The Bullwhip Effect

Henry C. Co
Technology and Operations Management,
California Polytechnic and State University
Next time you need gasoline …
 Pause for a moment and consider
 All you’ve had to do is coast into a gas station and
you’d find … gasoline. It’s simply there, ready for you to
buy – every time, all the time. For you, and for
countless other motorists.
 Yet Somebody must have put the gasoline into the
gas station’s underground tank for you to pump
from.
 To begin at the beginning, somebody must have
prospected for oil, found it, and then dug the well to
extract it.
 Next, somebody must have shipped the oil to a
refinery, converted it into gasoline, and then
transported the gasoline to your favorite gas station.
 In short, an awful lot of work must have occurred,
across a long and vast network of firms – the supply
chain, to deliver a reliable supply of gasoline.

The BullWhip Effect 2

The Bullwhip Effect
 The supply chain for gasoline is indeed quite
reliable, so much so that most consumers
take it for granted.

 In 2001, Cisco was forced to write down $2.2

billion worth of obsolete inventory, victim of a
pernicious pathology in its supply chain.
 That particular disease even has a terrifying
name: the Bullwhip Effect.

The BullWhip Effect 3

The Beer Game
 Role-playing simulation developed in the
1960’s at MIT’s Sloan School of Management
 Production and distribution of beer.
 Players divide themselves into groups: Retailer,
Wholesaler, Distributor, and Brewer.
 Weekly consumer demand simulated by a deck of
cards
 Retailer sells from his inventory and reorders
from the Wholesaler, who sells from his inventory
and reorders from the Distributor, who in turn
sells from his inventory and reorders from the
Brewer, who finally sells from his inventory and
restocks from his production.
 Order processing delays; Shipping delays
 Inventory carrying costs; Stockout costs
 Players base their decisions strictly on the orders
they receive from their respective buyers.

The BullWhip Effect 4

 “During the game emotions run high. Many players
report feelings of frustration and helplessness. Many
blame their teammates for their problems;
occasionally heated arguments break out.”

 “In virtually all cases, the inventory levels of the

retailer decline, followed in sequence by a decline in
the inventory of the wholesaler, distributor, and
factory. As inventory falls, players tend to increase
their orders. Players soon stock out. Backlogs of
unfilled orders grow. Faced with rising orders and
large backlogs, players dramatically boost the orders
they place with their supplier. Eventually, the factory
brews and ships this huge quantity of beer, and
inventory levels surge. In many cases one can
observe a second cycle.”

John Sterman, one of the original proponents of the Beer Game

The BullWhip Effect 5

 Stakeholders along supply chain
 Have different and frequently conflicting
objectives.
 Often operated independently.

 The network can oscillate in very large

swings as each organization in the
supply chain seeks to solve the
problem from its own perspective.

The BullWhip Effect 6

Variability increases as one moves up the
supply chain

Source: Johnson & Pike, 1999

The BullWhip Effect 7

Consequences of the Bullwhip Effect
 Lower revenues.  Higher costs.
 Stockouts and backlogs  High carrying cost
mean lost sales, as  Stockout cost
customers take their
business elsewhere.
 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.

The BullWhip Effect 8

 Worse quality.  Poorer service.
 Quirky, unplanned  Irregular,
changes in unpredictable
production and production and
delivery schedules delivery schedules
disrupt and subvert also lengthen lead
control processes, time, causing delay
begetting diverse and customer
quality problems that dissatisfaction.
prove costly to
rectify.

The BullWhip Effect 9

Causes of Bullwhip Effect
 Demand variability, quality problems,
strikes, plant fires, etc.
 Variability coupled with time delays in
the transmission of information up the
supply chain and time delays in
manufacturing and shipping goods
down the supply chain create the
bullwhip effect.

The BullWhip Effect 11

1. Overreaction to backlogs
2. Neglecting to order in an attempt to
reduce inventory
3. No communication up and down the
supply chain
4. No coordination up and down the
supply chain
5. Delay times for information and
material flow

The BullWhip Effect 12

1. Order batching - larger orders result in
more variance. Order batching occurs in an
effort to reduce ordering costs, to take
advantage of transportation economics such
as full truck load economies, and to benefit
from sales incentives. Promotions often
result in forward buying to benefit more
from the lower prices.
2. Shortage gaming: customers order more
than they need during a period of short
supply, hoping that the partial shipments
they receive will be sufficient.

The BullWhip Effect 13

1. Demand forecast inaccuracies:
everybody in the chain adds a certain
percentage to the demand estimates.
The result is no visibility of true
customer demand.
2. Free return policies

The BullWhip Effect 14

Countermeasures to the
Bullwhip Effect
1. Countermeasures to order batching
2. Countermeasures to shortage gaming
3. Countermeasures to fluctuating
prices
4. Countermeasures to demand forecast
inaccuracies
5. Free return policies

The BullWhip Effect 16

Order Batching
 High order cost is countered with Electronic
Data Interchange (EDI) and computer aided
ordering (CAO).
 Full truck load economics are countered with
third-party logistics and assorted truckloads.
Random or correlated ordering is countered with
regular delivery appointments.
 More frequent ordering results in smaller orders
and smaller variance.
 However, when an entity orders more often, it
will not see a reduction in its own demand
variance - the reduction is seen by the upstream
entities.
 Also, when an entity orders more frequently, its
required safety stock may increase or decrease;
see the standard loss function in the Inventory
Management section.
The BullWhip Effect 17
Shortage Gaming
 Proportional rationing schemes are
countered by allocating units based on past
sales.
 Ignorance of supply chain conditions can be
addressed by sharing capacity and supply
information.
 Unrestricted ordering capability can be addressed
by reducing the order size flexibility and
implementing capacity reservations.
 For example, one can reserve a fixed quantity for
a given year and specify the quantity of each
order shortly before it is needed, as long as the
sum of the order quantities equals to the reserved
quantity.

The BullWhip Effect 18

Fluctuating Prices
 High-low pricing can be replaced with
every day low prices (EDLP). Special
purchase contracts can be
implemented in order to specify
ordering at regular intervals to better
synchronize delivery and purchase.

The BullWhip Effect 19

Demand Forecast Inaccuracies
 Lack of demand visibility can be
addressed by providing access to point
of sale (POS) data.
 Changes in pricing and trade
promotions and channel initiatives,
such as vendor managed inventory
(VMI), coordinated forecasting and
replenishment (CFAR), and continuous
replenishment can significantly reduce
demand variance.

The BullWhip Effect 20

Free Return Policies
 Free return policies are not addressed
easily.
 Often, such policies simply must be
prohibited or limited.

The BullWhip Effect 21

Vendor Managed Inventory
 Popularized in the late 1980s by Wal-
Mart and Procter & Gamble, VMI
became one of the key programs in
the grocery industry’s pursuit of
“efficient consumer response” and the
garment industry’s “quick response.”
 Successful VMI initiatives have been
trumpeted by other companies in the
United States, including Campbell
Soup and Johnson & Johnson, and by
European firms like Barilla (the pasta
manufacturer).

The BullWhip Effect 23

The VMI Partnership
 The supplier—usually the manufacturer but
sometimes a reseller or distributor—makes
the main inventory replenishment decisions
for the consuming organization.
 The supplier monitors the buyer’s inventory levels
(physically or via electronic messaging) and
makes periodic resupply decisions regarding order
quantities, shipping, and timing.
 Transactions customarily initiated by the buyer
(like purchase orders) are initiated by the supplier
instead.
 The purchase order acknowledgment from the
supplier may be the first indication that a
transaction is taking place; an advance shipping
notice informs the buyer of materials in transit.

The BullWhip Effect 24

 The
manufacturer is
responsible for
both its own
inventory and
the inventory
stored at is
customers’
distribution
centers.

The BullWhip Effect 25