Customer

Coordination
and Collaboration

MIT Center for

Transportation & Logistics
 Over-Arching Question
How should we use information to coordinate the
different activities of the various players in the
supply chain?

Firm

Customer
Supplier

SRM ISCM CRM

“source” “make, move, store” “sell”

Supplier / Vendor Internal Production Customer Demand

Management Management Management

How can I collaborate with my customers to better coordinate

the flow of goods in the supply chain?
Lesson: Customer Coordination and Collaboration 2
Supply Chain Coordination & the
Bullwhip Effect

Lesson: Customer Coordination and Collaboration 3

Supply Chain Coordination
• What is supply chain coordination?
n Actions that align the different stages in a supply
chain to increase total supply chain profit
• A coordinated supply chain features:
w Information exchange between players
w Understanding impact of actions on other players
• Supply chains are often NOT coordinated

Lesson: Customer Coordination and Collaboration 4

Does it really happen? • Retailer Sales

Weekly Quantity
• Shipments from
Mfg to Dists

Weeks

3M P&G Dist Ret.

Units Ordered

Units Ordered
Units Demanded

Units Demanded
Time Time Time Time

Commonly referred to as the Bullwhip Effect

Lesson: Customer Coordination and Collaboration 5
Bullwhip Effect
• Bullwhip is present when the variability of demand in
different stages increases as we move upstream.

• So, what! What are the impacts?

n Increased manufacturing costs
n Higher inventory levels & costs
n Longer replenishment lead times
n Higher transportation costs
n Lower product availability
n Deteriorates trading partner relationships
n Lowers supply chain profitability

References:
• Lee HL, Padmanabhan V, Whang S (1997a) Information distortion in a supply chain: The bullwhip effect. Management Sci 43(4):546–558
• Lee HL, Padmanabhan V, Whang S (1997b) The bullwhip effect in supply chains. Sloan Management Review 38(4):93–102

Lesson: Customer Coordination and Collaboration 6

Causes of the Bullwhip Effect

Lesson: Customer Coordination and Collaboration 7

Causes of the Bullwhip Effect
• Primary Root Causes
n Different stages have different owners, objectives, incentives
n Firms tend to optimize their own performance
• Underlying Causes (Lee et al 1997a & 1997b)
n Demand Forecasting
n Rationing and Shortage Gaming
n Order Batching
n Price Fluctuation

Lesson: Customer Coordination and Collaboration 8

Demand Forecasting
• Typical forecasting relies on the demand each firm sees from
its immediate downstream partner or customer
n Forecasting is only made on orders – not end customer demand
n Small increases in demand are amplified as they move upstream
n New demand information is used to re-estimate inventory policy
(safety stock and order-up to levels)
n Effect is exacerbated by longer lead times

3M P&G Dist Ret.

Units Ordered

Units Ordered
Units Demanded

Units Demanded
Time Time Time Time

Lesson: Customer Coordination and Collaboration 9

Rationing and Shortage Gaming
• Situation where demand exceeds supply
n New product launches
n Scarce technology (eg. DRAM Chips)
• So, what happens?
n Manufacturer will typically ration supply
n Customers, knowing this, will often inflate orders or
submit phantom orders
n Orders evaporate when supply is made available

• Net effect is false demand signals that ripple and are

amplified upstream

Lesson: Customer Coordination and Collaboration 10

Order Batching & Price Fluctuations

Lesson: Customer Coordination and Collaboration 11

Order Batching
• Example: Simple Supply Chain
n Measure the Bullwhip Effect as the ratio of the variance of the orders
placed to the wholesaler to the demand seen by the retailer
n One retailer selling one item replenished by one wholesaler DC
w Daily demand at store is ~N(100, 10)
w Orders are placed every day and are delivered the next day
• Result for Daily Ordering:
n Variance of Retail Demand ~100
n Variance of Wholesaler DC orders ~100
n No Bullwhip Effect!
• Suppose we Implement Weekly Ordering
n Variance of Retail Demand ~ 100
n Variance of Wholesaler DC orders >60,000!
n Note that the daily average does not change
Lesson: Customer Coordination and Collaboration 12
Order Batching
Batching of orders leads to higher order variability as we move upstream.

800

700

600

500

400

300

200

100

0
0 10 20 30 40 50 60 70 80 90 100

-100

Store Demand Order Daily Order EOD Order Weekly

Lesson: Customer Coordination and Collaboration 13

Order Batching
• But what if there are more retailers?
n Suppose a single wholesalers supports n retailers
n Each retailer has the same demand pattern Var[stores]
• Three cases to consider:
n Random Ordering – stores order independently and randomly
n Positively Correlated Ordering – stores all order on same day
n Balanced Ordering – store ordering is spread out evenly across all days
• Then,
n Var[Correlated] ≥ Var[Random] ≥ Var[Balanced] ≥ Var[Stores]*N

Lesson: Customer Coordination and Collaboration 14

Order Batching & Price Fluctuations
• Why would a firm batch orders?
n Ordering set up costs
n Optimal lot-sizing
n Periodic review policies
n Volume discounts
n Minimum order quantities
n Limited transportation mode options
n Forward buying
• Impact is exacerbated if forecasting is made only
from immediate customer’s orders

Lesson: Customer Coordination and Collaboration 15

Measuring & Quantifying the Bullwhip Effect

Lesson: Customer Coordination and Collaboration 16

 Quantifying the Effect
• Same example: Simple Supply Chain
n One retailer selling one item replenished by one wholesaler DC
w Daily demand at store is ~N(100, 10)
w Daily review period with (R,S) inventory policy (order up to)
w St = μtL + kσt√L
n μt = expected daily demand estimated at time t
n σt = standard deviation of daily demand estimated at time t
n L = leadtime in days
n k = Safety factor
w Forecasting uses simple moving average of the last M time periods
n Implies that μ and σ will change each period based on new forecast
n This impacts the order up to level and safety stock

• It can be shown that:

Var [ RetailOrders] 2L 2L2
≥ 1+ + 2
Var [CustomerDemand ] M M

References:
• Chen YF, Drezner Z, Ryan JK, Simchi-Levi D (2000a) Quantifying the bullwhip effect in a simple supply chain: The impact of forecasting, lead
times and information. Management Sci 46(3):436–443
• Fransoo JC,Wouters MJF (2000) Measuring the bullwhip effect in the supply chain. Supply Chain Management 5(2):78–89
Lesson: Customer Coordination and Collaboration 17
Quantifying the Effect Var [ RetailOrders]
Var [CustomerDemand ]
≥ 1+
2L 2L2
+ 2
M M

• The bullwhip effect is increased as:

n Lead time (L) is increased
n Review time is increased
n Number of periods included in the forecast (M) is decreased.
• Relation to forecasting – central or decentralized
n Assume n stages in the supply chain (retailer n=0)
n Centralized – each stage uses retailer forecast
w The lead time for the nth stage is = L1 + L2 + L3 + . . .+ Ln
2

Var !"n Stage's Orders#$

th

≥ 1+
2∑ Li
n

i=1
+
2 (∑ L )
n

i=1 i

Var [CustomerDemand ] M M2

n Decentralized – each stage uses the (n-1)th stage orders for their
forecast th
Var !"n Stage's Orders#$ & 2Li 2Li2 )n
≥ ∏ (1+ + +
Var [CustomerDemand ] i−1
' M M2 *

Lesson: Customer Coordination and Collaboration 18

Counteracting the Bullwhip Effect

Lesson: Customer Coordination and Collaboration 19

Counteracting the Bullwhip Effect
• Improve forecasting methodology
n Eliminate multiple forecasts that only use immediate partner order data
n Employ point-of-sale or end consumer data, if possible
n Avoid “nervous” forecasting techniques
• Design single-stage replenishment control
n Have upstream partner manage its downstream partner’s inventory
n Referred to as Vendor Managed Inventory (VMI) or Continuous
Replenishment Programs (CRP)
n Bypass the downstream stages – consumer direct policies
• Shorten lead and review period times
n More frequent review and faster delivery reduces impact
n Less time for uncertainty to build
n Incent orders to be better distributed over time

Lesson: Customer Coordination and Collaboration 20

Counteracting the Bullwhip Effect
• Reduce batching of orders
n Reduce the fixed cost of order set up and delivery (lower friction)
n Shift from minimum order quantity (MOQ) of individual SKUs (or families)
to minimum volume quantity of a wider assortment of products
n Reduce transportation costs by using: milk-runs, multi-zone trucks
(ambient, refrigerated, and frozen), 3PL solutions . . .
• Reduce the incentive of forward buying
n Be selective on the use of price promotions
n Analyze the true costs of a promotion using ABC accounting
n Shift sales incentives from “Sell-To” to “Sell-Through”
n Use supply chain risk and other contracts to coordinate sales
• Better sharing of information
n Allowing visibility into POS or end customer demand
n Sharing of plans and intentions – sometimes called Collaborative Planning,
Forecasting, and Replenishment (CPFR)
Lesson: Customer Coordination and Collaboration 21
Key Take Aways

Lesson: Customer Coordination and Collaboration 22

Key Take Aways
• Supply Chain Coordination
n Identified the Bullwhip Effect
n Increasing demand/order variability as we move upstream
n Results in increased costs, lost efficiencies, lower profits
• Causes of Bullwhip Effect
n Misaligned Incentives & Behavior
n Poor Demand Forecasting
n Order Batching and Timing
• Counteracting the Bullwhip Effect / Better Coordination
n Forecasting > Consider end consumer demand
n Operational > Shorten lead/review time, reduce cost of orders
n Behavior > Shift sales incentives, evaluate promotion effectiveness
n Combine Stages > One player takes over replenishment (VMI, CRP)
n Information Sharing > End demand as well as plans (CPFR)
Lesson: Customer Coordination and Collaboration 23
Questions, Comments, Suggestions?
Use the Discussion!

“Wilson & Dexter wanting to collaborate on getting more food”

Yankee Golden Retriever Rescued Dogs (www.ygrr.org)

MIT Center for

Transportation & Logistics caplice@mit.edu
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Lesson: Customer Coordination and Collaboration 25