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The Bullwhip Effect: Is there a Solution?

Dr. Syed Shahabuddin, Central Michigan University, Mount Pleasant, MI ABSTRACT Many researchers are concerned about what causes the bullwhip effect and, more importantly, how to reduce or eliminate it. The bullwhip effect has undesirable consequences for the supply chain, such as inaccurate forecasts, inefficiency, and waste. Even though the bullwhip effect can be explained, it cannot be controlled, at least not in the current business and economic climate. For good or ill, control would require a degree of cooperation and openness among all members of a supply chain that is antithetical to the secrecy and competitiveness of free-market systems. Therefore, we must be satisfied with better understanding the causes and consequences of the bullwhip effect. Key words: Supply chain, bullwhip effect, economies of scale INTRODUCTION The bullwhip effect is a major concern for companies in a supply chain. The bullwhip effect has been defined as demand order variabilities in supply chains are amplified as they move up the supply chain (Goyal, 2002). In other words, the bullwhip effect refers to the fluctuation of orders (and thus inventory) as they move up the supply chain and as each organization reacts to solve, from its own perspective, its inventory or production problems. This variability becomes more severe when there are many members in the supply chain. The bullwhip effect is a concern for supply chain members, because variability of demand within the chain creates too much inventory and an inefficient supply chain. That is, the bullwhip effect increases orders resulting in higher cost of inventory, lower reliability of operations, and fluctuation of inventory. One way to reduce the bullwhip effect is for all members of supply chain to work together to plan and coordinate. However, plans require forecasts. Most forecasts have errors, and errors increase as one moves up the supply chain. Wheatley (2004) has stated that "the most common cause [of the bullwhip effect] is the amplification of the inherent uncertainty that surrounds forecasts" (p. 1). According to an Accelerated Analytics (2009), even though there will be less fluctuation at POS, the forecast becomes chaotic and unpredictable as it moves up the chain. A fluctuation in actual customer demand of 5 percent will be interpreted by supply chain participants as a change in demand of up to 40 percent. As shown in Figure 1, the actual demand may only change 5, but the upstream members reactions are exaggerated, thus the bullwhip effect, which the U.S. Department of Commerce estimates accounts for $3 trillion in excess inventory in the U.S. and European supply chain.
Figure 1

Bullwhip Effect

Source: Accelerated Analytics (2009)

Procter and Gambles experience with the volatility of demand has been cited by many researchers. Procter and Gamble believed that volatility would not occur, because its consumer demand was reasonably stable. Holt, Modigliani and Shelton (1968) noted a similar misperception among television set manufacturers; Hammond (1994) observed it in the pasta supply industry; Lee, Padmanabhan, and Whang (1997b) noticed it among soup companies;

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and Anderson, Fine, and Parker (2000) were concerned with the substantial volatility in the machine tool industry. Many similar fluctuations have been observed in the semiconductor equipment industry, which has been more volatile than the personal computer industry. Ironically, some researchers, such as Sterman (1992), have found the same perceptions about volatility even when subjects managed a fictitious supply chain (i.e., the beer game). Proctor and Gamble also experienced fluctuation among its wholesale orders over time but found that its orders for raw materials fluctuated even more than its wholesale orders. A similar problem has been experienced by other companies in their internal supply chains (Baljko 1999a, 1999b). Baganha and Cohen (1998) have discussed empirical evidence of order fluctuation in industries with high levels of order variation, and Kahn (1987) even presented a macroeconomic proof of the relationship among order volatility, inventory, and cost. However, the proof assumes that supply chains work perfectly according to supply chain principles, i.e., that all members in the supply chain share information and are genuine partners in the system, working together to achieve the most efficient supply chain. CAUSES AND MEASUREMENTS Lee, Padmanabhan, and Whang (1997a) have argued that the problem with solving the bullwhip effect is that it has no single identifiable cause. However, the bullwhip effect occurs mostly for the following reasons (Carlsson and Fuller (2002)), all of which have unacceptable consequences for everyone in the supply chain:
1. Many or all members of the supply chain react to inventory and order fluctuations in their own ways; 2. Not all members share information about supply and demand with the others; 3. Not all members coordinate with other chain members; 4. Many or all members pursue their own goals of minimizing costs and maximizing profit; 5. Batch processing requires producing a certain quantity to be efficient; 6. Discount pricing to encourage sales; and 7. Uncertain demand conditions.

Economists and operations management specialists suggest that firms should smooth out production (batching) to maintain a stable workforce and achieve efficiency. If firms follow this approach, they might carry more inventory during slow sales but would still be able to meet the market demand during high sales. However, Miron and Zeldes (1988) and Eichenbaum (1989) have found that many firms do not operate with levelized production (cf. Blinder & Maccini, 1991; Khah, 1987, 1992; Brawn, 1991; Mosser, 1991; Rossana, 1998; West, 1986). However, using aggregate data from the U.S. Census Bureau and the Bureau of Economic Analysis (BEA), Cachon, Randal, & Schmidt (2007) have concluded that we do not observe the bullwhip effect among retailers and we generally do not observe it among manufacturers. Although the majority of wholesalers amplify, there is little evidence [that] demand volatility is highest among manufacturers and least among retailers (p. 458). In contrast, Dejonckheere, Randal, and Schmidt (2004) calculated the bullwhip effect based on the actual European retail supply chain. They found that the bullwhip effect is an even larger culprit than many have predicted. Retail shops and wholesalers appeared to be the biggest contributors to the bullwhip effect. Dejonckheere et al. (2004) observed that manufacturers were trying to dampen volatility among orders that required high volume production while actively creating volatility among orders that required low volume production. Dejonkcheere, Randal, and Schmidt (2003) have illustrated with non-aggregate data that production and shipment, whether weekly or daily, vary widely. In their analysis, weekly fluctuation was less pronounced than daily, but variation still existed between production and shipment. Previously, Lee et al. (1997a) had suggested five reasons for such fluctuation: 1) lack of demand information, 2) restrained lead time, 3) order batching, 4) shortage, and 5) price fluctuation. Demand amplification certainly exists, and methods have been suggested to reduce it. For example, Van Ackere, Larsen, and Moresoft (1993) suggested 1) redesigning the physical process in the supply chain (e.g., reducing lead-time and channel); 2) redesigning the informational channel (e.g., information sharing); and 3) redesigning the decision process (e.g., using different replenishment rules). Berry, Naim, and Towill (1995) suggested that the proper design and reengineering of the supply chain can reduce amplification, and Towill and McCullen (1999) suggested that amplification could be reduced by using principles of material flow. Croson and Donohue (2005) showed that human decision maker in a four-member, serial supply chain continued to exhibit bullwhip behavior in their ordering pattern even after all operational causes of the bullwhip

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effects were removed (p. 250). Behavioral factors included 1) not fully accounting for ones supply line when making ordering decisions (Sterman, 1989), 2) mistrusting members of the supply chain, and 3) developing counteracting strategies for the performance of ones fellow supply chain members (Croson et al., 2005). Dejonkcheere et al. (2004) concluded that, while order-up-to (OUT) will cause a bullwhip effect regardless of the forecasting method used to reduce demand amplification, information sharing will significantly reduce the magnitude of the effect. In traditional supply chains, the magnitude of the bullwhip effect increases geometrically, but information sharing can make the shape linear rather than geometrical, which confirms the findings of Lee et al. (1997) and Simchi-Levi, Kaminsky, and Simchi-Levi (2000). But information is only possible if the partners in a supply chain are willing to implement tighter coordination, such as vendor-managed inventory. Madlberger (2009) has recently noted that all business transactions require minimum information to process orders and defined anything more than minimum information as information sharing, i.e., as a regular exchange of data beyond processing transactions. Information sharing has four characteristics: 1) type of information, 2) the frequency of information, 3) the extent of information, and 4) the currency of information. In addition, it is economical to share information electronically. Lee, So, and Tang (2000) also argued for the advantages of information sharing but noted that it requires ability, willingness, and intention to participate. The partners need motives and incentives to share information. Madlberger (2009) has concluded that incentives to share information must be internal, e.g., active information policies, commitment of top-management, and technical readiness and capabilities. However, Croson and Donohue (2005) have stated that sharing upstream inventory information led to no significant improvement in order oscillations overall (p. 252). Information sharing is critical to meeting the goals of a supply chain and reducing the bullwhip effect. But how much information should be shared without a company exposing itself to potential exploitation? Clark and Scarf (1960) suggested echelon-based inventory, and Tang (1990) has also suggested that, with some modification, echelon inventory can improve OUT performance. For this plan to work, upstream companies must monitor the inventory of downstream companies and trigger production when the echelon inventory is low. This strategy assumes that there is one echelon that provides to the set of outlets in the echelon which are expected to provide information on a regular basis to the echelon, but if this does not happen, the use of an echelon-inventory will not solve the bullwhip problem. As Fransoo and Wouters (2000) have stated, In many supply chains, demand data is not available (p. 80) at the distribution centers or at the echelon level. Instead, data are sometimes incomplete or only available at a highly aggregated product or time level (p. 81). They have also stated that, Specifying which part of the total bullwhip effect can be attributed to a specific cause can be problematic (p. 84). In other words, the data each member provides might not be consistent, and variations in lead time and promotional policies might distort the real demand. Kim, Chatfield, Harrison, and Hayya (2006) found that use of OUT-level updating with information sharing had a variance of 52.5, but without information sharing, the variance was 179. Interestingly, the standard deviation of OUT-level updating with information sharing rose as the process moved upstream, from 20 (customers) to 52.5 (factory). In contrast, the standard deviation for OUT-level updating without information sharing increased from 20 (customers) to 179 (factory). Kim et al. (2006) also found that in echelon inventory, the variance for OUTlevel updating with information was linear with some slope, while the variance for OUT-level updating without information reflected exponential growth as the process moved upstream. Despite many attempts to coordinate information among the chain members, they have not managed to reduce inventory, because the desire among manufacturing firms for levelized production and economical batch runs does not justify their adjusting production to reduce the bullwhip effect. Reducing the bullwhip effect instead of levelizing production would be a costly process for manufacturing firms and should not be used. The reason is illustrated by the following charts, which show the changes in industrial production and private inventories among U.S. companies. The fluctuation between industrial production and private inventory is quite large, as can be seen in Figure 2. For example, in 2001-2002, industrial production dropped by 6% while private inventories dropped by less than 1%. Private businesses were not carrying a large enough inventory, requiring them to adjust their quantities to accommodate the drop in manufacturing. Thus, manufacturing firms, wholesalers, and retailers have not synchronized their sales and inventory. That is, each firm has taken action independently to maximize its return.

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Figure 2

Source: Federal Reserve Bank of St Louis

Based on data from 1950 to 2007 from the Bureau of Economic Analysis about durable and nondurable inventory, averages and standard deviations have been calculated for percent change in durables and non-durables for manufacturing, wholesalers, and retailers. The results (Table 1) show that the average change in durables for manufacturing is small (2.83) compared to durables for wholesalers (4.27) and retailers (4.58). However, the standard deviation of change in durable inventory of both manufacturers and retailers is quite large (5.24 and 5.48 respectively) compared to wholesalers (3.92). The averages of nondurables in manufacturing (2.43) are close to those of wholesalers and retailers (3.67 and 3.93 respectively). The standard deviations (2.78, 3.09, and 3.19) behave the same way. The data show that the bullwhip effect exists among all members of the supply chain, although it is more pronounced among retailers and wholesalers of non-durable goods than previously thought.
Table 1 Comparison of Percent Change in Inventory, by Average and Standard Deviation Average SD Change in inventory manufacturing, durables 2.83 5.24 Change in inventory manufacturing, non-durables 2.43 2.78 Change in inventory wholesaler, durables 4.27 3.92 Change in inventory wholesaler, non-durables 3.67 3.09 Change in inventory retailer durable 4.56 5.48 Change in inventory retailer non-durable 3.93 3.19 Source: Bureau of Economic Analysis

The inventory data (Figures 3 and 4) confirm that fluctuations among supply chain members and inventory have not changed significantly over the last 57 years. As the figures show, durable inventory among members has a higher rate of fluctuation (-5 to +15 percent) compared to non-durable inventory, where the fluctuation is between -5 to +10 percent. In addition, durable inventory among members behaves more consistently in that the fluctuation of inventory among members is very close to each other, while the fluctuation of non-durable inventory has wide variation among members. These data further indicate the bullwhip effect. Studies by the National Retail Federation, AMR Research, and Voluntary Interindustry Commerce Solutions (VICS) indicate that sharing demand and collaboration affect both revenue and profit margin (Accelerated Dynamics, 2009). Their findings indicate that collaboration and sharing of data could Increase sales by 5 - 10% Reduce out-of-stock from 8 - 40% to 6 - 32% Increase operating margin by 5%

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Figure 3 Durable Inventory Percent Change


Durable Percent Change
25 20 15

Percent Change

10 5 0

19 47

19 50

19 53

19 62

19 65

19 74

19 83

19 86

19 95

19 98

20 04

19 56

19 59

19 68

19 71

19 77

19 80

19 89

19 92

-5

-10 -15 Year

20 01

Manufacturing Wholesaler Retailer

Figure 4 Non-Durable Inventory Percent Change


Nondurable Percent Change

15

10

Percent Change

-10 Year
Manufaturing Wholesale Retailer

Croson and Donohue (2002) summarized the results of the experiment by Kaminsky and Simchi-Levi (1998) and Gupta, Steckel, and Bemerji (2001), and stated that Kaminsky and Simchi-Levi using normally distributed, stationary demand function with incentive observed the bullwhip effect. Holmstrom (1997) found that supply chain variability measured by standard deviation increases from 9 to 29 for some products going from consumers to manufacturers. The order oscillations were significant with an average standard deviation of 8.5. Even when they reduced the lead time, the average standard order oscillation was 12.68, but the overall cost dropped. Gupta et al. (2001) used a non-normal distributed demand, which was not disclosed to the participants, and by decreasing the lag time did reduce costs. These results might indicate that lags do affect cost. Gupta et al. (2001) also used step demand and found that sharing POS information did reduce retailers costs but not costs for wholesales and manufacturers. Using S-shaped demand without errors, Gupta et al. (2001) found that by sharing POS information, costs for retailers and wholesalers did not change, while the costs for manufacturers increased significantly. Using S-shaped demand with errors, sharing POS data did reduce the costs for retailers but had no effect on the costs for wholesalers and manufacturers. Croson and Donohue (1999a) also conducted experiments based on POS sharing or knowledge of the distribution of consumer demand. Those suppliers who knew POS data showed a significant reduction in order oscillation and amplification of orders at all level of the supply chain. As Fransoo and Wouters (2000) have claimed,

19 47 19 50 19 53 19 56 19 59 19 62 19 65 19 68 19 71 19 74 19 77 19 80 19 83 19 86 19 89 19 92 19 95 19 98 20 01 20 04 20 07
-5

METHODS FOR REDUCING THE BULLWHIP EFFECT

20 07

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Providing the suppliers upstream with EPOS data can reduce the bullwhip effect (p. 79). They have also stated that reducing lead time, revising reorder procedures, eliminating price fluctuation, and integrating measurements of planning and performance can reduce the bullwhip effect. Lee and Billington (1992), Towill (1996), Lee et al. (1997a and 1998b), and Lee, SO and Tang (2000) have also suggested these same measures. However, when Fransoo and Wouter (2000) used EPOS data to measure the bullwhip effect, they found that the same basic data lead to different measurements of the bullwhip effect. The problem was caused by how data was sequenced in aggregating data.
Table 2 Approaches to Mitigating the Causes of the Bullwhip Effect

The bullwhip effect can be effectively mitigated only by combining measures of information sharing, channel alignment, and operational efficiency.
Causes Demand Forecast Updating Information Sharing - Visibility of end user demand data across the supply chain - Visibility of end user demand data across the supply chain - Order processing costs reduction (e.g. through computer/ internet-based order management systems) - Visibility of end user demand data across the supply chain Channel Alignment Operational Efficiency

Order Batching

- Vendor Managed Inventory (VMI) - Lead-time reduction - Consumer direct - Echelon-based inventory control - Logistics outsourcing (e.g. 3PLs) - Order processing costs reduction - Discounts for truck-load assortments (e.g. through computer/ internet-based (of different products) order management systems) - Delivery consolidation - Continuous Replenishment Program (CRP) - Stabilize prices through Every Day Low Price (EDLP: selling price) and Every Day Low Cost (EDLC: buying price) - Define cancellation policies - Activity Based Costing (ABC) to clearly analyze inventory costs, handling costs, transportation costs etc. and compare them with product price promotion benefit

Forward Buying

Shortage Gaming Source: Goyal (2002)

- Share sales, capacity, and inventory data

Croson and Donohue (1999) studied the impact of sharing inventory information on the bullwhip effect on the knowledge of the distribution of demand. They found that oscillation of orders was significantly reduced at all levels and more specifically among distributors and manufacturers (Croson and Donohue, 2002). Table 2 shows the approaches suggested by Goyal (2002) for reducing the bullwhip effect. It is important to note that measurement of the bullwhip effect does not tell us what causes it in any given situation or what solutions might be most effective (Fransoo and Wouter, 2000). In addition, the question of whether to share information requires determining which part of the bullwhip effect is due to incomplete demand information and that any benefits from sharing EPOS must be clear before this information is shared (p. 79). CONCLUSION Researchers and academics have been concerned about the bullwhip effect for a long time and are researching its causes and how to stop it. But none of the suggested methods to overcome the bullwhip effect is practical and has never been feasibly implemented. As previously mentioned, Van Ackere at al. (1993) suggested 1) redesigning the physical process in the supply chain, 2) redesigning the informational channel, and 3) redesigning the decision process, but these suggestions are impractical if businesses fail to implement them and researchers fail to understand the basic principles of supply chains. As long as companies pursue only their own objectives to maximize profits, the bullwhip effect will continue. A supply chain must be viewed as a partnership in which every member must coordinate and cooperate to deliver value to the customers. The supply chain members must accept the principles of a supply chain, not just as a theory but as a real set of relationships that requires the efforts of all suppliers, retailers, and manufacturers working together to reduce costs, improve service and quality, and create value for customers. The lack of coordination is not due to a disregard for the need to create value for customers; rather, coordinating the efforts in a supply chain of many different manufacturers, suppliers, and retailers that have many differentand frequently competinggoals and structures simply isnt feasible. Consequently, it seems that the bullwhip effect will continue to exist regardless of what methods are adopted by supply chain members. While researchers might find it inherently interesting to analyze the causes of the bullwhip effect and suggest ways to control it, such analyses might simply be pointless.

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We should accept the bullwhip effect as a phenomenon intrinsic to business. As Lee (1997) has stated, "The bullwhip will continue to be a problem for a long time to come. REFERENCES
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