mitigate the Bullwhip Effect

Causes of the Bullwhip Effect (1 of 6) Lack of Coordination: When each link in a supply chain tries to maximize its own benefit, the overall effectiveness suffers Inefficiencies arise when the links in a supply chain optimize individually instead of coordinating efforts

Causes of the Bullwhip Effect (2 of 6) Lack of Communication: Lack of communication between each link in the supply chain makes it difficult for processes to run smoothly

Causes of the Bullwhip Effect (3 of 6) Order Batching: Managers at different supply chain links perceive product demand differently They order larger/smaller amounts of a product than what is needed due to an over/under reaction to the supply chain

Causes of the Bullwhip Effect (4 of 6) Shortage Gaming: Customers order more than they need during a period of short supply, hoping that the partial shipments will be sufficient Inflated orders placed by supply chain occupants during shortage periods tend to boost the bullwhip effect

Causes of the Bullwhip Effect (5 of 6) Demand Forecast Inaccuracies: Using past demand to estimate current demand does not take into account fluctuations that occur over a period of time

Causes of the Bullwhip Effect (6 of 6) Lead Time: Physical delays and information delays Price Fluctuations: Cause uneven production Distort demand information

Question and Answer What behavior is involved when managers order quantities that differ from what is needed due to an overreaction to the supply chain? Lead Time Order Batching Price Fluctuations Shortage Gaming

Question and Answer Which bullwhip effect cause involves both physical and informational delays? Lead Time Order Batching Price Fluctuations Shortage Gaming

Question and Answer Which bullwhip effect cause stems from supply chain members placing inflated orders during shortage periods? Lead Time Order Batching Price Fluctuations Shortage Gaming

Inventory Replenishment Policies Lesson Topics: Single-Product Supply Chains The Bullwhip Analogy Causes of the Bullwhip Effect Inventory Replenishment Policies Collaborative Inventory Policy Strategies to Mitigate the Bullwhip Effect

Inventory Replenishment Policies The choices we make influence our supply chain’s performance Following an inventory policy will help us and our supply chain members perform better to reduce the bullwhip effect

Policy 1: Installation (On-Hand) Inventory Policy Base replenishment orders on inventory target levels and on-hand inventory at your installation only Try to maintain some target of on-hand inventory When you fall below your target, order enough to get back up to the target level

Weaknesses of the Installation Inventory Policy Doesn’t take into account delays in the transmission of information or delays in the flow of goods Ordering today’s shortfall from an on-hand inventory target isn’t very effective (especially since the order won’t arrive for several days)

Policy 2: Echelon Stock Policy Echelon stock is: NOTE: This amount may be negative if backorders exist! All downstream supply chain inventory On-hand Inventory On-order + Base your target inventory levels and replenishment orders on all inventory at the location and all inventory at lower levels in the supply chain

How to Use an Echelon Stock Policy Keep all downstream supply chain echelons (toward the retailer) in mind Keep an even wider perspective (upward and downward) of the supply chain During each period, order enough to raise the echelon stock to a target level. The inventory in the supply chain (inventory on-order plus your link downstream) will remain constant.

Which is the Best Inventory Replenishment Policy? The Echelon Stock Policy is the best of the two Each link of the supply chain is ordering what the customers at the (retail) end of the supply chain demanded Such customer demand information is called point- of-sale (POS) data Echelon Stock Policy results in: Lowest inventory Lowest cost Most responsive supply chain

Would an Echelon Stock Policy Work in The Cotton Ball Game? Echelon Stock Policy results in: Less time to respond to changes Only one level of forecasting Elimination of the demand signal traveling up to the manufacturer (in the form of orders) The manufacturer can see and respond to changes in demand instantaneously This policy would avoid amplification of signals that occur when each level observes and reacts to increased/ decreased demand

Question and Answer An Installation (On-Hand) Inventory Policy bases its replenishment orders from inventory at which location? Manufacturer and distributor’s location Individual member’s location Individual member’s and retailer’s location Retailer’s location

Question and Answer An Echelon Stock Policy bases replenishment orders from inventory at what location? Manufacturer and distributor’s location Individual member’s location, on-order inventory, and all downstream members in the supply chain Individual member’s location and all upstream members in the supply chain Retailer’s location

Collaborative Inventory Policy Lesson Topics: Single-Product Supply Chains The Bullwhip Analogy Causes of the Bullwhip Effect Inventory Replenishment Policies Collaborative Inventory Policy Strategies to Mitigate the Bullwhip Effect

Collaborative Inventory Policy Inventory policy that encompasses the entire supply chain Requires collaboration among all supply chain partners: Integrated information-sharing Integrated business processes Integrated decision-making

Integrated Information-Sharing To determine the daily production quantity at the factory, the Manufacturer needs to know what was demanded by customers at the retailer that day Consumer Retailer Distributors Suppliers POS data Integrated information-sharing

Integrated Business Processes The Wholesaler and Distributor would need to follow the rules and could not hold inventory at their locations Consumer Retailer Distributors Suppliers Integrated business process

Integrated Decision-Making All Locations would need to collaborate on the design of this policy and agree to follow the processes that it entails. They would also need to agree on the demand forecast and safety stock Consumer Retailer Distributors Suppliers Integrated decision-making

Inventory Order Policy- Producer/Manufacturer The daily production decisions determine how much inventory will be added to the supply chain This decision will be responding to retail demand, and not to orders from the Wholesaler

Inventory Order Policy- Wholesaler and Distributor Your role is to place orders according to the plan Ship whatever they receive

Inventory Order Policy- Retailer Your role is to: Satisfy customer demand from available inventory Order according to the plan

Question and Answer When POS or retail demand data is sent from the consumer directly to the Manufacturer, this results in which integrated component? Integrated business processes Integrative decision-making Integrated information-sharing All of these

Question and Answer Which of the 3 integrative components describes supply chain members collaborating on the design of an inventory policy and agreeing to follow the demand forecast? Integrated business processes Integrative decision-making Integrated information-sharing All of these

Exercise: The Cotton Ball Game Part 2 Small Group Exercise: Same original teams and team members Refer to Module 7, Lesson 2, Exercise 2 CME130_M7_L2_E2_Exercise_FINAL.docx CME130_M7_L2_Cotton_Ball_Game_Worksheet.xlsx Read the directions in the exercise Complete the activity; be prepared to share your responses Time allowed: 1.5 hours

Pleased Satisfied Enlightened Exercise Discussion How did you feel playing the game a second time? Were you and your team more in control this time? Was there more trust between supply chain members? How did this occur? How well did communication play a role in managing a collaborative supply chain? Pleased Satisfied Enlightened

Strategies to Mitigate the Bullwhip Effect Lesson Topics: Single-Product Supply Chains The Bullwhip Analogy Causes of the Bullwhip Effect Inventory Replenishment Policies Collaborative Inventory Policy Strategies to Mitigate the Bullwhip Effect

Strategies to Mitigate the Bullwhip Effect We’ve experienced some of the causes leading to a bullwhip effect: lack of communication, poor inventory policies, long lead times, order batching, poor information sharing

Electronic Data Interchange (EDI) An electronic computer-to-computer exchange of data Aim - reduce the need for paper transactions Standards vary among industries but formats include: Benefits - near real-time data and accurate information-sharing for better decision-making Purchase orders, invoices, bill of lading American National Standards Institute (ANSI), Electronic Data Interchange for Administration, Commerce and Transport (EDIFACT), TRADACOMS, and Extensible Markup Language (XML)

Efficient Consumer Response (ECR) Consumer-pulled system using POS information Used in the Grocery/Food Service Industry Aim - to improve efficiency of the supply chain and reduce costs 4 Specific Strategies: Collaboration in product development Efficient product introduction = Carrying the best mixture of products Efficient store assortment = Right product, quantity, location, time Efficient replenishment = Cost efficient marketing plan Efficient promotion =

Vendor Managed Inventory (VMI) Process where vendors create orders for customers based on POS demand information sent through EDI Aim - improve supply chain performance by reducing inventories and eliminating stock-out situations Benefits Inventory can be placed where it is needed Better, equitable service levels for customers Eliminates fictitious orders that drive bullwhip

Collaborative Planning Forecasting and Replenishment (CPFR) The practice of collaborating among supply chain partners in the planning and fulfillment of customer demand Aim - increase product availability to the customer while reducing inventory, transportation and logistics costs Links sales and marketing practices to supply chain planning and execution processes

Milk Runs One truck picks up from many suppliers and delivers to one customer Supplier 1 2 3 Customer

Peddle Route One truck picks up from one supplier and delivers to many customers Supplier Customer 1 Customer 2 Customer 3

Cross Docking Receiving product from one location and delivering it directly to the customer with little or no material- handling in between Benefits - Reduce labor costs, lead times, storage space Various types of cross docking

Manufacturing Use of Cross Docking Receiving purchased and inbound products required by manufacturing The warehouse may receive the products and prepare subassemblies for the production orders Offload raw material Send to Work Centers for production

Retail Use of Cross Docking Receiving products from multiple vendors and sorting them onto outbound trucks for a number of retail stores Refined by Wal-Mart in the 1980s Receive product Load onto outbound trucks Send to retail stores

Distributor Use of Cross Docking Consolidating inbound products from different vendors into a mixed product pallet Pallet is delivered to the customer when the final item is received Receive products Consolidate products together Send to customers

Postponement Decisions on where to postpone goods in the supply chain Benefits Lower inventory costs Lower risk of unsold items Faster response to customers Lower shipping costs Two types of delay strategies: Time Postponement Form Postponement

Time Postponement Delaying delivery of a product until customer demand is known This allows for inventory to be reduced since there is minimal need to maintain large stocks at distribution centers

Form Postponement Occurs in 2 stages: Parts common to more than one model are used to build a generic product platform The semi-finished product is shipped to markets where high value parts will be later added when a customer’s order is received

What strategy is primarily used in the Grocery Industry? Question and Answer What strategy is primarily used in the Grocery Industry? Efficient Consumer Response (ECR) Milk Runs Postponement Strategic Vendor Exchange

Question and Answer What strategy involves moving product from one location and delivering it directly to the customer with little or no material-handling in between? Postponement Cross docking Electronic Data Interchange (EDI) Peddle Routes

Question and Answer This is the process where the vendor creates orders for its customers based on POS demand information sent through EDI. Milk Runs Peddle Route Postponement Vendor Managed Inventory (VMI)

Question and Answer What transportation strategy accumulates goods from a number of suppliers on a single truck for delivery to one customer? Electronic Data Interchange (EDI) Milk Runs Peddle Route Postponement

Case Study Activity Individual Activity Refer to the Dell case study on page 76-77 Identify indicators of the bullwhip effect and mitigation strategies references within the interview Be prepared to share your responses

Summary (1 of 3) Having completed this lesson, you should now be able to: Illustrate a single-product supply chain for a given scenario Predict the impact of the bullwhip effect on a supply chain for a given scenario Identify common causes of the bullwhip effect

Summary (2 of 3) Differentiate between installation and echelon inventory policies Identify strategies contractors use to mitigate the bullwhip effect

Summary (3 of 3) Your understanding of the bullwhip effect, its impact, and mitigation strategies will enable you to recognize when your suppliers are struggling with these challenges and to provide support toward remedying the problem.