Logistics practitioners and academics have long been aware of the "bullwhip" phenomenon in supply chains: As demand for a product filters back up the chain from the consumer toward the original source of the component raw materials, that demand becomes more and more erratic and swings in larger and large cycles. These swings in demand often create excess capacity, excess inventories, as well as poor customer service in the supply chain, as myopic producers and suppliers seek to deal with them. In this article, Prof. Lee and his Stanford colleagues analyze the bullwhip effect, identifying the causes of it, and suggesting several ways to reduce or mitigate the phenomenon. Those who want a more technical exposition of this research may want to see the companion article by the same authors, "Information Distortion in a Supply Chain," Management Science, Vol. 43, No. 4 (April 1997) pp. 546-558.
According to the authors, four factors cause the bullwhip effect:
They argue that to counteract the effect, firms must modify the supply chain’s infrastructure and related processes. We will briefly summarize each factor and discuss the authors’ recommended antidote for each.
Demand forecast updating. Ordinarily, every company in a supply chain forecasts its demand myopically--that is by looking at the past demands they have faced from their own direct customers. Since each upstream chain member sees fluctuations in demand caused by the bullwhip effect from downstream, that member orders accordingly, creating further swings for the upstream suppliers. This occurs even when the ultimate demand is relatively stable. One obvious way to counteract this forecast effect is for all members of a supply chain to use the same basic demand data coming from the furthest downstream points. Technologies such as point-of-sale (POS) data collection, electronic data interchange (EDI), vendor-managed inventories (VMI), as well as lead time reduction can all help to reduce the problem.
Order batching. Companies placing orders on upstream suppliers usually do so periodically, ordering a batch of an item to last several days or weeks, thus reducing transportation costs or transaction costs or both. These tactics contribute to larger demand fluctuations further up the chain. Here the authors suggest reducing transaction costs through various forms of electronic ordering, offering discounts for mixed-load ordering (to reduce the demand for solid loads of one product), and the use of third party logistics providers to economically combine many small replenishments for/to many suppliers/customers.
Price fluctuation. Frequent price changes--both up and down--lead buyers to purchase large quantities when prices are low, and avoid buying when prices are high. A common practice in the grocery industry, this forward buying creates havoc upstream in the supply chain. The answer here is for sellers to stabilize prices (e.g. "every day low prices"). Activity-based costing systems which highlight the excessive costs in the supply chain caused by price fluctuations and forward buying also can help provide the incentive for the entire chain to operate with relatively stable prices.
Rationing and shortage gaming. Cyclical industries face alternating periods of oversupply and undersupply. When buyers know that a shortage is imminent and rationing will occur, they will often increase the size of their orders to insure they get the amounts they really need. To counteract this behavior, Lee and his colleagues advocate allocation of demand among customers based on past usage, not on present orders. Furthermore, they encourage more open sharing of sales, capacity, and inventory data so that buyers are not surprised by shortages.
This is an excellent article that summarizes several well-known initiatives already being taken in various industries to deal with this common and widespread problem known as the bullwhip effect. Firms not using these techniques might well consider implementing one or more of them, and encouraging their trading partners in the supply chain to do so as well.