FUNDAMENTAL OF SUPPLY CHAIN

INTRODUCTION OF SUPPLY CHAIN MANAGEMENT Supply Chain management (SCM) is the process of planning, implementing and controlling the operations of the supply chain as efficiently as possible. Supply Chain management spans all movement and storage of raw materials, work-in-process inventory and finished goods from point-of-origin to point-of-consumption. Traditionally, marketing, distribution, planning, manufacturing, and the purchasing organizations along the supply chain operated independently. These organizations have their own objectives and these are often conflicting. Marketing’s objective of high customer service and maximum sales operations are designed to maximize throughout and lower costs with little consideration for the impact on inventory levels and distribution capabilities. Purchasing contracts are often negotiated with very little information beyond historical buying patterns. The result of these factors is that there is not a single, integrated plan for the organization there were as many plans as businesses. Clearly, there is a need for mechanism through which these different functions can be integrated together. Supply Chain management is a strategy through which such integration can be achieved. Through the past decades we have seen an increasing rate of globalization of the economy and thereby also of supply chains. Products are no longer produced and consumed within the geographical area. Even the different parts of a product may, and often do, come from all over the world. This creates longer and more complex supply chains, and therefore it also changes the requirements within supply chain management. This again effects the effectiveness of computer systems employed in the supply chain. A longer supply chain will often involve longer order to delivery lead times. Flaherty has states, in accordance with the discussion in Section that the consequences of longer lead times will often be less dependable forecasts as these have to be made earlier, reduced production flexibility, i.e greater difficulties to adjust to order changes, higher levels of inventory. Therese M. Flaherty.Global Operations management.McGrow-Hill,New York,1996. The evident answer to the problem of longer lead times is to speed up the supply chain. But a limit is often reached beyond which further effort to shorten lead times are futile, especially in international supply chains. Another approach is to restructure the supply chain. This simply means to reconsider the strategic level decisions priory made. A third approach identified by Flaherty is changing coordination : The order, forecasting, procurement, and information sharing procedures among the members of supply chain. Globalization also brings foreign competition into markets that traditionally were local. Local companies are thereby forced to respond by improving their manufacturing practices and supply chain management.Bhatnagar et al. states that attempts have focused, among others, on reduction of inventory levels and increased flexibility through reduced lead times. Yet again we see how industry focused on the issues of inventory management and flexibility to maintain high levels of customer satisfaction. A supply chain is a system of organizations, people, technology, activities, information and resources involved in moving a product or service from supplier to customer. Supply chain activities transform natural resources, raw materials and components into a finished product that is delivered to the end customer. The key supply chain processes stated by Lambert(2004) are : Customer service management Demand management Manufacturing flow management Supplier relationship management Inventory management Warehousing & Distribution management Procurement management Transportation & Physical management Returns management DEFINITON OF BULLWHIP EFFECT The supply chain is a complex group of companies that move goods from raw materials suppliers to finished goods retailers. These companies work together when meeting consumer demand for a product; supply chains allow companies to focus on their specific processes to maintain maximum probability. Unfortunately, supply chains may stumble when market conditions change and consumer demand shifts. The bullwhip effect on the supply chain occurs when changes in consumer demand causes the companies in a supply chain to order more goods to meet the new demand. The bullwhip effect usually flows up the supply chain, starting with the retailer, wholesaler, distributor, manufacturer and then the raw materials supplier. This effect can be observed through most supply chains across several industries; it occurs because the demand for goods is based on demand forecasts from companies, rather than actual consumer demand. Through the numerous stages of a supply chain, key factors such as time and supply of order decisions, demand for the supply, lack of communication and disorganization can result in one of the most common problems in supply chain management. This common problem is known as the bullwhip effect.Also sometimes the whiplash effect. The bullwhip effect can be explained as an occurrence detected by the supply chain where orders sent to the manufacturer and supplier create larger variance then the sales to the end customer. These irregular orders in the lower part of the supply chain develop to be more distinct higher up in the supply chain. This variance can interrupt the smoothness of the supply chain process as each link in the supply chain will over or underestimate the product demand resulting in exaggerated fluctuations. According to Wikipedia.org,( http://en.wikipedia.org/wiki/Bullwhip_effect) The bullwhip effect (or whiplash effect) is an observed phenomenon in forecast-driven distribution channels. It refers to a trend of larger and larger swings in inventory in response to changes in demand, as one looks at firms further back in the supply chain for a product. The concept first appeared in Jay Forrester's Industrial Dynamics (1961) and thus it is also known as the Forrester effect. Since the oscillating demand magnification upstream a supply chain is reminiscent of a cracking whip, it became known as the bullwhip. Bullwhip Effect Diagram According to Business Dictionary, (http://www.businessdictionary.com/definition/bullwhip-effect.html) , Bullwhip effect can be defined as, “Tendency of consumers of a material or product in short supply to buy more than they need in the immediate future”. In other definition by Wall Street Journal article explains, “This phenomenon occurs when companies significantly cut or add inventories. Economists call it a bullwhip because even small increases in demand can cause a big snap in the need for parts and materials further down the supply chain”. The diagram above means the more steps that are in between of the consumer and the supplier, the bigger the variation gets. THE CAUSES & CONSEQUENCES OF BULLWHIP EFFECT 3.1 CAUSES Perhaps the best illustration of the bullwhip effect is the well-known "beer game. “In the game, participants (students, managers, analysts, and so on) play the roles of customers, retailers, wholesalers, and suppliers of a popular brand of beer. The participants cannot communicate with each other and must make order decisions based only on orders from the next downstream player. The ordering patterns share a common, recurring theme: the variability of an upstream site are always greater than those of the downstream site, a simple, yet powerful illustration of the bullwhip effect. This amplified order variability may be attributed to the players' irrational decision making. Indeed, Sterman's experiments showed that human behavior, such as misconceptions about inventory and demand information, may cause the bullwhip effect. We have identified the causes of the bullwhip effect: 3.1.1 Demand Forecast Updating Every company in a supply chain usually does product forecasting for its production scheduling, capacity planning, inventory control, and material requirements planning. Forecasting is often based on the order history from the company's immediate customers. The outcomes of the beer game are the consequence of many behavioral factors, such as the players' perceptions and mistrust. An important factor is each player's thought process in projecting the demand pattern based on what he or she observes. When a downstream operation places an order, the upstream manager processes that piece of information as a signal about future product demand. Based on this signal, the upstream manager readjusts his or her demand forecasts and, in turn, the orders placed with the suppliers of the upstream operation. We contend that demand signal processing is a major contributor to the bullwhip effect. The future demands and the associated safety stocks are updated using the smoothing technique. With long lead times, it is not uncommon to have weeks of safety stocks. The result is that the fluctuations in the order quantities over time can be much greater than those in the demand data. 3.1.2 Order Batching In a supply chain, each company places orders with an upstream organization using some inventory monitoring or control. Demands come in, depleting inventory, but the company may not immediately place an order with its supplier. It often batches or accumulates demands before issuing an order. There are two forms of order batching: periodic ordering and push ordering. Instead of ordering frequently, companies may order weekly, biweekly, or even monthly. There are many common reasons for an inventory system based on order cycles. Often the supplier cannot handle frequent order processing because the time and cost of processing an order can be substantial. Many manufacturers place purchase orders with suppliers when they run their material requirements planning (MRP) systems. MRP systems are often run monthly, resulting in monthly ordering with suppliers. A company with slow-moving items may prefer to order on a regular cyclical basis because there may not be enough items consumed to warrant resupply if it orders more frequently. Consider a company that orders once a month from its supplier. The supplier faces a highly erratic stream of orders. There is a spike in demand at one time during the month, followed by no demands for the rest of the month. Of course, this variability is higher than the demands the company itself faces. Periodic ordering amplifies variability and contributes to the bullwhip effect. One common obstacle for a company that wants to order frequently is the economics of transportation. There are substantial differences between full truckload (FTL) and less-than-truckload rates, so companies have a strong incentive to fill a truckload when they order materials from a supplier. Sometimes, suppliers give their best pricing for FTL orders. For most items, a full truckload could be a supply of a month or more. Full or close to full truckload ordering would thus lead to moderate to excessively long order cycles. In push ordering, a company experiences regular surges in demand. The company has orders "pushed" on it from customers periodically because salespeople are regularly measured, sometimes quarterly or annually, which causes end-of-quarter or end-of-year order surges. Salespersons who need to fill sales quotas may "borrow" ahead and sign orders prematurely. For companies, the ordering pattern from their customers is more erratic than the consumption patterns that their customers experience. The "hockey stick" phenomenon is quite prevalent. When a company faces periodic ordering by its customers, the bullwhip effect results. If all customers' order cycles were spread out evenly throughout the week, the bullwhip effect would be minimal. The periodic surges in demand by some customers would be insignificant because not all would be ordering at the same time. Unfortunately, such an ideal situation rarely exists. Orders are more likely to be randomly spread out or, worse, to overlap. When order cycles overlap, most customers that order periodically do so at the same time. As a result, the surge in demand is even more pronounced, and the variability from the bullwhip effect is at its highest. If the majority of companies that do MRP or distribution requirement planning (DRP) to generate purchase orders do so at the beginning of the month (or end of the month), order cycles overlap. Periodic execution of MRPs contributes to the bullwhip effect, or "MRP jitters" or "DRP jitters." 3.1.3 Price Fluctuation Estimates indicate that 80 percent of the transactions between manufacturers and distributors in the grocery industry were made in a "forward buy" arrangement in which items were bought in advance of requirements, usually because of a manufacturer's attractive price offer. Manufacturers and distributors periodically have special promotions like price discounts, quantity discounts, coupons, rebates, and so on. All these promotions result in price fluctuations. Additionally, manufacturers offer trade deals (e.g. special discounts, price terms, and payment terms) to the distributors and wholesalers, which are an indirect form of price discounts. What happens if forward buying becomes the norm? When a product's price is low (through direct discount or promotional schemes), a customer buys in bigger quantities than needed. When the product's price returns to normal, the customer stops buying until it has depleted its inventory As a result, the customer's buying pattern does not reflect its consumption pattern, and the variation of the buying quantities is much bigger than the variation of the consumption rate. When high-low pricing occurs, forward buying may well be a rational decision. If the cost of holding inventory is less than the price differential, buying in advance makes sense. In fact, the high-low pricing phenomenon has induced a stream of research on how companies should order optimally to take advantage of the low price opportunities. Although some companies claim to thrive on high-low buying practices, most suffer. 3.1.4 Rationing and Shortage Gaming When product demand exceeds supply, a manufacturer often rations its product to customers. In one scheme, the manufacturer allocates the amount in proportion to the amount ordered. For example, if the total supply is only 50 percent of the total demand, all customers receive 50 percent of what they order. Knowing that the manufacturer will ration when the product is in short supply, customers exaggerate their real needs when they order. Later, when demand cools, orders will suddenly disappear and cancellations pour in. This seeming overreaction by customers anticipating shortages results when organizations and individuals make sound, rational economic decisions and "game" the potential rationing. The effect of "gaming" is that customers' orders give the supplier little information on the product's real demand, a particularly vexing problem for manufacturers in a products early stages. The gaming practice is very common. In the 1980s, on several occasions, the computer industry perceived a shortage of DRAM chips. Orders shot up, not because of an increase in consumption, but because of anticipation. Customers place duplicate orders with multiple suppliers and buy from the first one that can deliver, then cancel all other duplicate orders. More recently, Hewlett-Packard could not meet the demand for its LaserJet III printer and rationed the product. Orders surged, but HP managers could not discern whether the orders genuinely reflected real market demands or were simply phantom orders from resellers trying to get better allocation of the product. When HP lifted its constraints on resupply of the Laser Jets, many resellers canceled their orders. HP's costs in excess inventory after the allocation period and in unnecessary capacity increases were in the millions of dollars. 3.2 CONSEQUENCES The bullwhip effect is a phenomenon in supply chains. It occurs when consumer behavior varies, even slightly, from predictions. The result of these variances is that variances occur throughout the supply chain, becoming larger and larger as one moves up the supply chain. It is called the bullwhip effect because it resembles the way in which a small flick of a bullwhip causes a larger and larger motion toward the end of the whip. The bullwhip effect is widely regarded as a negative occurrence and the sign of a poorly structured supply chain. Familiarizing yourself with the effects of the bullwhip effect can help you to understand what happened and why. 3.2.1 Excessive Inventory As forecast inaccuracies become amplified up the supply chain, it can result in a highly inaccurate demand forecast being made by the producer. As a result, the producer may end up producing more of the product than the market is actually willing to accept. This means that the producer will have produced too many units. This can be disastrous in some cases, as it may not be possible to offload the products for a profit. The products will likely be sold at a deep discount to secondary markets (for example, companies that purchase wholesale overstocks). In a worst-case scenario, it could result in having an excess of products that must simply be destroyed. 3.2.2 Inefficient Production The bullwhip effect can lead to inefficient production. This happens when the producer does not have accurate demand data and cannot accurately produce the required amount of product ahead of time and cannot schedule production in an efficient way. This can lead to a reactive production, where the producer does not produce enough and then must rush to produce more. This is extremely inefficient because it means that rather than operating at a constant rate, the producer is alternating between times where it is producing nothing and times where it is at maximum capacity. 3.2.3 Increases of Cost The most important effect that the bullwhip effect has is that it increases costs (sometimes dramatically). This happens for a variety of reasons. When there is an inefficient production, it means that stock-outs will occur (that is to say, that customers will not be able to get their products). Stock-outs result in lost revenues from sales that are missed. They can cause costly losses to a company's reputation and they can result in the competition gaining your customers. Also, inefficient production can be much more costly because it requires hiring and training extra staff, paying overtime wages and may require sourcing materials from the quickest (rather than cheapest) supplier. 4.0 STRATEGIES TO OVERCOME BULLWHIP EFFECT Understanding the causes of the bullwhip effect can help us find strategies to mitigate it. Indeed, many companies have begun to implement innovative programs that partially address the effect. Next we examine how companies tackle each of the four causes. Channel alignment is the coordination of pricing, transportation, inventory planning, and ownership between the upstream and downstream sites in a supply chain. Operational efficiency refers to activities that improve performance, such as reduced costs and lead-time. 4.1 Avoid Multiple Demand Forecast Updates Ordinarily, every member of a supply chain conducts some sort of forecasting in connection with its planning (e.g., the manufacturer does the production planning, the wholesaler, the logistics planning, and so on). Bullwhip effects are created when supply chain members process the demand input from the irimmediate downstream member in producing their own forecasts. Demand input from the immediate downstream member, results from that member's forecasting, with input from its own downstream member. One remedy to the repetitive processing of consumption data in a supply chain is to make demand data at a downstream site available to the upstream site. Hence, both sites can update their forecasts with the same raw data In the computer industry, manufacturers request sell-through data on withdrawn stocks from their resellers' central warehouse. Although the data are not as complete as point-of-sale (POS) data from the resellers' stores, they offer significantly more information than was available when manufacturers didn't know what happened after they shipped their products. IBM, HP, and Apple all require sell-through data as part of their contract with resellers. Supply chain partners can use electronic data interchange (EDI) to share data. In the consumer products industry, 20 percent of orders by retailers of consumer products was transmitted via EDI in 1990. In 1992, that figure was close to 40 percent and, in 1995, nearly 60 percent. The increasing use of EDI will undoubtedly facilitate information transmission and sharing among chain members. Even if the multiple organizations in a supply chain use the same source demand data to perform forecast updates, the differences in forecasting methods and buying practices can still lead to unnecessary fluctuations in the order data placed with the upstream site. In a more radical approach, the upstream site could control resupply from upstream to downstream. The upstream site would have access to the demand and inventory information at the downstream site and update the necessary forecasts and resupply for the downstream site. The downstream site, in turn, would become a passive partner in the supply chain. For example, in the consumer products industry, this practice is known as vendor-managed inventory (VMI) or a continuous replenishment program (CRP). Many companies such as Campbell Soup, M&M/Mars, Nestle, Quaker Oats, Nabisco, P&G, and Scott Paper use CRP with some or most of their customers. Inventory reductions of up to 25 percent are common in these alliances. P&G uses VMI in its diaper supply chain, starting with its supplier, 3M, and its customer, Wal-Mart. Even in the high-technology sector, companies such as Texas Instruments, HP Motorola, and Apple use VMI with some of their suppliers and, in some cases, with their customers. Inventory researchers have long recognized that multi-echelon inventory systems can operate better when inventory and demand information from downstream sites is available upstream. Echelon inventory the total inventory at its upstream and downstream sites is key to optimal inventory control. Finally, as we noted before, long resupply lead times can aggravate the bullwhip effect. Improvements in operational efficiency can help reduce the highly variable demand due to multiple forecast updates. Hence, just-in-time replenishment is an effective way to mitigate the effect. 4.2 Break Order Batches Since order batching contributes to the bullwhip effect, companies need to devise strategies that lead to smaller batches or more frequent resupply. In addition, the counterstrategies we described earlier are useful. When an upstream company receives consumption data on a fixed, periodic schedule from its downstream customers, it will not be surprised by an unusually large batched order when there is a demand surge. One reason that order batches are large or order frequencies low is the relatively high cost of placing an order and replenishing it. Now some manufacturers induce their distributors to order assortments of different products. Hence a truckload may contain different products from the same manufacturer (either a plant warehouse site or a manufacturer's market warehouse) instead of a full load of the same product. The effect is that, for each product, the order frequency is much higher, the frequency of deliveries to the distributors remains unchanged, and the transportation efficiency is preserved. "Composite distribution" for fresh produce and chilled products uses the same mixed-SKU concept to make resupply more frequent. Since fresh produce and chilled foods need to be stored at different temperatures, trucks to transport them need to have various temperatures. British retailers like Tesco and Sainsbury use trucks with separate compartments at different temperatures so that they can transport many products on the same truck. The use of third-party logistics companies also helps make small batch replenishments economical. These companies allow economies of scale that were not feasible in a single supplier-customer relationship. By consolidating loads from multiple suppliers located near each other, a company can realize full truckload economies without the batches coming from the same supplier. If each customer is supplied separately via full truckloads, using third-party logistics companies can mean moving from weekly to daily replenishments. For small customers whose volumes do not justify frequent full truckload replenishments independently, this is especially appealing. Some grocery wholesalers that receive FTL shipments from manufacturers and then ship mixed loads to wholesalers' independent stores use logistics companies. When customers spread their periodic orders or replenishments evenly over time, they can reduce the negative effect of batching. Some manufacturers coordinate their resupply with their customers. For example, P&G coordinates regular delivery appointments with its customers. Hence, it spreads the replenishments to all the retailers evenly over a week. 4.3 Stabilize Prices The simplest way to control the bullwhip effect caused by forward buying and diversions is to reduce both the frequency and the level of wholesale price discounting. The manufacturer can reduce the incentives for retail forward buying by establishing a uniform wholesale pricing policy. In the grocery industry, major manufacturers such as P&G, Kraft, and Pillsbury have moved to an everyday low price (EDLP) or value pricing strategy. During the past three years, P&G has reduced its list prices by 12 percent to 24 percent and aggressively slashed the promotions it offers to trade customers. The costs of such practices are huge but may not show up in conventional accounting systems. ABC systems provide explicit accounting of the costs of inventory, storage, special handling, premium transportation, and so on that previously were hidden and often outweigh the benefits of promotions. ABC therefore helps companies implement the EDLP strategy. 4.4 Eliminate Gaming in Shortage Situations when a supplier faces a shortage, instead of allocating products based on orders, it can allocate in proportion to past sales records. Customers then have no incentive to exaggerate their orders. General Motors has long used this method of allocation in cases of short supply, and other companies, Such as Texas Instruments and Hewlett-Packard, are switching to it. "Gaming" during shortages peaks when customers have little information on the manufacturers' supply situation. The sharing of capacity and inventory information helps to alleviate customers' anxiety and, consequently, lessen their need to engage in gaming. But sharing capacity information is insufficient when there is a genuine shortage. Some manufacturers work with customers to place orders well in advance of the sales season. Thus they can adjust production capacity or scheduling with better knowledge of product demand. Finally, the generous return policies that manufacturers offer retailers aggravate gaming. Without a penalty, retailers will continue to exaggerate their needs and cancel orders. Not surprisingly, some computer manufacturers are beginning to enforce more stringent cancellation policies. We contend that the bullwhip effect results from rational decision making by members in the supply chain. Companies can effectively counteract the effect by thoroughly understanding its underlying causes. Industry leaders like Procter & Gamble are implementing innovative strategies that pose new challenges: integrating new information systems, defining new organizational relationships, and implementing new incentive and measurement systems. The choice for companies is clear: either let the bullwhip effect paralyze you or find a way to conquer it. 5.0 SAMPLE CASE OF BULLWHIP EFFECT An example may clarify what the bullwhip effect is all about:- San Remo Macaroni Co Pty Ltd, a major pasta producer located in Australia provides a demonstrative of issues resulting from the bullwhip effect. San Remo offered special discounts to their customer who ordered full truckload of their goods. Such marketing deals created customer demand-patterns were highly peaked and volatile. The supply chain costs were so high that they outstripped the benefits from full truckload transportation. San Remo case was one of the first published cases that empirically supported the bullwhip phenomenon. The 5 major reasons leading to the bullwhip effect according to Lee: Demand signal processing is the practice of decision makers adjusting the parameters of the inventory replenishment rule. Target stock levels, safety stocks and demand forecasts are updated in view of information or deviations from targets. Another major cause of the bullwhip problem is the lead-time, which is caused by two components. The physical delays and also delays in cause of information. The lead-time is a key parameter to calculate safety stocks. The third bullwhip creator is the practice of order batching. Economies of scale in ordering, production set-ups or transportation will quite clearly increase order variability. The fourth major cause of bullwhip has to do with price fluctuations. Price discounts and quantity discounts are often offered by retailers. So the retailers buy goods in advance and quantities and store them.The fifth cause of bullwhip is connected with rationing and shortage gaming. Inflated orders placed by supply chain occupants during shortage periods tend to boost the bullwhip effect. Possibilities to minimize the bullwhip effect (in order to avoid costs): Improve communication in the supply chain. Simultaneousness of actions Centralization of disposition Establish strategic alliances Reduce the variability 6.0 CONCLUSION Supply Chain Management (SCM) is nowadays seen as one of the most important areas that should be developed because the present trend aim at cooperation and managing the whole chain. The bullwhip effect is one of the main problem inside any supply chain because it has bad impact on those enterprises, which are not closed to the end customer. I have tried to show how it may come into existence. If each member of the supply chain wants to minimize its inventory cost, the bullwhip effect always appears. As described above, sometimes it doesn’t appear as the demand amplification effect, but it is hidden in the growth of the inventory level and the inventory cost. Unfortunately, it is nearly impossible to avoid it, because any company must count with uncertainty. Better cooperation and communication are seen as key elements in preventing or at least mitigating the consequences of the bullwhip effect. Reductions in lead time also help, as do a variety of new shipping, ordering and pricing methodologies that can introduce a greater degree of stability and prevent small fluctuations in demand from breeding excessive changes on the suppliers end of the chain. ------------------------------------------------END--------------------------------------------------------- 7.0 REFERENCES http://en.wikipedia.org/wiki/Bullwhip_effect http://www.beergame.lim.ethz.ch J. Sterman, "Modeling Managerial Behavior: Misperception of Feedback in a Dynamic Decision-Making Experiment," Management 5f/rarf, volume 35, number 3. 1989, pp. 321-339 http://www.businessdictionary.com/definition/bullwhip-effect.html Bullwhip Effect-BUSM 361 Sec. 2,November 28, 2005,Jeremy Leishman, Jed Robison, Chris Rogers, Sarajane Zarbock. Lee, H., P. Padmanabhan and S. Whang (1997) “Information Distortion in a Supply Chain: The Bullwhip Effect,” Management Science, 43, 546-558. Baljko, J. (1999a) “Expert Warns of ‘Bullwhip Effect’,” Electronic Buyers’ News, July 26. http://www.aalhysterforklifts.com.au/index.php/about/blog-post/what_is_the_bullwhip_effect_understanding_the_concept_definition 17