By Mike Loughrin, CEO for Transformance Advisors
The bullwhip effect was first articulated in 1997 in the MIT Sloan Management Review by Hau L. Lee, V. Padmanabhan, and Seungjin Whang.
The term is used to describe how small ripples in demand are magnified as requirements flow upstream in our supply chains. For example, a comment by some famous person concerning the benefits of sun screen could set the bullwhip in motion. The “endorsement” could lead to a small increase in consumer demand which ripples upstream and becomes a large snap in demand at the suppliers of ingredients, bottles, and packaging materials.
This snap happens when:
- Consumer demand ripples up by a few units a week at the retailer
- Retailer responds to the increase and orders another case for each store
- Distributor responds to the retailer and orders another truckload from the manufacturer
- Manufacturer schedules a 90 day supply and orders the items in the bill of materials from numerous suppliers
- Suppliers receive the orders with a request to fulfill immediately
The first startling thing, about the bullwhip effect, is how each participant in the supply chain is exhibiting rational behavior which allows the small ripple to become a loud snap. And this loud snap is just a metaphor for the sound of service failures and excessive costs as everyone scrambles to recover and meet the needs of their customers.
While our example described the impact whereby consumer demand increased, the second startling thing about the bullwhip effect is how the use of routine planning processes will also lead to the loud snap – even when there is no change in consumer demand.
And the final impact, from our nemesis, is how the bullwhip will tend to snap and drive everyone to produce more inventory. Then, after inventory is produced and expedited through the supply chain, the next sound is nothing but silence as most supply chain participants have no orders and nothing to do.
Then and Now
The original report in 1997 described four major causes of the bullwhip effect:
- Demand forecast updating
- Order batching
- Price fluctuation
- Rationing and shortage gaming
While these four causes are still important factors, the remainder of this article will explore the four main issues that impact today’s efforts to create sustainable lean organizations:
- Long cycle times
- Large order quantities
- Poorly planned promotions
- Meaningless changes
Long Cycle Times
The globalization of supply chains has not allowed many organizations to reduce overall cycle times. A lean improvement initiative by a manufacturer might cut internal cycle times by 50 to 90%. Unfortunately, the same manufacturer could have switched to suppliers in low cost regions, increasing the purchasing cycle time by 1,000%.
Let’s look at one example of the impact of long cycle times.
- In scenario 1, your cycle time is 2 weeks and the demand changes from 100 per week to 105 per week. With this small ripple, you now need an additional 5 units per week over a 2 week cycle time or 10 more units. For many organizations, these 10 units would not be a big impact and might even be fully covered by safety stock. There is no snap of the bullwhip.
- In scenario 2, your cycle time is 26 weeks, but you have gotten a great price from a supplier who has very limited flexibility. Now, the additional 5 units per week over a 26 week cycle time is 130 more units. Given the natural way planning systems work, your rational behavior is to launch a new order for at least 130 units. It might be even worse if this new demand is considered an increase in variability and your system also increases your safety stock at the same time. The bottom line is: long cycle times cause the bullwhip to snap for the smallest of ripples.
For all supply chain participants, the challenge with long cycle times is to look closer at the total landed cost of dealing with suppliers who are not fast and flexible:
- On one hand, those working to become sustainable organizations can send their experts to poorly performing suppliers to help them to eliminate the waste which is causing long cycle times.
- On the other hand, you can reassess your cost models. Many organizations are finding cheap, but slow, suppliers have a much higher total landed cost than suppliers who are fast and flexible.
Large Order Quantities
The big focus on cost control, at many organizations, has led to an overemphasis on leveraging economies of scale. There is pressure to build large volumes to keep equipment running and minimize the costs of changeovers. The pressure is more subtle with suppliers who offer lower prices for buying enormous quantities.
Large order quantities have multiple impacts.
- They are an obvious magnifier of demand as 5 units of consumer demand becomes a 6,000 unit minimum run in manufacturing and a 20,000 unit minimum purchase from a supplier.
- More damaging, many times, is the increase in the number of items impacted by a large order quantity. For example, think about scrambling to make 6,000 of something that is assembled from 20 components. Chances are, few of those components will have enough inventory available. Thus, you may snap the bullwhip for all 20 components and cause massive chaos at multiple suppliers.
For manufacturers and their suppliers, the challenge with large order quantities is to address the root causes which promote the notion that it costs less to make more than is needed:
- When equipment changeover costs drive large order quantities, then the standard changeover reduction program from the lean toolkit is a must do project.
- When logistics costs drive the desire to ship full containers or full truckloads, then you need better coordination of the overall supply chain network.
- When suppliers are not flexible and quote better prices for large volume orders, then use blanket orders to get the discount, but use blanket releases or vendor managed inventory (VMI) programs to get just the amount you need.
Poorly Planned Promotions
The world is full of promotions and everyone likes a sale. The best promotions are designed to stimulate consumer demand. And, when they are well planned and communicated, a good promotion will not cause the bullwhip to snap.
- Promotions that simply cause one supply chain participant to increase inventory will often cause the bullwhip to snap. For example, a distributor may stock up on inventory and order a couple truckloads to take advantage of a discounted price. If nothing is done to stimulate consumer demand, then the inventory will just deplete over time. Thus the distributor may not place another order for a month or more.
- Poorly planned promotions can also lead to problems if they have not been communicated and upstream participants need to scramble in reaction to demand that was not anticipated.
Promotions are normal business practices in many industries. For all supply chain participants, opportunities for improvement include:
- Ensure that promotions are designed to drive consumer demand and they are are planned according to the appropriate cycle time. The best view of a promotion is to assess the consumer demand at the retailer and work upstream taking into account the inventory and replenishment parameters used by each supply chain participant.
- In many aspects, the snap of the bullwhip from poorly planned promotions is magnified by the long cycle times and large order quantities. You can make the case that even a well planned promotion will snap the bullwhip. Thus, the best plan of action for those creating sustainable lean supply chains is to address the long cycle times and large order quantities.
Software can be a great tool to dramatically improve the effectiveness of planning and execution processes. Unfortunately, it can also be used to automate and accelerate processes that add no value. Too many software tools have been configured to automate the planning and communication of item level details that change on a daily basis and cause the bullwhip to snap like popcorn cooking at a theater.
- It might sound impressive to say you have 10 million item level forecasts that go out 52 weeks and you can recalculate all of them everyday. If these item level forecasts are used by upstream participants, then there will be millions of changes everyday. Combining these daily changes with long cycle times, large order quantities, and poorly planned promotions is a recipe for disaster.
- Similar to forecasts, software has made it easy to calculate new planning parameters over and over again. For example, safety stock should be designed to protect an organization from variation in demand and supply. It has become too easy to use both simple rules of thumb (like 4 weeks supply) or some poorly understood black box calculation (like 95% service based upon forecast error) to change safety stock and other parameters in a manner that snaps the bullwhip needlessly.
Sustainable organizations do not need item level forecasts and they do not need planning parameters to change everyday. Organizations that have used software to over-automate supply chain management should step back and assess how high flexibility scheduling can simplify and improve their processes. A thorough assessment might reveal the need to:
- Develop aggregate level forecasts and supply plans that reflect the best information available. These supply plans should then be used to position capacity and common components that will be used when demand materializes.
- Implement a master scheduling process that sets the drum beat of your value streams that is aligned with the takt time. This master schedule should be at an aggregate level where meaningless changes do not cause the bullwhip to snap. Many of the meaningless item level changes will cancel each other out and strategically developed safety stock parameters will protect you from normal variation.
- Gain access to true consumer demand through collaboration techniques such as vendor managed inventory (VMI) programs. Create a detail schedule from true demand leveraging kanban and visual controls.
The snap of the bullwhip is still a common occurrence for many organizations. The small ripples from changes in consumer demand or just reacting to normal variation are magnified as information flows upstream.
The impact is large as service levels drop and costs increase.
- When the snap says you need more, the call goes out for overtime and airfreight
- When the snap says you have too much, the call goes out to shut everything down
For those seeking to craft sustainable lean organizations, the call to action includes:
- Collaborate with customers; design promotions to drive consumer demand
- Collaborate with fast and flexible suppliers; use total landed cost as your guide
- Lower those order quantities; work the standard changeover reduction techniques
- Stop the meaningless changes; implement high flexibility scheduling processes