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					                      Bullwhip Effect
                      SC Partnerships

                      Ch 17 of Chopra

     Bullwhip Effect
     Distortion of demand information of a product while it passes from
       one firm to the next across SC.
                 »    Misinterpretation
                 »    Unreliable EDI protocols
                 »    Loss during encryption / decryption
                 »    Buyback contracts: Rediform buysback planner from retailers. Its shipment data
                      is quite different from the planner of POS data. The retailers return a big chunk
                      of the planners at the end of the season.

        P&G found out that the diaper orders issued by the distributors have a degree of
         variability that cannot be explained by consumer demand fluctuations.
           – Diaper consumption should be stable with a low standard deviation.
           – P&G observed orders with a high standard deviation at the distributors.
        At HP, orders placed by retailers to printer division have much bigger variations
         than consumer demands
     Bullwhip Effect
          The information transferred in the form of “orders” tend to be
           distorted and can misguide the upstream in SC in their
           inventory and production decisions.
          In particular, “variance of my orders” > “variance of my sales”
             – Or, variance of my production > variance of my demand

          Information sharing in SCs is important
             – Sales Information deduced form the orders received from the
               downstream should be used with great caution.

     Three causes of Bullwhip Effect
           Suppose that we have three conditions
              – Finite supply shared by many retailers
                      » Rationing game: retailer orders more than demand
              – Fixed ordering cost
              – Wholesale price varies over time
                      » Inflationary / deflationary environment
                      » Prices with no trend but variability

        Each condition by itself leads to the bullwhip effect.

     The Rationing Game
         Consider a product whose demand sometimes exceeds supply due
          to limitation in production capacity or uncertainty of production
           – New, successful high-tech products
         Manufacturer allocates capacity to retailers proportionally to their
            – In order to secure more units, each retailer will issue an order which
              exceeds in quantity what the retailer would order if the production is
                  » IBM’s semiconductor manufacturing plants allocate capacity to products
                         Memory, CPU, Telecommunication chips
                  » Units managing these products overestimate their orders.
         Optimal order quantity for retailer in the rationing game exceeds
          the order quantity in the traditional newsvendor problem.
     Order Batching
      Fixed ordering costs lump the demand together
         – Order in some periods in big quantities
         – Ex. Given the demand rate of 1 per day. Suppose that ordering becomes
           infrequent with fixed ordering costs. What happens to the standard
           deviation of order sizes over a month of 30 days while the standard
           deviation of demand is constant at zero?

                      Order once Order once Order once Order once Order once
                      in 1 day       in 2 days in 3 days in 4 days in 5 days
    St deviation                 0      1.017      1.438       1.799        2.034

      Sales commissioned salespeople tend to close deals generally at
       the end of a period (such as a month or a year).
      Price Variations
     Frequent markdowns or promotions by the supplier will distress SC.
     Smart retailers will wait for the lower price.
        – Supplier’s demand will not be uniform because retailer shifts its orders to low
          price periods.
     Overstocking will result
     Even when there is no price trends but variability, a risk sensitive
      retailer will order in larger quantities to reduce the exposure to price
              » Southwest airlines buys jet gas in advance to reduce its risk exposure to oil prices

     The reverse can be argued for a risk-seeking retailer. But many SC
      partners are not risk-seeking.

     Beergame results 2002
    Average demand=50, stdev=20, daily averages and stdev of orders:
          Factory           DC         W/H        Retailer
                      112         93         71              46   Year 2002
                      46          45         48              47   Year 2002
                      50          51         51              51   Year 2002

           Factory DC                  W/H        Retailer
                 227             141         96              50 Year 2002
                      38         32          30              26 Year 2002
                      35         31          31              17 Year 2002
                      49         39          41              46 Year 2002     8
     Beergame results in 2005 Spring
    Average demand=50, stdev=20, daily averages and stdev of orders:
          Factory            DC         W/H          Retailer
                       45          45          45               50   Year 2005
                         -         39          40               45   Year 2005
                       117        126          117              51   Year 2005

           Factory DC                   W/H          Retailer
                  32              38          16                18 Year 2005
                        -          41          19               18 Year 2005
                      127         143         122               15 Year 2005
     Further Reading on Bullwhip Effect

                 The Bullwhip Effect by Lee, Padmanabhan, Whang,
                  Management Science Vol.43, No.4, April 1997
                 Forrester, 1961 pointed out that basic form and policies
                  used by an organization can give rise to characteristic and
                  undesirable behaviors in the supply chain.
                 Sterman, 1989 – “Beer Distribution Game”
                 Economical point of view, Holt, 1960; Blinder,1982 and
                 Kahn,1987, positive serial correlation and backlogging
                  also results bullwhip effect.

Is there really a bullwhip effect everywhere?
In search of the bullwhip effect. Unpublished paper by Cachon, Randall and Schmidt

    Claim is that there is not much empirical evidence for bullwhip effect.

Is there really a bullwhip effect everywhere?
In search of the bullwhip effect. Unpublished paper by Cachon, Randall and Schmidt

                      See the article for manufacturing industries.
     Information Sharing applications between SC members

     Bullwhip    effect propagates in an amplified form upwards
        the supply chain if each member processes order signals
        coming immediately from below.

       Information sharing enhances SC in two fundamental ways
          – It enables supplier to respond consumer demand quicker by appropriately
            scheduling production and replenishing retailer`s inventory
                » Continuous Replenishment Program (CRP)
                » Vendor Managed Inventory (VMI)
          – It improves accuracy of demand forecast
                » Collaborative Forecasting and Replenishment (CFAR) facilitates sharing of
                  both short term and long term demand forecasts between manufacturer and
                  retailer                                                                 13
       Upstream partnerships: Cisco`s e-hub project, Cisco is
        able to see not only first tier supplier inventories but
        also second tier supplier inventories
       3M, P&G, Wal-Mart
       Advance Information:
            – Singapore Airport, flight schedule information is given to taxi
              drivers to reduce inside airport traffic
            – Pre-registration at UTD

     Strategic Partnership (SP)
         What is SP?
            – Idea is to achieve benefits of vertical organization with
              independent companies by systematically driving
              independent players towards a single and common objective
                  » Use contracts to “align the misaligned objectives”
            – It is not exclusive!
         What is SP not?
            – Ownership
            – Franchising
                  » Franchising is exclusive

           Strategic Partnering: Types                of SP:

    Only POS: Retailer determines its order sizes and timing but in
       addition passes POS (point of sales) data to the supplier. POS
       improves Supplier’s forecasts.
         – Recall the Japanese 7-eleven

      Reverse Purchase Order: Retailer determines order sizes and
       timing after discussing with supplier. Suppliers often send their
       recommendations for order sizes and times, these recommendations
       are known as reverse purchase order.
         – Panasonic (supplier) and BestBuy (retailer) decide on Bestbuy’s order sizes
           using the Reverse Purchase Order concept.
         – Upside: Panasonic seems to be providing high service.
         – Downside: Panasonic does not see the real demand.
           Strategic Partnering
   Vendor Managed Inventory (VMI):

            » VMI Projects at Dillard Department Stores, J.C. Penney, and
              Wal-Mart have shown sales increases of 20 to 25 percent, and
              30 percent inventory turnover improvements.
            » Continuous Replenishment: Vendors receive POS data and use it to
              prepare shipments at previously agreed upon intervals to maintain agreed
              levels of inventory.

                     Wal-Mart, Kmart
            » Advanced Continuous Replenishment: Suppliers may gradually decrease
              inventory levels at the retailer’s store or distribution center as long as service
              levels are met. Inventory levels are thus continuously improved in a
              structured way.
                     Kmart
           VMI at VF and Wal-Mart
   VF headquartered in Greensboro, NC, engages in the design, manufacture, and marketing of
    branded apparel and related products. The company offers its product lines under various
    brands, including Lee, Wrangler, Riders, Rustler, Vanity Fair, Vassarette, Bestform, Lily of France, Nautica, Earl
    Jean, John Varvatos, JanSport, Eastpak, The North Face, Vans, Napapijri, Kipling, Lee Sport, and Red Kap brands.

   Its 2005 revenue is $6.5B.
   VF does VMI with Wal-Mart. VF knows
      – Wal-Mart inventories: VF ships to Wal-Mart when Wal-Mart inventories drop
      – Wal-Mart store models: Each store’s demographics and psychographics (psychological
        characteristics of the consumers).
      – Wal-Mart POS data: Somewhat useful for managing Latin America production, whose
        lead time is 4 weeks. Not so useful for far east production whose lead time is six months.
   The North Face places three orders in a season to far east producers. The first order
    is small and it is for samples and sales people. The second order is larger and it is
    based on field research not POS. The last order, if necessary, is based on POS.
    Therefore, POS data are used to place the last order and to estimate the next
    season’s sales. The use of POS data increases as the lead times become shorter.
                        Source: “Planning at a Global Scale Pays off for VF corp.” in Supply Chain Leader, October 2006 issue, published by i2 corp.: 4-8.
          Strategic Partnering

        Quick Response: Suppliers receive POS data from retailers, and use this
         information to synchronize production and inventory activities at the supplier.
         In this strategy, the retailer still prepares individual orders, but the POS data
         is used by the supplier to improve forecasting and scheduling.
           – Good example: Milliken and Company: The lead time from order receipt
             at Milliken’s textile plants to final clothing receipt at several of the
             department stores involved was reduced from eighteen weeks down to
             three weeks.
           – Bad example: Ordering a bridal dress from far east; lead time is 4 months

           Main Characteristics of SP

      Criteria               Decision           Inventory        New Skills
      Types                   Maker             Ownership   Employed by suppliers
   With POS and              Retailer            Retailer     Forecasting Skills
  Quick Response
       VMI                   Supplier              ?          Inventory planning
    Continuous        To Contractually Agreed    Either     Forecasting & Inventory
  Replenishment               Levels             Party              Control
    Advanced          To Contractually agreed    Either     Forecasting & Inventory
    Continuous            & Continuously         Party              Control
  Replenishment          Improved Levels

           Requirements for Effective SP

                 Advanced information systems

                      – Information Technology is a mean for SP not an end.

                 Top management commitment

                 Common standards and culture

                 Mutual trust

           Incentives to lie
          Think of a consortium of three companies (A,B,C), which
           collects data from its members and publicizes industry trends
           based on this data.
           Let us say that the industry trend is the sum of the sales
           (SA,SB,SC) made by A,B,C
             – Suppose that these sales are respectively sa, sb, sc
             – But company C lies and reports a sale of sc+x, while A and B tell the
               truth to the consortium
             – The sum now becomes sa+sb+sc+x and that is what is announced by the
             – However, the true sum is sa+sb+sc
             – Which of the companies know the correct sum after the consortium’s
             – Does any company have incentive to report the sales truthfully?

          Unanswered question: What information sharing mechanisms
           prompt the companies to truthfully share their data? Are there
           incentive compatible data sharing mechanisms?                22
      Do banks report lower Interbank Loan Rates?
      Is Libor (London inter-bank offered rate) reliable?
     Libor is based on information supplied by 16 banks all over the world. It is a measure of
      the average interest rate at which banks make 3-month loans to one another.
     Libor=2.71594% on April 15, 2008 from the rates:
        –   Top quartile
                              HBOS 2.75%, Credit Suisse 2.74%, Bank of America 2.73%, JP Morgan 2.72%
        –   Libor based on two center quartile
                              HSBC 2.72%, Tokyo-Mitsubishi 2.72%, Barclays 2.72%, Norinchukin 2.72%,
                              Bank of Canada 2.7175, Lloyds 2.71%, Westdeutsche Landesbank 2.71%, Radobank 2.71%.
        –   Bottom quartile
                              UBS AG 2.71%, Bank of Scotland 2.705%, Deutsche Bank 2.7%, Citigroup 2.7%.
     “Some banks do not want to report the high rates they are paying for 3-month loans
      because they do not want to tip off the market that they are desperate for cash.”
                           –    C. Mollenkamp, Bankers Cast Doubt On Key Rate Amid Crisis, Page A1, WSJ issue on April 16, 2008.
     Bank for International Settlements (a bankers consortium) is concerned that banks might
      be reporting inaccurate rates as of Spring 2008.
     A Citigroup analyst predicts that if banks provided accurate data about their borrowing
      costs, three-month Libor would be higher by as much as 0.3%.
        –   0.3% change in interest rate is not small. For a 30 year mortgage for $200K,
              » $199 K is the total interest payments with 5.3% interest
              » $186 K is the total interest payments with 5.0% interest
     Bottomline: Banks’ misrepresentation could mean that consumers are paying artificially
      low rates on their loans. … good for borrowers, but could be very bad for the banks. 23
          Important SP Issues

         Inventory ownership:

            – Supplier owns the goods until they are sold or,

                  » Dell’s suppliers own the goods which are maintained in a facility
                    rented from Dell and the facility is only 15 minutes driving distance
                    from Dell.

            – Retailer owns the goods

         Performance measures: Fill rate, inventory level, inventory turns

          Important SP Issues
       Confidentiality
          – Problem: Nonexclusiveness. P&G partners with both KMart-Sears and Wal-Mart
          – Solution: Partially-Hiding data smartly
          – Problem: Data linking.
                » Use publicly available records to link databases to makeup the hidden data
                         Real estate agent problem: Reveals that a house (known by address) is for sale. But
                          hides the house owner information to avoid buyer’s direct negotiation with the
                          owner. House tax records can be used to link house addresses to owners.

       Communication and cooperation
          – When First Brands (cleaning products such as clorox) started partnering with Kmart,
            Kmart often claimed that its supplier was not living up to its agreement to keep two
            weeks of inventory at all times. It turned out that this was due to the fact that the two
            companies employed different forecasting methods.
          Steps in SP Implementation

           Contractual negotiations
              –   Ownership
              –   Credit terms
              –   Ordering decisions
              –   Performance measures
           Reengineer SC operations
           Develop or integrate information systems
           Develop effective forecasting techniques
           Develop a tactical decision support tool to assist in coordinating
            inventory management and transportation policies
          Advantages and Disadvantages of SP

                 Fully utilize system knowledge
                      – Consider the partnership between White-Hall
                        Robbins (W-R), who makes over-the-counter drugs
                        such as Advil, and Kmart. W-R initially disagreed
                        with Kmart about forecasts, and in this case, it
                        turned out that W-R forecasts were more accurate
                        because they have a much more extensive
                        knowledge of their products than Kmart does.

           Advantages of SP

                 Decrease required inventory levels

                 Improve service levels

                 Decrease work duplication

                      – In apparel industry manufacturers prepare garments for
                        sale at the stores, attaching labels, packaging.

                 Improve forecasts

          Disadvantages of SP

                 Expensive advanced technology may be required

                 Supplier/retailer trust must be developed.

                 Supplier responsibility increases.

                 Expenses at the supplier often increase.
                      – Cost sharing?


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