Value of Information

Objectives
Describe supply chain coordination, the bullwhip effect, and their impact on performance Identify causes of the bullwhip effect and obstacles to coordination in the supply chain Discuss managerial levers that help achieve coordination in the supply chain Describe actions that facilitate the building of strategic partnerships and trust within the supply chain Summary discussion: Barilla SpA

Outline
Lack of Supply Chain Coordination and the Bullwhip Effect Effect of Lack of Coordination on Performance Obstacles to Coordination in the Supply Chain Managerial Levers to Achieve Coordination Building Strategic Partnerships and Trust Within a Supply Chain Achieving Coordination in Practice

Lack of SC Coordination and the Bullwhip Effect

Supply chain coordination all stages in the supply chain take actions together (usually results in greater total supply chain profits) SC coordination requires that each stage take into account the effects of its actions on the other stages Lack of coordination results when:
Objectives of different stages conflict or Information moving between stages is distorted

Bullwhip Effect
Fluctuations in orders increase as they move up the supply chain from retailers to wholesalers to manufacturers to suppliers Distorts demand information within the supply chain, where different stages have very different estimates of what demand looks like Results in a loss of supply chain coordination Examples: Proctor & Gamble (Pampers); HP (printers); Barilla (pasta)

Increasing Variability of Orders Up the Supply Chain

Lee, H, P. Padmanabhan and S. Wang (1997), Sloan Management Review

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Example - Procter & Gamble: Pampers

Smooth consumer demand Fluctuating sales at retail stores Highly variable demand on distributors Wild swings in demand on manufacturing Greatest swings in demand on suppliers

Higher Variability: Retailers orders to distributor

Consumer Sales at Retailer
1000

Consumer demand

900 800 700 600 500 400 300 200 100 0 11 13 15 17 19 21 23 25 27 29 31 33 35 37 37 39 39 41 41 1 3 5 7 9

Retailer's Orders to Distributor

1000 900

Retailer Order

800 700 600 500 400 300 200

100
0 11 13 15 17 19 21 23 25 27 29 31 33 35 1 3 5 7 9

Higher Variability: Distributors orders to P&G

Retailer's Orders to Distributor
1000

900

Retailer Order

800 700 600 500 400 300

200
100 0 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41 41 1 3 5 7 9

Distributor's Orders to P&G

1000

Distributor Order

900 800 700 600 500 400 300 200 100 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 0 1 3 5 7 9

Higher Variability: P&Gs orders to 3M - supplier

Distributors Orders to P&G
1000

Distributor Order

900
800 700 600

500
400 300 200 100 0 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41
40

P&G's Orders with 3M

1000 900 800 700

P&G Order

600 500 400 300 200 100 0 10 13 16 19 22 25 28 31 34 37 1 4 7

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Finally: Notice variability difference

Consumer Sales at Retailer
1000

Consumer demand

900 800 700 600 500 400 300 200 100 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39

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P&G's Orders with 3M

1000 900 800 700

P&G Order

600 500 400 300 200 100 0 10 13 16 19 22 25 28 31 34 40 1 4 7

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0 1 3 5 7 9

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The Effect of Lack of Coordination on Performance

Manufacturing cost (increases) Inventory cost (increases) Replenishment lead time (increases) Transportation cost (increases) Labor cost for shipping and receiving (increases) Level of product availability (decreases) Relationships across the supply chain (worsens) Profitability (decreases) The bullwhip effect reduces supply chain profitability by making it more expensive to provide a given level of product availability
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Obstacles to Coordination in a Supply Chain

Incentive Obstacles Information Processing Obstacles Operational Obstacles Pricing Obstacles Behavioral Obstacles

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Incentive Obstacles
When incentives offered to different stages or participants in a supply chain lead to actions (forward buy)
increase variability reduce total supply chain profits misalignment of total supply chain objectives and individual objectives

Local optimization within functions or stages of a supply chain Sales force incentives

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Information Processing Obstacles

When demand information is distorted as it moves between different stages of the supply chain, leading to increased variability in orders within the supply chain Forecasting based on orders, not customer demand
Forecasting demand based on orders magnifies demand fluctuations moving up the supply chain from retailer to manufacturer

Lack of information sharing: each member of the supply chain makes independent forecasts without any access to actual sales data
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Operational Obstacles
Actions taken in the course of placing and filling orders that lead to an increase in variability Ordering in large lots (much larger than dictated by demand) Large replenishment lead times Rationing and shortage gaming (common in the computer industry because of periodic cycles of component shortages and surpluses)

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Pricing Obstacles
When pricing policies for a product lead to an increase in variability of orders placed Lot-size based quantity decisions Price fluctuations (resulting in forward buying)

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Behavioral Obstacles
Problems in learning, often related to communication in the supply chain and how the supply chain is structured Each stage of the supply chain views its actions locally and is unable to see the impact of its actions on other stages Different stages react to the current local situation rather than trying to identify the root causes Based on local analysis, different stages blame each other for the fluctuations, with successive stages becoming enemies rather than partners No stage learns from its actions over time because the most significant consequences of the actions of any one stage occur elsewhere, resulting in a vicious cycle of actions and blame Lack of trust results in opportunism, duplication of effort, and lack of information sharing
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Causes for Demand Fluctuations

Transportation discounts
Volume discount Promotional activity

No minimum or maximum order quantities

Product proliferation Long order lead times

Poor customer service rates

Poor communication

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The Causes of Bullwhip Effect

Demand Forecast Long lead times Order Batching Price fluctuation (Promotional sales) Inflated orders - IBM Aptiva orders increased by 2-3 times when retailers
thought that IBM would be out of stock over Christmas - Same with Motorolas Cellular phones

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Consequences of the Bullwhip Effect Lower revenues.

Stockouts and backlogs mean lost sales, as customers take their business elsewhere.
Higher costs. High carrying cost Stockout cost Distributors need to expedite orders (at higher shipping expenses) Manufactures need to adjust jobs (at higher setups and changeover expenses, higher labor expenses for overtime, perhaps even higher materials expenses for scarce components.) All entities in the supply chain must also invest heavily in outsized facilities (plants, warehouses) to handle peaks in demand, resulting in alternating under or over-utilization.

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Consequences of the Bullwhip Effect

Worse quality.
Quirky, unplanned changes in production and delivery schedules disrupt and subvert control processes, begetting diverse quality problems that prove costly to rectify.

Poorer service.
Irregular, unpredictable production and delivery schedules also lengthen lead time, causing delay and customer dissatisfaction.

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Barilla SpA Part A

Barilla SpA is the worlds 2nd largest pasta manufacturer in 1990 The company sells to a wide range of Italian retailers, primarily through third party distributors During the late 1980s, Barilla suffered increasing operational inefficiencies and cost penalties that resulted from large week-to-week variations in its distributors order patterns

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Barilla SpA Part A

Channels of Distribution Products divided in 2 categories Fresh and Dry Retail Outlets Small independent shops and Supermarkets Sales and Marketing Advertising heavily, brand positioned as highest quality Trade promotions frequent promotions, use of canvas period Sales representative
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Figure 4.2

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Figure 4.3 Weekly Demand for Barilla Dry Products from Corteses Northeast Distribution Center to the Pedrignano CDC, 1989.

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Causes of Demand Variability

What exactly is causing the distributors order pattern to look this way? What are the underlying drivers of the fluctuations?

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Causes for Demand Fluctuations

Transportation discounts Volume discount Promotional activity

No minimum or maximum order quantities

Product proliferation Long order lead times Poor customer service rates Poor communication
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Methods employed to reduce variability

Additional inventory to check fluctuations in distributors orders. Carrying extra inventory.

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Outcomes of this method

1. 2. 3. 4.

Thinning retailer/manufacturer margins Increased holding/storage costs Poor product delivery management Impossible to anticipate demand swings

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Barilla SpA Part A (continued)

To address this problem, the director of logistics suggests the implementation of Just-in-Time Distribution (JITD), with Barillas distributors. Under the proposed JITD system, decision-making authority for determining shipments from Barilla to a distributor would transfer from the distributor to Barilla. Specifically, rather than simply filling orders specified by the distributor, Barilla would monitor the flow of its product through the distributors warehouse, and then decide what to ship to the distributor and when to ship it.
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Evaluation of the JITD Proposal

Clearly the variation in demand is imposing additional costs on the channel. What do you think of the JITD proposal as a mechanism for reducing these costs? Why should this work? How does it work? What makes Barilla think that it can do a better job of determining a good product/delivery sequence than its distributors?
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Implementation Issues Resistance from the Distributors

Managing stock is my job; I dont need you to see my warehouse or my figures. I could improve my inventory and service level myself if you would deliver my orders more quickly; I would place my order and you would deliver within 36 hours. We would be giving Barilla the power to push products into our warehouse just so that Barilla can reduce its costs. ?
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Implementation Issues Resistance from Sales and Marketing (1/2) Our sales levels would flatten if we put this program in place. How can we get the trade to push Barilla product to retailers if we dont offer some sort of incentive? If space is freed up in our distributors warehouses, the distributors would then push our competitors product more than ours. It seems that the distribution organization is not yet ready to handle such a sophisticated relationship.
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Implementation Issues Resistance from Sales and Marketing (2/2) We run the risk of not being able to adjust our shipments sufficiently quickly to changes in selling patterns or increased promotions. We increase the risk of having our customers stock out of our product if we have disruption in our supply process. We wouldnt be able to run trade promotions with JITD. It is not clear that costs would even be reduced.

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Vitalis proposal - Just in Time

Advantages

Manufacturer
Reduced manufacturing costs Increased supply chain visibility Improvement in manufacturing planning Reduced inventory levels Reduced distribution costs Improved fill rates to stores

Distributor

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JIT contd
Implementation Problems

Employee Concerns
Flattened sales levels Inability to adjust shipments quickly to stock-outs Lack of infrastructure to handle JIT Increased competitor shelf space at distributor

Unconvinced Distributors
Perceived power transfer to Barilla Lack of faith in Barillas inventory management

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How Can Maggiali Solve the Implementation Problems? Demonstrate that JITD benefits the distributors (lowering inventory, improving their service levels and increasing their returns on assets); Run experiment at one or more of Barillas 18 depots

Maggiali needs to look at JITD not as a logistics program, but as a company-wide effort; Get top management closely involved Trust

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Barilla SpA Part B What did Barilla learn from the experiments in Florence and Milan? (Fig 4.9 & 4.10) How should Barilla change the way it attempts to sell the JITD concept to its distributors? If you were a Barilla distributor, would you sign onto the program after seeing these results?

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Figure 4.9

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Figure 4.10

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Figure 4.11

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Figure 4.12

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Barilla SpA Part C

How do you evaluate the implementation process Barilla used with Cortese?
Figure 4.11 Figure 4.12

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The Bullwhip Effect and its Impact on the Supply Chain

Consider the order pattern of a single color television model sold by a large electronics manufacturer to one of its accounts, a national retailer.

Figure 1. Order Stream

Huang at el. (1996), Working paper, Philips Lab

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The Bullwhip Effect and its Impact on the Supply Chain

Figure 2. Point-of-sales Data-Original

Figure 3. POS Data After Removing Promotions

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The Bullwhip Effect and its Impact on the Supply Chain

Figure 4. POS Data After Removing Promotion & Trend

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Higher Variability in Orders Placed by Computer Retailer to Manufacturer Than Actual Sales

Lee, H, P. Padmanabhan and S. Wang (1997), Sloan Management Review

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Managerial Levers to Achieve Coordination

Aligning Goals and Incentives Improving Information Accuracy Improving Operational Performance Designing Pricing Strategies to Stabilize Orders Building Strategic Partnerships and Trust

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Aligning Goals and Incentives

Align incentives so that each participant has an incentive to do the things that will maximize total supply chain profits Align incentives across functions Pricing for coordination Alter sales force incentives from sell-in (to the retailer) to sell-through (by the retailer)

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Improving Information Accuracy

Sharing point of sale data Collaborative forecasting and planning Single stage control of replenishment
Continuous replenishment programs (CRP) Vendor managed inventory (VMI)

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Improving Operational Performance

Reducing replenishment lead time
Reduces uncertainty in demand EDI is useful

Reducing lot sizes

Computer-assisted ordering, B2B exchanges Shipping in LTL sizes by combining shipments Technology and other methods to simplify receiving Changing customer ordering behavior

Rationing based on past sales and sharing information to limit gaming

Turn-and-earn Information sharing
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Designing Pricing Strategies to Stabilize Orders

Encouraging retailers to order in smaller lots and reduce forward buying Moving from lot size-based to volume-based quantity discounts (consider total purchases over a specified time period) Stabilizing pricing
Eliminate promotions (everyday low pricing, EDLP) Limit quantity purchased during a promotion Tie promotion payments to sell-through rather than amount purchased

Building strategic partnerships and trust easier to implement these approaches if there is trust
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Building Strategic Partnerships and Trust in a Supply Chain

Background Designing a Relationship with Cooperation and Trust Managing Supply Chain Relationships for Cooperation and Trust

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Building Strategic Partnerships and Trust in a Supply Chain

Trust-based relationship Dependability Leap of faith Cooperation and trust work because: Alignment of incentives and goals Actions to achieve coordination are easier to implement Supply chain productivity improves by reducing duplication or allocation of effort to appropriate stage Greater information sharing results
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Trust in the Supply Chain

Table 16.2 shows benefits Historically, supply chain relationships are based on power or trust Disadvantages of power-based relationship:
Results in one stage maximizing profits, often at the expense of other stages Can hurt a company when balance of power changes Less powerful stages have sought ways to resist

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Building Trust into a Supply Chain Relationship

Deterrence-based view
Use formal contracts Parties behave in trusting manner out of self-interest

Process-based view
Trust and cooperation are built up over time as a result of a series of interactions Positive interactions strengthen the belief in cooperation of other party

Neither view holds exclusively in all situations

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Building Trust into a Supply Chain Relationship

Initially more reliance on deterrence-based view, then evolves to a process-based view Co-identification: ideal goal Two phases to a supply chain relationship
Design phase Management phase

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Designing a Relationship with Cooperation and Trust

Assessing the value of the relationship and its contributions Identifying operational roles and decision rights for each party Creating effective contracts Designing effective conflict resolution mechanisms

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Assessing the Value of the Relationship and its Contributions

Identify the mutual benefit provided Identify the criteria used to evaluate the relationship (equity is important) Important to share benefits equitably Clarify contribution of each party and the benefits each party will receive

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Identifying Operational Roles and Decision Rights for Each Party

Recognize interdependence between parties
Sequential interdependence: activities of one partner precede the other Reciprocal interdependence: the parties come together, exchange information and inputs in both directions

Sequential interdependence is the traditional supply chain form Reciprocal interdependence is more difficult but can result in more benefits Figure 16.4

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Effects of Interdependence on Supply Chain Relationships (Figure 16.4)

Organizations Dependence

High

Partner Relatively Powerful

High Level of Interdependence

Effective Relationship

Low

Low Level of Interdependence

Organization Relatively Powerful High

Low

Partners Dependence
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Creating Effective Contracts

Create contracts that encourage negotiation when unplanned contingencies arise It is impossible to define and plan for every possible occurrence Informal relationships and agreements can fill in the gaps in contracts Informal arrangements may eventually be formalized in later contracts

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Designing Effective Conflict Resolution Mechanisms

Initial formal specification of rules and guidelines for procedures and transactions Regular, frequent meetings to promote communication Courts or other intermediaries

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Managing Supply Chain Relationships for Cooperation and Trust

Effective management of a relationship is important for its success Top management is often involved in the design but not management of a relationship Figure 16.5 -- process of alliance evolution Perceptions of reduced benefits or opportunistic actions can significantly impair a supply chain partnership

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Achieving Coordination in Practice

Quantify the bullwhip effect Get top management commitment for coordination Devote resources to coordination Focus on communication with other stages Try to achieve coordination in the entire supply chain network Use technology to improve connectivity in the supply chain Share the benefits of coordination equitably

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Summary of Learning Objectives

What are supply chain coordination and the bullwhip effect, and what are their effects on supply chain performance? What are the causes of the bullwhip effect, and what are obstacles to coordination in the supply chain? What are the managerial levers that help achieve coordination in the supply chain? What are actions that facilitate the building of strategic partnerships and trust in the supply chain?

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