Inventory Management - Bullwhip Effect

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Bullwhip Effect
• Tendency of a player in the supply chain of a material or product in short supply to buy more than they need in the immediate future. • Logistic phenomenon named after the way the amplitude of a whip increases down its length.

Why the bullwhip effect occurs? Demand Forecasting
• One day, the manager of a retailer observed a larger demand (sales) than expected. • He increased the inventory level because he expected more demand in the future (forecasting). • The manager of his wholesaler observed more demand (some of which are not actual demand) than usual and increased his inventory. • This caused more (non-real) demand to his maker; the manager of the maker increased his inventory, and so on. This is the basic reason of the bull whip effect.

Bullwhip Effect
• Businesses must forecast demand in order to properly position inventory and other resources. • Forecast are traditionally based on statistics and are rarely perfectly accurate. • Because forecast errors are a given, companies often carry inventory buffer (safety stock). • Demand information is distorted as it travels within the supply chain, so that different stages have different perspectives and estimates of the chain demand.

Why the bullwhip effect occurs? Lead time
• With longer lead times, a small change in the estimate of demand variability implies a significant change in safety stock, reorder level, and thus in order quantities. • Thus a longer lead time leads to an increase in variability and the bull whip effect.

Why the bullwhip effect occurs? Batch Ordering
• When using a min-max inventory policy, then the wholesaler will observe a large order, followed by several periods of no orders, followed by another large order, and so on. • The wholesaler sees a distorted and highly variable pattern of orders. • Thus, batch ordering increases the bull whip effect.

Why the bullwhip effect occurs? Variability of Price
• Retailers (or wholesalers or makers) offer promotions and discounts at certain times or for certain quantities. • Retailers (or customers) often attempt to stock up when prices are lower. • It increases the variability of demands and the bull whip effect.

Why the bullwhip effect occurs? Lack of supply and supply allocation • When retailers suspect that a product will be in short supply, and therefore anticipate receiving supply proportional to the amount ordered (supply allocation). • When the period of shortage is over, the retailer goes back to its standard orders, leading to all kinds of distortions and variations

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.

Consequences of the Bullwhip Effect
• Lower revenues.
– Stockouts and backlogs mean lost sales, as customers take their business elsewhere.

• Higher costs.

– High carrying cost – Stockout cost – 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...
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