How To Counteract The Bullwhip Effect?

(Part IV)

A case on how to manage batch orders in order to paralyse bullwhip effect

Bullwhip effect is a phenomenon where greater variability is observed in a supply

chain even when there is a steady demand at retailers. It has also been referred to as
“whiplash” or “whipsaw’ effect.

To paralyse the bullwhip effect, the following solutions are recommended:

1. Avoid multiple demand forecast updates

2. Break order batches
3. Stabilise prices

Break order batches

Companies need to develop strategies that favour smaller batches or more frequent
resupply because order batching contributes significantly to the bullwhip effect. Order
batches tend to be large or order frequencies tend to be low because of the high relative
costs involved in placing and replenishing an order. Use of EDI and Computer Assisted
Ordering  (CAO) by Nabisco, P&G and General Electric have helped them to reduce the
transaction costs. A paper purchase order, which earlier cost about $50 to process, is now around 
$6.

The cost of transportation is another factor that encourages large order batches. These is a
considerable difference between the rates of Full Truck Load   (FTL) and less than FTL.
Even if order processing is done with little effort and cost using EDI, the improvements
in order efficiency will go vain due to the FTL constraint.  Since FTL is economical, most
manufacturers today insist their distributors to order assortments of different products.
Instead of a FTL of the same product, a truckload may contain different product of the
same manufacturer. Therefore, the order frequency for each product is much higher; the
frequency of deliveries remains unaffected while preserving the economy of FTL. P&G
has given price discounts to distributors, who ordered a FTL of mixed-SKU (STOCK Keeping
Unit) i.e. full load of different products.

The mixed-SKU concept is also used by “composite distribution” for fresh produce and
chilled products to make resupply more frequent. The trucks to transport fresh produce
and chilled products require various temperatures because these products have to be
stored at different 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.

Use of third-party logistics has helped many companies to make small batch
replenishments economical. If a single supplier cannot utilise FTL, the company allows
multiple suppliers located near each other to consolidate their loads to realise FTL
economies.  Such consolidation or multiple pickups incur additional handling and
administrative costs, but the savings outweigh the costs.

A third party logistics can utilise a FTL to deliver to customers who could also be
competitors such as neighbouring supermarkets. This is especially beneficial for small
customers whose volumes do not justify the use of FTL.  Tesco and Sainsbury have used
National Freight Company for logistics.

The negative effect of batching can be reduced if the customers can spread their
replenishments or placing of periodic orders uniformly over time.  For example, P&G, by
regularly coordinating with its customers, has spread the replenishment to all its retailers
over a week.

Price stabilisation is another effective strategy that helps to eliminate bullwhip effect.
Details of this strategy will be discussed in the next article.

How To Counteract The Bullwhip Effect? (Part V)

 A case on how to stabilise the prices in order to paralyse bullwhip effect

The simplest and the best way to mitigate the bullwhip effect caused by forward buying
and diversions are through reduction of both the frequency and the level of wholesale
price discounting.  When companies run regional promotions, some retailers buy
products in bulk in the area where the promotions are held. Then these products are
diverted to other regions for consumption.  This tactic is called diversion. By establishing
a uniform wholesale pricing policy, the manufacturer can discourage forward buying
and diversions by the retailer.

Major manufacturers of the grocery industry such as P&G, Pillsbury, Kraft in the US has
switched on to Every Day Low Price (EDLP) or value pricing strategy. P&G has cut its discounts
on list prices from 24 to 12% and assertively slashed its promotional offers to trade customers. 
This move has helped P&G to increase its profit margins and market share. Similarly, retailers
and distributors can also negotiate with their suppliers to give them Every Day Low Cost  
(EDLC).

From the operational point of view, practices such as Continuous Replenishment

Programme (CRP) and Computer-Assisted Ordering (CAO) along with a sensible
wholesale pricing strategy can control the tactics of retailers such as forward buying and
diversion. Use of CAO by manufacturers to send orders will minimise the possibility of
such tactics by the retailers.

Activity-Based Costing (ABC) systems help companies to identify the excessive costs
involved in forward buying and diversions. ABC is more than just a way of doing
accounting—it is a tool for making strategic decisions and a method of focusing on
operational inefficiencies. It is powerful because it is simple and is based on identifying
the drivers of cost and calculating the associated cost.

The costs of practices such as forward buying and diversions are huge and are generally
not showed in the conventional accounting systems.  Whereas ABC systems provide
clear picture of the costs of inventory, storage, special handling, premium transportation,
which often outweigh the benefits of promotion. Therefore, ABC systems help companies
to implement the EDLP strategy.

Eliminate Shortage Gaming situations:  When a supplier faces a shortage, he should not
allocate products on the basis of orders. Instead he should allocate the products in
proportion to past sales records. This will discourage the customers to exaggerate their
orders. This method of allocation is being used by General Motors for a long time.   Hewlett-
Packard and Texas Instruments are switching to this method of allocation in case of short supply.

When customers have very little information on the manufacturers’ supply situation,
shortage gaming will be at its peak. The sharing of capacity and inventory information
helps to lessen the customers’ anxiety. This discourages the customers to engage in
gaming. When there is a genuine shortage, sharing information on capacity is
insufficient. Some manufacturers work with customers to place orders well in advance of
the sales seasons. This helps manufactures to adjust their production capacity or
scheduling with better knowledge of product demand.

The liberal product return policies offered to the retailers by manufacturers increases
gaming.   If there is no penalty for cancellation of orders, retailers tend to exaggerate their
needs and later cancel their orders. Some computer companies are enforcing strict
cancellation policies.

Bullwhip effect is not the result of poor planning or irrational behaviour on the part of
players in the supply chain. But is due to each individual acting to optimise his position. 
Companies can conquer bullwhip effect by thoroughly understanding its underlying
causes.