Bullwhip - forester effect

The causes of bullwhip - forrester effect

Research Paper (postgraduate) , 2011 , 7 Pages , Grade: 9,5 of 10

Business economics - Supply, Production, Logistics

The phenomenon where orders to the supplier tend to have larger variance than sales to the buyer (i.e. demand distortion), and the distortion propagates upstream in an amplified form (i.e. variance amplification)” is a simple yet precise definition of the bullwhip effect. With this definition as a reference point I will in this assignment investigate the bullwhip effect.

Supply network costs account for a significant proportion of a company’s costs. On average supply network costs in a pharmaceutical company is 9% of total costs and in supply companies on average 15%. We see significant differences, up to 12%, between “best in class” companies and the average company.

Table of Contents

1.0 Introduction

2.0 Implications of the Bullwhip effect

3.0 Two causes of the Bullwhip Effect
3.1 The rationing game
3.2 Order batching

4.0 Conclusion

5.0 References

1.0 Introduction

“The phenomenon where orders to the supplier tend to have larger variance than sales to the buyer (i.e. demand distortion), and the distortion propagates upstream in an amplified form (i.e. variance amplification)” is a simple yet precise definition of the bullwhip effect (Lee, V. et al. 1997) With this definition as a reference point I will in this assignment investigate the bullwhip effect. Supply network costs account for a significant proportion of a company’s costs. On average supply network costs in a pharmaceutical company is 9% of total costs and in supply companies on average 15%. We see significant differences, up to 12%, between “best in class” companies and the average company. Combined with evidence from DuPont(Weele 2010), where an example illustrates that a 2% cost reduction, can lead to a 25% increase in RONA¹, it is clearly crucial for companies to manage their supply network effectively and efficiently. In order to do so they must, among others, tame the bullwhip. Depending on context, taming the bullwhip may increase product profitability up to 30% (Metters 1997) (Rinks 2002) and reduce supply network costs with 50%. (Rinks 2002)

I will start out by identifying and analysing the implications of the Bullwhip Effect.

Six major causes of the bullwhip effect have been identified in related literature. These are: demand signal processing, lead times, the rationing game, order batching, price variations and level of intermediaries in the supply network. I will, due to taut word count, limit my exploration to two causes, namely the rationing game and order batching.

Before we move on, please consider the simple example beneath, which clearly depicts the bullwhip effect in a simple two echelon supply network. Inventory has been set to; 2 * observed demand, which is quite realistic. Note how dramatically the variance increases from one echelon to another.

Abbildung in dieser Leseprobe nicht enthalten

2.0 Implications of the Bullwhip effect

The key issue when discussing the Bullwhip Effect and the implications hereof is the creation and amplification of variance and volatility as we move upstream in the supply network. Variance and volatility in supply networks have several negative impacts throughout the outwork and to all intermediaries.

- Increased stock levels
- To prevent stock-outs companies applies forecasting techniques and safety stock calculations. With increased variance and volatility, forecasting is less precise and hence safety stock must be increased to prevent stock outs. Higher stock levels increases inventory costs and may require additional warehouse facilities.
- Decreased customer service/satisfaction
- The increase in variance and volatility and the corresponding less precise forecasts, causes longer lead times for customers and increased risk of stock outs.
- Inefficient use of resources
- Increased variance and volatility furthermore affects the manpower required from one period to another, which increases hiring/firing and training costs or leads to inefficient use of manpower
- Increased variance and volatility causes less efficient production planning, e.g. machine utilization, purchase of supplies etc.
- Inefficient use of transport, i.e. unfilled trucks, extra routes etc.

Decreased profitability is the combined result of the implications above and as I described in the introduction, the decrease in profitability can be substantial.

3.0 Two causes of the Bullwhip Effect

3.1 The rationing game

Has strong connections and similarities to Nash Equilibrium.² The rationing game is essentially a game between companies to ensure sufficient supply.

The rationing game is triggered by upswing in demand or suspicion from buyers that supplies will be scarce.(Miragliotta 2006; Simchi-Levi, Kaminsky et al. 2008)

When a buyer suspects that demand will be scarce or he/she will be subject to rationing, the buyer has an incentive to inflate orders - hoping to satisfy “true” demand. In the example beneath we consider a supplier with 5 customers, whose real demand of 26 is higher than the suppliers’ current capacity of 20. The supplier applies a simple³ allocation formula; Customer demand x capacity /total customer demand = allocation to customer. In the first example none of the customers has been able to predict the shortage or deduct the supplier’s allocation strategy. None of the customers has true demand satisfied.

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¹ Return on net Assets

² I.e. company X makes the best decision it can, taking company Y’s decision into account, and company Y makes the best decision it can, taking company X’s decision in consideration.

³ To simple to be realistic, but useful in exemplifying the concept of inflated orders.

• College: Griffith University (MBA)
• Course: Strategic Supply Chain Management
• Grade: 9,5 of 10
• Author: Lasse Skaksen (Author)
• Publication Year: 2011
• Pages: 7
• Catalog Number: V233409
• ISBN (eBook): 9783656500223
• ISBN (Book): 9783656501732
• Language: English
• Tags: bullwhip