Bullwhip Effect: Minimizing Strategy

Bullwhip

Lee et al. define the bullwhip effect as “the amplification of demand variability from a downstream site to an upstream site”. The bullwhip phenomenon is observed in supply chains where the decisions at the subsequent stages of the supply chain are made greedily based on local information, rather than through coordination based on global information on the state of the whole chain. The first consequence of this information distortion is higher variance in purchasing quantities compared to sales quantities at a particular supply chain stage. The second consequence is increasingly higher variance in order quantities and inventory levels in the upstream stages compared to their downstream stages (buyers).

Understanding the causes of the bullwhip effect can help managers find strategies to mitigate it. Lee suggested that making demand data available at downstream site to an upstream site is a remedy to mitigate demand signal processing. Thus, both sites can then use same data while updating their forecasts. Their strategy can be achieved by using Electronic Data Interchange (EDI) and Point of Sales (POS). Using collaboration tools like Vendor Managed Inventory (VMI) can be very useful as these systems make available the demand data and inventory position information to members of the supply chain.

Now batch ordering has often led to bullwhip effect, which has serious implications for the whole chain. One reason that order batches are large or order frequencies are low is the relatively high cost of placing an order and replenishing it. Hence, discount on assorted truckload, consolidation by third party logistics and regular delivery appointment are solutions to the bullwhip effect. Smaller and synchronized batch sizes can also be seemed as a good way.

‘Forward Buy’ arrangement in which items are bought in advanced of requirements, usually to take advantage of manufacturer’s attractive price offer is another source for bullwhip effect. The simplest way to minimize the effect caused by such forward buying and diversions is to reduce both the frequency and the level of wholesale price discounting. The manufacturer can reduce the incentives for forward buying by establishing a uniform wholesale pricing policy. From an operational perspective, practices such as Continuous Replenishment Program (CRP) together with a rationalized wholesale pricing policy can help to control retailer’s tactics, such as diversion.

Asprova creates concrete information integrity between supply chain members, allowing for smooth dissemination of superior quality demand data from downstream site to the upstream site. Our advanced planning and scheduling functions improve operation processes, shorten lead times and reduce demand volatility which proves to be effective in mitigating the bullwhip effect. Nevertheless, it plays an active role in future development of supply chain strategic alliance.

 

Photo credit: ©Flickr davidd

ABC Analysis

© MIKI Yoshihito

Vilfredo Pareto (1848-1923), an Italian economist and sociologist, made the observation that a large proportion of national wealth tended to be under the control of a relatively small number of individuals. Pareto concluded that in any series of elements to be controlled a selected small factor in terms of number of elements (20%) almost always accounts for a larger factor in terms of effort (80%). Pareto subsequently developed this observation into a more defined 80:20 rule.

The Pareto principle serves as the basis for materials management value segmentation and in this context is more commonly referred to as ABC analysis. It is based on the concept that approximately 80 percent of the total value of stock items will be accounted for by approximately 20 percent of the items. In other words, just a few stock items account for a very large proportion of total stock value; these are the key items over which management control should be exercised.

Now the question that arises is how you will identify what stock value is attached to the stored materials. Well the answer is simple – Asprova. It has features that will display the usage value of each item, which will elevate the ABC analysis concept one stage further into three stock categories used extensively in stock control.

  • Category A items: The ‘vital few’. Small in number but high in usage value.
  • Category B items: ‘Normal items’. Medium in number, medium usage value.
  • Category C items: The ‘trivial many’. High in number, low usage value.

In the purchasing context the Pareto principle can be interpreted as 80% of spends being directed towards just 20% of the suppliers. This elementary form of segmentation can then be used to separate the critical few suppliers from the trivial many. In other words, more purchasing effort and energy needs to be focused on the category ‘A’ suppliers and the materials that are purchased from them.

Whilst the remaining items in other classifications cannot be neglected, appropriate ‘low maintenance’ replenishment controls should be considered. An example of low maintenance controls would be the use of Vendor Managed Inventory (VMI), a system by which responsibility for managing the stock is placed in the hands of the supplier, thereby minimizing the purchasing effort.

The powerful tools in Asprova will allow you to keep the entire stock at your fingertips. More precisely, our detailed production scheduling and visualization functions enable superior control of the critical category ‘A’ items. It ensures that the stock level of this particular class of items remain optimized the whole time through elimination of excessive buildup and/or abundant consumption, thereby reducing overall cost and improving customer service by avoiding stockouts.

 

 

Photo credit © MIKI Yoshihito

Vendor Managed Inventory

VMIVendor Managed Inventory (VMI) was introduced by Kurt Solomon Associates in 1992. VMI is a collaborative strategy between the buyer and supplier to optimize the availability of products at a minimal cost. Under VMI, the buyer authorizes the supplier to manage the inventory of stock-keeping units (SKU) at the buyer’s site(s) under a mutually agreed framework of performance targets. The buyer provides the supplier with sales and/or inventory status information whereas the supplier makes and implements decisions about replenishment quantities and timing.

VMI provides the supplier with the opportunity to better manage its own production, inventory and transportation cost. In exchange, the buyer typically receives price discounts or improved terms of payment from the supplier. A well-designed and developed approach to VMI can lead not only to reductions in inventory levels in the chain, but also to secondary savings arising from simplification of systems and procedures.

A supplier of industrial fasteners to a customer in the automobile industry supplies track-side and assembly positions, and is paid a predetermined sum for each vehicle completed and shipped. VMI avoids accounting for single or small quantities of low-cost items, and consolidates a large number of small payments into a smaller number of larger payments. The benefits are shared where buyers receive higher service levels, and improved cash flows. In return, vendors enjoy better visibility of changing demand and greater customer loyalty.

The real benefits are those which attach neither to the buyer nor the seller in particular, but to the supply chain as a whole. These include management undertaken by whoever is best positioned or qualified, a smoother flow of materials, an enhanced flow of information, simplified administrative procedures, and the placing of the competencies of supply more firmly with the supplier.

It is unlikely that vendor management will be seen as appropriate for all classes of inventory. Generally speaking, it is likely that category C items (wide range, low cost) might be seen as being particularly appropriate, where there is a wide market and a number of suppliers wishing to differentiate their offerings by virtue of service. Items where there is a strong interdependence between seller and buyer might attract consideration of the possibilities of VMI.

The great news is that a data-driven approach using Asprova has shown to achieve big improvements in forecast accuracy. Our users can now precisely estimate the future inventory of materials based on the quantity of finished products that consumers will purchase. In VMI collaborative environment, clients can then easily furnish their suppliers with these prospective materials requisition or their suppliers can simply access these records via Electronic Data Interchange. Hence, Asprova has been instrumental in successful implementation of VMI between our clients and their suppliers.

Photo credit: Flickr © Nick Saltmarsh