Bullwhip Effect: What Causes it and Using

Bullwhip Effect:

What causes it and using ECR and VMI to counteract its effects

"The bullwhip effect occurs when the demand order variabilities in the supply chain are amplified as they moved up the supply chain" (Lee, Padmanabhan & Wang 1997). The bullwhip effect could be characterized as a kind of a gigantic game of 'telephone,' in which the first message becomes distorted in the retelling, and subsequent transmissions of the information result in greater and greater errors. "The common symptoms of such variations could be excessive inventory, poor product forecasts, insufficient or excessive capacities, poor customer service due to unavailable products or long backlogs, uncertain production planning (i.e., excessive revisions), and high costs for corrections, such as for expedited shipments and overtime" (Lee, Padmanabhan & Wang 1997).

Individuals on the supply chain can only make use of information from the person on the chain immediately before them. Information is often not fully accurate, because even though demand may be consistent within an industry, it can be distorted because of monthly variations of demand; the desire to make orders large enough to fill a shipment truckload; and buying in bulk to save money which interferes with the ability to engage in accurate forecasting. The first step in counteracting the bullwhip effect is the use of Efficient Consumer Response systems (ECR). These computerized systems alleviate some of the asymmetries of information that are the cause of the bullwhip effect. ECR "attempts to integrate all departments and functions across a company onto a single computer system that can serve all those different departments' particular needs" (Wailgum 2008). ECR ensures "when a customer service representative enters a customer order into an ECR system, he has all the information necessary to complete the order... People in these different departments all see the same information and can update it. When one department finishes with the order it is automatically routed via the ECR system to the next department. To find out where the order is at any point, you need only log in to the ECR system and track it down" (Wailgum 2008:1). ECRs allow for integrated customer and financial information and standardized information. "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 their immediate downstream member in producing their own forecasts" (Lee, Padmanabhan & Wang 1997). With ECRs, forecasting is simultaneous and everyone uses the same information.

However, ECRs are only the first step in lessening the effects of the bullwhip. With Vendor Managed Inventory "the vendor creates orders for their customers based on demand information that they receive from the customer. The vendor and customer are bound by an agreement which detECRines inventory levels, fill rates and costs. This arrangement can improve supply chain performance by reducing inventories and eliminating stock-out situations" (Murray 2012). When there are high levels of preorders because of expected surges in inventory, or 'safety stock' because of a desire to anticipate a surge in consumer demand, take advantage of lower prices, or reduce transportation costs because of bulk orders, supplies can build up. Instead of this inefficient search for 'bargains,' VMI creates value through efficiency.

VMI has been suggested as a solution for some of the problems currently afflicting the Indian consumer durable goods industry, which is currently experiencing a boom, but not enjoying the expected levels of productivity and growth, despite India's burgeoning middle class. "The key cause for inefficiency is the poor integration between the retailer and supplier. None of the retailers...has so far an automated system for information exchange with their suppliers. In developed countries, retailers practice Vendor Management Inventory (VMI) systems, where the supplier has access to the point of sales data of the retailer and plans automatic replenishments responding to the stocks available at the retailer....best practice retailers globally have implemented techniques like milk runs -- having continuous orders to suppliers as the inventory depletes and doing multiple small lot shipments from the supplier to stores" (Organised retail in India will top U.S.$22bn, 2009, Indian microfinance). Using traditional methods of forecasting, such as relying upon historical data, will not allow manufactures in the developing world to keep pace with the new global economy given how rapidly their area of the world is changing. The Indian automotive sector has begun to use VMI technology, and it is hoped that the practice will gradually spread throughout other industries (Organised retail in India will top U.S.$22bn, 2009, Indian microfinance).