2 Higher Variability in Orders Placed by Computer Retailer to Manufacturer Than Actual Sales Lee, H, P. Padmanabhan and S. Wang (1997), Sloan Management Review
3 Increasing Variability of Orders Up the Supply Chain Lee, H, P. Padmanabhan and S. Wang (1997), Sloan Management Review
4 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.
5 The Bullwhip Effect and its Impact on the Supply Chain Point-of-sales Data-OriginalPOS Data After Removing Promotions
6 The Bullwhip Effect and its Impact on the Supply Chain POS Data After Removing Promotion & Trend
7 We Conclude ….Order variability is amplified up the supply chain; upstream echelons face higher variability.What you see is not what they face.
8 What are the Causes…. Promotional sales Forward buyingVolume and transportation discountsBatchingInflated ordersIBM Aptiva orders increased by 2-3 times when retailers thought that IBM would be out of stock over ChristmasMotorola cell phones
9 What are the Causes…. Single retailer, single manufacturer. Retailer observes customer demand, Dt.Retailer orders qt from manufacturer.What if there are promotional activities, no transportation discounts and no inflated order? Are we still going to see an increase in variability? Consider a simple supply chain with a single retailer and a single manufacturerDtqtRetailerManufacturerL
10 What are the Causes…. Promotional sales Volume and transportation discountsInflated ordersDemand forecastingOrder-up-to points are modified as forecasts change – orders increase more than forecastsLong cycle timesLong lead times magnify this effect
11 What are the Causes…. Single retailer, single manufacturer. Retailer observes customer demand, Dt.Retailer orders qt from manufacturer.DtqtRetailerManufacturerL
12 How big is the increase?Suppose a P period moving average is used.
13 Var(q)/Var(D): For Various Lead Times 14L=5L=512108L=3L=364L=1L=1251015202530
14 Consequences….Increased safety stockReduced service levelInefficient allocation of resourcesIncreased transportation costs
15 Multi-Stage Supply Chains Consider a multi-stage supply chain:Stage i places order qi to stage i+1.Li is lead time between stage i and i+1.qo=Dq1RetailerStage 1ManufacturerStage 2q2SupplierStage 3L1L2
16 Multi stage systemsCentralized: each stage bases orders on retailer’s forecast demand.Decentralized: each stage bases orders on previous stage’s demand
18 The Bullwhip Effect: Managerial Insights Exists, in part, due to the retailer’s need to estimate the mean and variance of demand.The increase in variability is an increasing function of the lead time.The more complicated the demand models and the forecasting techniques, the greater the increase.Centralized demand information can significantly reduce the bullwhip effect, but will not eliminate it.
19 Coping with the Bullwhip Effect in Leading Companies Reduce uncertaintyPOSSharing informationSharing forecasts and policiesReduce variabilityEliminate promotionsYear-round low pricingReduce lead timesEDICross dockingStrategic partnershipsVendor managed inventoryData sharing
20 Example: Quick Response at Benetton Benetton, the Italian sportswear manufacturer, was founded in In 1975 Benetton had 200 stores across Italy.Ten years later, the company expanded to the U.S., Japan and Eastern Europe. Sales in 1991 reached 2 trillion.Many attribute Benetton’s success to successful use of communication and information technologies.
21 Example: Quick Response at Benetton Benetton uses an effective strategy, referred to as Quick Response, in which manufacturing, warehousing, sales and retailers are linked together. In this strategy a Benetton retailer reorders a product through a direct link with Benetton’s mainframe computer in Italy.Using this strategy, Benetton is capable of shipping a new order in only four weeks, several week earlier than most of its competitors.
22 How Does Benetton Cope with the Bullwhip Effect? 1. Integrated Information Systems• Global EDI network that links agents with productionand inventory information• EDI order transmission to HQ• EDI linkage with air carriers• Data linked to manufacturing2. Coordinated Planning• Frequent review allows fast reaction• Integrated distribution strategy
23 Information for Effective Forecasts Pricing, promotion, new productsDifferent parties have this informationRetailers may set pricing or promotion without telling distributorDistributor/Manufacturer might have new product or availability informationCollaborative Forecasting addresses these issues.
24 Information for Coordination of Systems Information is required to move from local to global optimizationQuestions:Who will optimize?How will savings be split?Information is needed :Production status and costsTransportation availability and costsInventory informationCapacity informationDemand information
25 Locating Desired Products How can demand be met if products are not in inventory?Locating products at other storesWhat about at other dealers?What level of customer service will be perceived?
26 Lead-Time Reduction Why? How? Customer orders are filled quickly Bullwhip effect is reducedForecasts are more accurateInventory levels are reducedHow?EDIPOS data leading to anticipating incoming orders.
27 Information to Address Conflicts Lot Size – Inventory:Advanced manufacturing systemsPOS data for advance warningsInventory -- Transportation:Lead time reduction for batchingInformation systems for combining shipmentsCross dockingAdvanced DSSLead Time – Transportation:Lower transportation costsImproved forecastingLower order lead timesProduct Variety – Inventory:Delayed differentiationCost – Customer Service:Transshipment
28 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
29 Obstacles to Coordination in a Supply Chain Incentive ObstaclesInformation Processing ObstaclesOperational ObstaclesPricing ObstaclesBehavioral Obstacles
30 Incentive ObstaclesWhen incentives offered to different stages or participants in a supply chain lead to actions that increase variability and reduce total supply chain profits – misalignment of total supply chain objectives and individual objectivesLocal optimization within functions or stages of a supply chainSales force incentives
31 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 chainForecasting based on orders, not customer demandForecasting demand based on orders magnifies demand fluctuations moving up the supply chain from retailer to manufacturerLack of information sharing
32 Operational Obstacles Actions taken in the course of placing and filling orders that lead to an increase in variabilityOrdering in large lots (much larger than dictated by demand) – Figure 17.2Large replenishment lead timesRationing and shortage gaming (common in the computer industry because of periodic cycles of component shortages and surpluses)
33 Pricing ObstaclesWhen pricing policies for a product lead to an increase in variability of orders placedLot-size based quantity decisionsPrice fluctuations (resulting in forward buying) – Figure 17.3
34 Behavioral ObstaclesProblems in learning, often related to communication in the supply chain and how the supply chain is structuredEach stage of the supply chain views its actions locally and is unable to see the impact of its actions on other stagesDifferent stages react to the current local situation rather than trying to identify the root causesBased on local analysis, different stages blame each other for the fluctuations, with successive stages becoming enemies rather than partnersNo 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 blameLack of trust results in opportunism, duplication of effort, and lack of information sharing
35 Managerial Levers to Achieve Coordination Aligning Goals and IncentivesImproving Information AccuracyImproving Operational PerformanceDesigning Pricing Strategies to Stabilize OrdersBuilding Strategic Partnerships and Trust
36 Aligning Goals and Incentives Align incentives so that each participant has an incentive to do the things that will maximize total supply chain profitsAlign incentives across functionsPricing for coordinationAlter sales force incentives from sell-in (to the retailer) to sell-through (by the retailer)
37 Improving Information Accuracy Sharing point of sale dataCollaborative forecasting and planningSingle stage control of replenishmentContinuous replenishment programs (CRP)Vendor managed inventory (VMI)
38 Improving Operational Performance Reducing replenishment lead timeReduces uncertainty in demandEDI is usefulReducing lot sizesComputer-assisted ordering, B2B exchangesShipping in LTL sizes by combining shipmentsTechnology and other methods to simplify receivingChanging customer ordering behaviorRationing based on past sales and sharing information to limit gaming“Turn-and-earn”Information sharing
39 Designing Pricing Strategies to Stabilize Orders Encouraging retailers to order in smaller lots and reduce forward buyingMoving from lot size-based to volume-based quantity discounts (consider total purchases over a specified time period)Stabilizing pricingEliminate promotions (everyday low pricing, EDLP)Limit quantity purchased during a promotionTie promotion payments to sell-through rather than amount purchasedBuilding strategic partnerships and trust – easier to implement these approaches if there is trust
40 Building Strategic Partnerships and Trust in a Supply Chain BackgroundDesigning a Relationship with Cooperation and TrustManaging Supply Chain Relationships for Cooperation and Trust
41 Building Strategic Partnerships and Trust in a Supply Chain Trust-based relationshipDependabilityLeap of faithCooperation and trust work because:Alignment of incentives and goalsActions to achieve coordination are easier to implementSupply chain productivity improves by reducing duplication or allocation of effort to appropriate stageGreater information sharing results
42 Trust in the Supply Chain Table 17.2 shows benefitsHistorically, supply chain relationships are based on power or trustDisadvantages of power-based relationship:Results in one stage maximizing profits, often at the expense of other stagesCan hurt a company when balance of power changesLess powerful stages have sought ways to resist
43 Building Trust into a Supply Chain Relationship Deterrence-based viewUse formal contractsParties behave in trusting manner out of self-interestProcess-based viewTrust and cooperation are built up over time as a result of a series of interactionsPositive interactions strengthen the belief in cooperation of other partyNeither view holds exclusively in all situations
44 Building Trust into a Supply Chain Relationship Initially more reliance on deterrence-based view, then evolves to a process-based viewCo-identification: ideal goalTwo phases to a supply chain relationshipDesign phaseManagement phase
45 Designing a Relationship with Cooperation and Trust Assessing the value of the relationship and its contributionsIdentifying operational roles and decision rights for each partyCreating effective contractsDesigning effective conflict resolution mechanisms
46 Assessing the Value of the Relationship and its Contributions Identify the mutual benefit providedIdentify the criteria used to evaluate the relationship (equity is important)Important to share benefits equitablyClarify contribution of each party and the benefits each party will receive
47 Creating Effective Contracts Create contracts that encourage negotiation when unplanned contingencies ariseIt is impossible to define and plan for every possible occurrenceInformal relationships and agreements can fill in the “gaps” in contractsInformal arrangements may eventually be formalized in later contracts
48 Designing Effective Conflict Resolution Mechanisms Initial formal specification of rules and guidelines for procedures and transactionsRegular, frequent meetings to promote communicationCourts or other intermediaries
49 Managing Supply Chain Relationships for Cooperation and Trust Effective management of a relationship is important for its successTop management is often involved in the design but not management of a relationshipFigure process of alliance evolutionPerceptions of reduced benefits or opportunistic actions can significantly impair a supply chain partnership
50 Achieving Coordination in Practice Quantify the bullwhip effectGet top management commitment for coordinationDevote resources to coordinationFocus on communication with other stagesTry to achieve coordination in the entire supply chain networkUse technology to improve connectivity in the supply chainShare the benefits of coordination equitably
51 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?
53 Laws of Forecasting Three Laws of Forecasting Forecasts are always wrong!Detailed forecasts are worst than aggregate forecasts!The further into the future, the less reliable the forecast will be!
54 Forecasting Starting point of all Production Planning systems Qualitative Forecasting techniquesQuantitative Forecasting techniquesDecisions strive for Robustness while relying on forecasts (e.g., agile manufacturing)
55 Qualitative Forecasting Relies on expertise of peopleDelphi MethodUsually used for technological forecasts (long term forecasts)
56 Quantitative Forecasting Causal modelsPredict a future parameter (e.g., demand for a product) as a function of other parameters (e.g., interest rates, marketing strategy).Time Series modelsPredict a future parameter as a function of past values of that parameter (e.g., historical demand).
57 Causal Forecasting Opening a fast food restaurant Demand forecast? Predictable parametersPopulation in the vicinityCompetitionUse statistics (e.g., regression) to estimate the parametersY = b0 + b1x1 + b2X2
58 Time Series Forecasting Time period i = 1,2,…..t (most recent data)A(i): Actual observationsf(t+λ): Forecasts for t + λ, λ = 1,2,……,F(t): smoothed estimate (current position of the process under consideration)T(t): smoothed trendA(i), i =1,2,…tTime Series Modelf(t+λ), λ =1,2,3,…,
59 Time Series Forecasting Moving-Average ModelExponential Smoothing ModelExponential Smoothing with a Linear Trend ModelWinter’s Method (adds seasonal multipliers to the exponential smoothing with linear trend model)
60 Moving-Average ModelSimply average the actual values to forecast future valuesDrawback-equal weights to all valuesHence, m data points are chosen (user decides the value of mHigher m makes model more stable, but less responsiveMA model ignores trends,T(t) = 0Model underestimates rising trend, overestimates decreasing trend
61 Exponential Smoothing Older the data point, lesser the weightα from 0 to 1Lower values of α would make the model less responsiveThe model will underestimate the parameters with an increasing trend
62 Trend Models Exponential smoothing with a linear trend Winter’s method for seasonality
63 Value of Information“In modern supply chains, information replaces inventory”Why is this true?Why is this false?Information is always better than no information. Why?InformationHelps reduce variabilityHelps improve forecastsEnables coordination of systems and strategiesImproves customer serviceFacilitates lead time reductionsEnables firms to react more quickly to changing market conditions.