What is the bullwhip effect
The bullwhip effect can be described as a series of events that leads to supplier demand variability up the supply chain. Trigger events include the frequency of orders, varying quantities ordered, or the combination of both events by downstream partners in a supply chain. As the orders make their way upstream, the perceived demand is amplified and produces what is known as the bullwhip effect (1).
The bullwhip effect has been perceived as an unavoidable effect of demand variation. Only recently have companies begun to tackle the ripple associated with variances in demand. The key to stemming the effect is realizing who is signaling the change in demand. Is it the manufacturer, distributor, the retailer, or the customer? Knowing where the demand shifts are originating is vital to attacking this problem.
How to manage it
There are a few methods that can be utilized to minimize the bullwhip effect. These methods are:
- Portfolio approach
- Information sharing between supply chain members
1. Portfolio planning
Portfolio planning places an emphasis on diversifying the supply base. Portfolio planning’s goal is to involve one or two suppliers in long-term contracts to cover a majority of the expected demand. The remaining demand is fulfilled by a smaller base of suppliers with short-term contracts who can respond quickly to changes in demand. These short-term contract suppliers receive a premium, because they are bearing the risk in this situation. Yet this short-term contract relationship with these suppliers allows the manufacturer to quickly adjust to shifts in demand.
The portfolio approach attacks procurement issues by diversifying the manufacturer’s risk, much like a financial planner would protect a client from wild swings in the stock market. This approach protects against uncertainties that are out of the manufacturer’s control.
For instance, a company that has exclusive long-term contracts with only one or two suppliers may choose the portfolio approach. It mitigates risk by giving these suppliers long-term contracts to handle up to 90 percent of expected demand. The remaining demand should then be covered through short-term contracts “with slightly higher unit prices but guaranteed availability, to cover uncertainties in demand variability (2).”
Hewlett Packard has recently adopted this approach in some aspects of its business. During the 90s, Hewlett Packard “transitioned from a full-time employee-only labor force to embrace a mix of full-time employees, part-time contractors, consultants and temps. By using a diversified mix of labor resources, HP increased its flexibility to match supply (labor) with demand, and reduced labor costs by 13% (2).”
Postponement is a concept in which the manufacturer delays completing, as much as possible, the final features of a product. Final assembly is normally done in regional distribution centers because these sites are closer to the customer than the manufacturing facility. For example, a canned corn manufacturer distributes its corn for various grocery store retailers. The distributor waits to see what grocery stores demand before labeling cans of corn under each grocer’s brand name.
Postponement is most successful in an environment that cannot forecast product assortments very well, but can aggregate end-user demand and delay the final step or steps in completing a product. Because the manufacturer can accurately judge the overall demand of a product category, the distributor can wait until the moment when the demand for a particular product is realized. The distributor can then differentiate the product quickly and the customer will be served better.
Hewlett Packard sells its printers in almost every country. It can forecast overall demand for its printers, but trying to pinpoint what country they will be sold in is very difficult. Because different countries employ different power requirements and the language varies (pertinent to user manuals), Hewlett Packard redesigned its printer so that it could wait until demand materializes and then add these country-specific items at its regional distribution centers rather than at central factories (3).
3. Information sharing
Information sharing involves supply chain members actively engaging in swapping final customer demand information. Information sharing is best exploited in an environment where customer demand is relatively stable. It is also the most intensive approach because of the degree of information sharing and coordination involved with the supply chain members.
Once the members of a supply chain group have decided that each member can improve operations by sharing information, the group can discuss how information visibility upstream will help diminish the bullwhip effect. The supply chain members can employ final customer demand information to more smoothly plan each individual’s planning function to optimize the entire supply chain. Retailers can share point-of-sales data with the upstream members so that these groups can have a clear understanding of what the real demand is for a particular product.
One of the most cited examples of demand variability difficulties involved one of Procter & Gamble’s best-selling items, Pampers. It is well documented that the customer demand for diapers does not fluctuate significantly. Yet, Procter & Gamble was faced with a substantial degree of variability in orders from its retailers, and this variance was amplified further up the supply chain to its own suppliers. After investigating why this was happening, Procter & Gamble discovered that the primary causes of the bullwhip effect were the demand signaling from its distributors; order batching, when distributors would order on an infrequent basis; changes in prices by the manufacturer; and distributors placing multiple orders when it is not certain that the manufacturer can meet the distributor’s demand. Armed with this knowledge, Procter & Gamble now employs “vendor-managed inventory (VMI) in its diaper supply chain, starting with its supplier, 3M, and its customer, Wal-Mart.” Manufacturers need to recognize these issues and exploit them in order to minimize the bullwhip effect.
(1) H. Lee, V. Padmanabhan, and S. Whang. “The Bullwhip Effect in Supply Chains,” Sloan Management Review, Spring 1997, 93-102.
(2) Billingham, C. (2002). HP Cuts Risk with Portfolio Approach. Purchasing.Com.
(3) Billingham, C. and Amarel, J. (1999). Investing in Product Design to Maximize Profitability Through Postponement. ASCET.com.