LogisticsWeek

Feature | 564 days ago |

Implementation of Electronic Data Interchange and Everyday Low Pricing are some ways to fight the bullwhip effect advices Padmini Pagadala

The festival season is here. The time for the diyas and the fire lanterns and the Christmas trees and the New Year cards has arrived. Interestingly, these are not the items that businesses seem to be worrying about at the moment; it is the non-seasonal items that seem to be taking up mind space in the heads of top VPs world over. There is good news. The global economy is finally coming around, but as TPG’s web site statistics show, the #1 white paper being read on our site is about inventory reduction. Businessmen are concerned about customer service and inventories.  Why?  An old nasty business phenomenon once thought eradicated has manifested itself again. The bullwhip is back.

The Bullwhip Effect

The distortion of actual customer demand information from the retailer up the supply chain to the manufacturer is known as the Bullwhip Effect. When a person cracks a whip, the wrist only needs to move just a little for the motion to get exaggerated at the top of the whip – making a grand arc. Small blips in the orders at the customer’s end may get exaggerated up the supply chain and translated into larger unnecessary swings in demand at the manufacturer much like the action of cracking a whip. These exaggerations drive up inventories greatly.

The Bullwhip Effect- Quantity Ordered

The bullwhip effect was first noticed in the sales of baby diapers at P&G. Although the demand for nappies were fairly constant (Don’t they have to be?), small increases in orders were getting conveyed a tad bit magnified up stream. As demand information inched its way back tier by tier it resulted in seemingly significant variations in demand at the manufacturing plant. The implication to P&G was large plant inventories to deal with this problem which led one executive to say “Crap.  There has to be a better way. Babies don’t behave like this.”

Bullwhip Brunt

Babies don’t, but supply chains do.  They especially do when uncertainty or change gets inserted into business like entering into and coming out of a recession. Tingting Yan, a researcher at Arizona State University has studied the demand volatility experienced in the U.S. when we entered the great recession of 2007.  He reports:

“… although the month-to-month volatility of [US] consumer demand INCREASED threefold during the recession [in 2007], monthly variation in retailer inventories actually DECREASED by four percent during the same time period. Wholesalers were able to reduce month-to-month variation in inventory, but their inventory levels increased by two percent; while manufacturers saw their inventories increase and become 150% more volatile on a month-to-month basis.”

Bear markets create the Bullwhip Effect, but so do lethargic bull markets. The recent recovery has led many of our US clients to lament about terrible manufacturing lead times coming out of Asia.  Many of the manufacturers were caught off guard.  They had belatedly driven down their inventories but had not forecast the need to build them up in time.  Finished goods flowing back to the west have struggled to make schedule.  At one of our apparel client manufacturers, orders have been consistently 50 to 60% late out of Asian factories from June through September! The culprit? Mainly raw material inventories. They were too low.

Effect In India

The Bull also raises its horns when there are many trading partners in a supply chain.  Because of our inherent interest in being tax efficient, inventories are excessive in India. My favourite repartee about the Indian Supply Chain is inspired from the Ancient Mariner /Inventory Inventory Everywhere, Not a Case to Ship/

We have a C&FA (Carry and Forward Agent) in almost every state. We have distributors in most cities. We have trucks in transit and worst yet trucks in-waiting at our warehouses and at the state borders. We have more “tiers” of inventory than our western colleagues.  And yet the order fulfillment rates in India are nowhere close to those in matured markets – in spite of having inventory everywhere.

The number of tiers actually works against us.  The bullwhip triggers the accumulation of great amounts of inventories –often the wrong inventory. A small blip seen by a retailer is exaggerated to the local distributor whose order is further misinterpreted as a bigger change up on the line – choking our profits with inventory carrying costs.

Taming The Bull

One would think that the Bullwhip would not have impacted the mature western markets as tech savvy as they are. But as the market went down, it was this very dependence on technology that caused the whiplash. The manufacturers and the distributors instead ought to have paid more attention to their immediate node up and down the supply chain stream.

Inventories should not just be set by an automated system but checked when there is a major change in the economy. Electronic Data Interchange (EDI) is significant for all the players to get a holistic idea that can fight their impulses to act exaggeratedly when there seems to be a small increase or decrease in customers’ orders.

While having a good relationship with your customer (retailer, distributor – whoever it may be) would ensure that they are not ordering in excess, based on their perception of how much you may short their order and thus avoid short gaming or rationing, Everyday Low Pricing would be a definite guard against sales blips owing to price reductions.

Sometimes you may receive various mixed signals from the market. Instead of adjusting up and down and trying to react to what you receive, in such times it may just be best to shorten planning horizons, order in smaller quantities more frequently and stabilize your inventory. The bull is that much more dangerous when inventories are already in excess. Strategizing based on a holistic look is the way to tame the bull.

The author can be reached at padminimp@theprogressgroup.com

Pictures and “Box”

1A small change at the source can cause a huge exaggerated interpretation up the Supply Chain (Source: Wikipedia)

Reasons for the Bullwhip Effect and how it can be dealt with