To study and quantify the Bullwhip effect in Supply Chain management

A Dissertation submitted to DEVI AHILYA VISHWAVIDYALAYA, INDORE towards partial fulfillment of the degree of Bachelor of Engineering (Mechanical Engineering)

Guided by: - Submitted by:-

Dr. Nagendra Sohani Sir Anup Chaturvedi Aviral Verma

Ganesh Patidar Prasanna Soni Sonu Sejkar

Department of Mechanical Engineering Institute of Engineering and Technology Khandwa Road, Indore (M.P.) 452017 www.iet.dauniv.ac.in

Institute of Engineering and Technology Devi Ahilya Vishwavidyalaya Indore

CERTIFICATE

This is to certify that the project report named “Study and quantify the Bullwhip effect in Supply Chain management” submitted by

Anup ChaturvediAviral VermaGanesh PatidarPrasanna SoniSonu Sejkar

to Devi Ahilya Vishwavidyalaya, Indore in partial fulfillment of the requirement for award of the degree of Bachelor of Engineering (Mechanical) is a satisfactory account of their project work.

Dr. Nagendra Sohani Project Guide

Department of Mechanical Engineering

Dr. Manohar Chandwani Director IET-DAVV

ACKNOWLEDGEMENT

Words tend to loose their effectiveness when we turn the pages of the encyclopedia of our hearts to express gratitude and thankfulness. We would like to convey our heartiest thanks to our project guide Dr. Nagendra Sohani sir. From the bottom of the heart without whom devoted indulgence and expert guidance the project could not have had taken the shape. We here by find the golden opportunity to acknowledge our sincere thanks to Dr. M.chandwani director IET-DAVV and Dr . Ashesh Tiwari (HOD- Mechanical Engineering) for letting us undertake this project.

Institute of Engineering and Technology

Devi Ahilya Vishwavidyalaya Indore

Dissertation approval sheet

This is to certify that Mr Anup chaturvedi , Mr. Aviral verma , Mr. Ganesh patidar, Mr. Prasanna soni, Mr. Sonu sejkar (III yr B.E. Mechanical Engineering) in the academic year 2008-09 of this institute have successfully completed the project phase1 work entitled “ To study and quantify the Bullwhip effect in Supply chain management” and have submitted a satisfactory report as a part of requirement for the award of degree of bachelor of engineering from Devi Ahilya Vishwavidhyalaya, Indore.

External Examiner Internal Examiner

CONTENTS

Page no.

1. Introduction to Supply Chain 5-12

2. Role of Information in Supply Chain 13-15

3. Bullwhip Effect 16-23

4. Beer Distribution game 24-28

5. Literature Review 29-31

6. Future endeavors 32-33

1 . Introduction to Supply Chain

Supply chain management (SCM) is the term used to describe the management of the flow of materials, information, and funds across the entire supply chain, from suppliers to component producers to final assemblers to distribution (warehouses and retailers), and ultimately to the consumer. In fact, it often includes after-sales service and returns or recycling. Figure 1 is a schematic of a supply chain. In contrast to multiechelon inventory management, which coordinates inventories at multiple locations, SCM typically involves coordination of information and materials among multiple firms.

Supply chain management has generated much interest in recent years for a number of reasons. Many managers now realize that actions taken by one member of the chain can influence the profitability of all others in the chain. Firms are increasingly thinking in terms of competing as part of a supply chain against other supply chains, rather than as a single firm against other individual firms. Also, as firms successfully streamline their own operations, the next opportunity for improvement is through better coordination with their suppliers and customers. The costs of poor coordination can be extremely high. In the Italian pasta industry, consumer demand is quite steady throughout the year. However, because of trade promotions, volume discounts, long lead times, full-truckload discounts, and end-of-quarter sales incentives the orders seen at the manufacturers are highly variable (Hammond (1994)). In fact, the variability increases in moving up the supply chain from consumer to grocery store to distribution center to central warehouse to factory, a phenomenon that is often called the bullwhipeffect .This would be discussed broadly in later section It seems that integration, long the dream of management gurus, has finally been sinking into the minds of western managers. Some would argue that managers have long been interested in integration, but the lack of information technology made it impossible to implement a more “systems-oriented” approach. Clearly industrial dynamics researchers dating back to the 1950’s (Forrester (1958); Forrester (1961)) have maintained that supply chains should be viewed as an

integrated system. With the recent explosion of inexpensive information technology, it seems only natural that business would become more supply chain focused. However, while technology is clearly an enabler of integration, it alone can not explain the radical organizational changes in both individual firms and whole industries. Changes in both technology and management theory set the stage for integrated supply chain management. One reason for the change in management theory is the power shift from manufacturers to retailers. Wal-Mart, for instance, has forced many manufacturers to improve their management of inventories, and even to manage inventories of their products at Wal-Mart. While integration, information technology and retail power may be key catalysts in the surge of interest surrounding supply chains, eBusiness is fueling even stronger excitement. eBusiness facilitates the virtual supply chain, and as companies manage these virtual networks, the importance of integration is magnified. Firms like Amazon.com are superb at managing the flow of information and funds, via the Internet and electronic funds transfer. Now, the challenge is to efficiently manage the flow of products. Some would argue that the language and metaphors are wrong. “Chains” evoke images of linear, unchanging, and powerless. “Supply” feels pushy and reeks of mass production rather than mass customization. Better names, like “demand networks” or “customer driven webs” have been proposed by many a potential book author hoping to invent a new trend. Yet, for now, the name “supply chain” seems to have stuck. And under any name, the future of supply chain management appears bright.

Effective supply chain management

The complexities of getting material ordered, manufactured and delivered overload most supply chain management (SCM) systems. The fact is, most systems are just not up to handling all the variables up and down the supply chain. For years, it was thought that it was enough for manufacturers to have an MRP or ERP system that could help answer fundamental questions such as: What are we going to make? What do we need to make the products? What do we have now? What materials do we need, and when? What resources/ capacity do we need and when? Manufacturers need to know a lot more today to have a truly effective supply chain. There are a number of fundamental weaknesses in the old system logic. Many planning and scheduling systems in use today assume that lead times are fixed, queues do not change, queues must exist, capacity is infinite and backward scheduling logic will produce valid load profiles and good shop floor schedules. These assumptions are totally illogical, and following them causes many schedule compliance problems. An effective fix is first to streamline operations and then to apply predictive, preventive forms of advanced planning and scheduling. SCM involves two flows. Information flow signals the need to start the flow of material. In a supply chain, the fast flow of high-quality information and material is inextricably linked and of paramount importance to SCM success. Untimely or low-quality information virtually guarantees poor performance. Manufacturers need to develop flexible supply chain processes that can adapt to the needs of various customer segments. They must also develop supply chain strategy, processes and supporting systems that conform to current and future requirements.

Generally, an effective SCM approach must focus on:• Flexible supply and production processes that can very quickly respond to changing customer demand• A short-cycle, demand-driven order-to-delivery process• Accurate, relevant information that is available on demand throughout the supply chain. Throughout the supply chain, there are some absolutely critical and predictive questions your system should accurately and quickly answer:

• When will specific orders really ship?• Which orders will be late?• Why will these orders be late?• What are the specific problems that are delaying the schedule?• What are the future schedule problems and when will they occur?• What is the best schedule that can be executed now?

If management can answer predictive questions, its decisions will greatly improve. Preventive actions can offset what were once unforeseen problems. The supply chain will be managed more effectively and improve chances of gaining a competitive advantage. In the early 1980s, with the introduction of just-in-time production to the United States, many were convinced that pull signals (kanbans) and instant material deliveries would eradicate the need for MRP. The announcement of MRP’s death was premature, except for firms with simple products and absolute control of supplier deliveries. Those with more complex productsrequiring more supply sources for more parts discovered that longer lead times and demand and supply variability were still issues to be dealt with. Simply put, the more diverse your product line and the more complex your products, the more valuable MRP is for planning raw material needs. This is not to say pull logic is not useful for raw material planning, because it is. Yet for most, it is not necessary (or desirable) to put every part number from every supplier on a pull system. Scheduling production with MRPpush logic, however, is like pushing a rope. You don’t know what direction it will go. Pull systems will eventually dominate the entire

supply chain—to customers and from suppliers, as well as internal material movement. Yet, MRP can, and must, coexist with pullscheduling. Cycle time compression should be the first objective in the order-to-delivery process. Midrange manufacturers often have limited clout with suppliers, making across-the-board mandatorylead-time reductions unlikely. While there are many ways to workout mutually beneficial and necessary improvements with suppliers, the real enemy is time. The alternative is to work selectively on supply improvements while using a rationalized inventory deployment strategy to support the first objective—reducing order-to-delivery cycle time.Good collaborative forecasting, good planning and realistic replenishment scheduling are essential to effective SCM. Further improvements come from redesigning supplier links to make them firm, fast and flexible for the benefit of the entire supply chain. During the transformation, companies have learned the value ofminimising cycle time and having predictable schedules, especially with mass customization. Both are necessary for effective supply chain performance.

Fig. Four supply chain scenarios

2. Role of information in supply chain

Information could be overlooked as a major supply chain driver because it does not have a physical presence. Information, however, deeply affects every part of supply chain. Its impact is easy to underestimate as information affects a supply chain in many different ways. Consider the following:

1) Information serves as the connection between the supply chain’s various stages, allowing them to coordinate and bring out many of the benefits of maximizing total supply chain profitability.

2) Information is also crucial to the daily operation of each stage in a supply chain. For instance, a production scheduling system uses information on Demand to create a schedule that allows a factory to produce the right products in an efficient manner .A warehouse management system uses information to create a visibility of the warehouse’s inventory. The company can then use this information to determine whether new orders can be filled.

Further we can classified information as follows

a) Centralized information –: one of the most frequent suggestion for reducing the bullwhip effect is to centralized demand information within a supply chain that is to provide each stage of supply chain with complete information on the actual customer demand. if the demand information is centralized, each stage of supply chain can use the actual customer demand data to create more accurate forecasts, rather than relying on the orders received from the previous which can vary significantly more than the actual customer demand

b) Decentralized information-: second type of supply chain that we consider is the decentralize supply chain. In this case the retailer does not make its forecast mean demand available to the remainder of supply chain . instead the wholesaler must estimate the mean demand based on the orders received from

the retailer.

Information is a driver whose importance has grown as company’s have used it to become both more efficient and more responsive. Another key decision involves what information is most valuable in reducing cost and improving responsiveness within a supply chain. This decision will very depending on the supply chain structure and the market segments served. Some companies target Customers who require customized product that carry a premium prize tag. This company might Find that investment in information allow them to respond more quickly to their customers.

3. Bullwhip Effect

What is the Bullwhip Effect?

The bullwhip effect is the magnification of demand fluctuations, not the magnification of demand. The bullwhip effect is evident in a supply chain when demand increases and decreases. The effect is that these increases and decreases are exaggerated up the supply chain.

The essence of the bullwhip effect is that orders to suppliers tend to have larger variance than sales to the buyer. The more chains in the supply chain the more complex this issue becomes. This distortion of demand is amplified the farther demand is passed up the supply chain.

Proctor & Gamble coined the term “bullwhip effect” by studying the demand fluctuations for Pampers (disposable diapers). This is a classic example of a product with very little consumer demand fluctuation. P&G observed that distributor orders to the factory varied far more than the preceding retail demand. P & G orders to their material suppliers fluctuated even more. Babies use diapers at a very predictable rate, and retail sales resemble this fact. Information is readily available concerning the number of babies in all stages of diaper wearing. Even so P&G observed that this product with uniform demand created a wave of changes up the supply chain due to very minor changes in demand.

Figure 3. Increasing variability of orders up the supply chain: Bullwhip effect

(Lee et al. 1997a).

The four main causesof the bullwhip effect have been identified by Lee et al. (1997a, b), which are Demand Forecast Updating, Order Batching, Rationing and Shortage Gaming, and PriceVariations. Demand forecast updating

Forecasting data used are normally based on the previous orders received by the company from its customers. The main reason for this problem is that the data are usually based on forecast orders and not actual customer demand. As most companies are untrusting, this leads to companies not wanting to share information about demand, which leads to information distortion throughout the supply chain (Lee et al. 1997a, b). Various methods of forecasting such as exponential smoothing or moving average forecasting have been employed by many companies to find the‘truest’ demand. Unfortunately, any type of forecasting can cause the bullwhip effect (Chen et al. 1998). However, it is possible to reduce the bullwhip effect significantly by using centralized information and allowing only one member of the supply chain to place orders on behalf of all other members via Vendor Managed Inventory (VMI) and Continuous Replenishment Programmes (CRP) (Lee et al. 1997a, b).

Order batching

Order batching has been identified as another major cause of the bullwhip effect (Lee et al. 1997a, b, Chen et al. 1998, 2000a). Order batching refers to a company ordering a large quantity of a product in one week and not ordering any for many weeks. The main reason for a company ordering in batches is that it may prove to be less costly because of transportation costs or the company will receive a discount if a large quantity is ordered

in one period. Although this may reduce the cost for the company, the other members of the supply chain are likely to suffer. The impact of batch ordering is simple to understand. Where the retailer uses batch ordering, the manufacturer will observe a very large order, followed by several periods of no orders and then another large order, etc. The manufacturer forecast demand will be greatly distorted as it will base future demand forecasts on orders rather than actual sales (Chen et al. 1998). One method of reducing the bullwhip effect is by ordering less product and more frequently, which will allow the supplier to determine the true demand.

Rationing and shortage gaming

When a product demand exceeds supply, a manufacturer often rations its product to customers (Lee et al. 1997a, b). Rationing schemes that allocate limited production in proportion to the orders placed by retailers lead to a magnification of the bullwhip effect (Chopra and Meindl 2004). When this problem arises, many customers will exaggerate their orders to ensure that they receive a sufficient amount of the required product. This can cause major problems, as when demand is not as high, the orders will stop, and cancellations will begin to arise. This leaves the manufacturer with excess inventory and no customer orders. This also makes it difficult for the manufacturer to believe that there is an increase in demand, whereas customer demand is actually unchanged.

Price variations/sales promotions

If the price of products changes dramatically, customers will purchase the product when it is cheapest. This may cause customers to buy in bulk, which also adds to the order-batching problem. Manufacturers and distributors occasionally have special promotions like price discounts, quantity discounts, coupons, rebates, etc. (Lee et al. 1997b). All these price promotions result in price fluctuations,

and the customers’ ordering patterns will not reflect the true demand pattern. One method of avoiding price fluctuations is by stabilizing

prices (Lee et al. 1997b). If companies can reduce the price of their product to a single reduced price, the fluctuations in demand will not be as aggressive. Sales promotion is another major contributor to this problem. If the consumer purchases more of the product because of the promotion, this will cause a large spike to appear in demand and further upstream the supply chain. Despite the lowered price for consumers, this will have the opposite effect on the supply chain causing forecast information to be distorted and in effect causing inefficiencies, i.e. excessive inventory, quality problems, higher raw-material costs, overtime expenses, shipping costs, poor customer service, and missed production schedule (Lee et al. 1997b, Chen et al. 1998). Campbells Soup provides a useful illustration of how price promotions can cause an increase in the bullwhip effect (Fisher 1997). With the use of Electronic Data Interchange (EDI) and shortened lead times, Campells became aware of the negative impact the overuse of price promotions can have on physical efficiency. When Campbells offered a promotion, retailers would stock up on the product. This proved inefficient for both the supplier and the retailer. The retailer had to pay to carry the excess inventory, and the supplier had to pay for the increase in shipments (Fisher 1997). This illustration proves that a consistent low price should be employed by retailers and suppliers to avoid the increase in demand. This increase in demand is the main cause of the bullwhip effect as it causes demand information to become distorted and large ‘one-off ’ shipments, which are extremely costly. Retailers use promotions to meet monthly quotas for products, which can result in the overuse of promotions. The result is an addiction to incentives that turn simple predictable demand patterns into a chaotic series of spikes that only add to cost (Fisher 1997). No matter where a promotion occurs, whether it is a sales promotion to consumer to buy a specific product or a discount for retailers from a manufacturer, it is more prudent to provide lower prices all year round and disregard promotional strategies altogether (Fisher 1997). In an ideal world, companies would use everyday low pricing. Unfortunately, this is not the case,

as companies compete with other competitors by using price promotions to increase profits and improve market share.

How to remedy the Bullwhip Effect?

When the bullwhip effect is first identified in a supply chain, it is important to identify the problem areas. The following areas are places in the supply chain that should be considered when trying to decrease the bullwhip effect. Although many of these areas many seem like proper business practices, the reality is that they diminish the efficiency of the supply chain. Once changes are made in these areas, the productivity and timeliness of the supply chain will increase greatly and the bullwhip effect will be dramatically lessened.

How do costs increase?

Excess raw materials costs arise from the last minute purchasing decisions made to accommodate an unplanned increase in demand. The result of these panicked buying periods is an inventory of unused supplies. As these unused supplies grow, so do the associated costs. Excess capacity during periods of low volume of demand is followed by inefficient utilization and overtime expenses incurred during high demand periods. This is made worse by the excess warehousing expenses that are incurred because of unused storage space, as well as increases in shipping costs caused by premium rates paid for last minute orders.

1. Demand Signal Processing • Retailers often use realized demand as an indicator of future demand. • Inference and data dependency problems.

2. Rationing Gaming • Used when demand outstrips supply. • Rationing might indicate internal problems that limit meeting supply goals. 3. Order Batching • Used because organizations are attempting to obtain benefits from large-volume pricing discounts and reduced costs of transportation. • Can lead to large inventory volumes and misleading demand figures for upstream suppliers. 4. Price Variations • Used to position suppliers that are involved in market share wars with other suppliers. • Might cut off established relationships in efforts to “shop around” for a better price.

4. The Beer Distribution Game

The Beer distribution game, which was developed by the Systems Dynamics Group at the Massachusetts Institute of Technology in the 1960s, demonstrates the bullwhip effect by simulating a make-to-stock supply chain with four tiers. Participants of the beer distribution game take the role of the retailer, the wholesaler, the distributor or the factory (see figure 3). An end customer places orders at the retailer. His demand pattern is given, but unknown to the participants. The retailer is asked for four units during the first six periods and for eight units during the following periods of the simulation. The partners up the supply chain receive orders from their customers and decide—based on their current stock situation, the products in transport, which will reach their stock within the next periods, and the orders they received—how much to order from their supplier for replenishment. This way, information on the end customer demand is passed onup the supply chain with a delay of one period of time at each tier. Material is forwarded in the other direction – down the supply chain. The material flow is delayed as well: Material has to be transported (see the trucks between tiers in figure 3) and it has to pass materials receiving. Therefore, it takes two periods until material received from a supplier can be delivered to a customer from stock at each tier. The goal is to minimise the over-all logistics costs of the simulated supply chain. A product on stock costs E0.5 per period (costs of capital employed). If a tier cannot deliver, this causes costs of E1 per product per period (penalty for out-of-stock situations). Thus participants have to take into account a trade-off between minimising the costs of capital employed in stocks on the one hand and avoiding of out-of-stock situations, on the other hand. The beer distribution game has proved to be an effective means of illustrating systems thinking(Goodwin and Franklin 1994). By enabling managers to experience the negative impact of the bullwhip effect on supply chain

performance, the beer distribution game makes them aware of the application of countermeasures in their companies. Therefore, the

beer distribution game is successfully applied in many management development programs.

The beer distribution game online: A supply chainwith humans and agents as participants

If the beer distribution game is played as a board game, the feedback given to participants is limited for time reasons. Usually giving feedback takes two persons: One presents diagrams of orders placed by the participants and of their stock situation during the game whereas the other is manually calculating the resulting costs for capital employed in stocks and backorders. The idea of giving an instant feedback on the beer distribution game originally led to the concept of the beer distribution game online (Center of Enterprise Sciences 2003, www.beergame.lim.ethz.ch). Participants from all over the world meet on the web site and arrange games. There are two game modes:

The classic version has the rules of the physical beer distribution game implemented while the version ‘classic plus’ allows parameterisation. Participants decide how many periods they would like to simulate, whether they want to have full visibility of the stock situation throughout the supply chain and whether they want to allow information exchange between players or not. Other participants can join the game and choose a tier of the supply chain (see figure 4). Alternatively, players can assign agent-based strategies (Hieber and Hartel 2003) to the tiers. Currently, there are two strategies to choose from. The first is ‘moving average/standard deviation’, where the agent orders the amount that was in average ordered from him during the last five periods, plus an amount to create a safety stock depending on the standard deviation of orders he received. The second strategy, ‘keep level of stock’, is even

simpler: Each order received from a customer is passed on to the supplier.

Surprisingly enough, this simple strategy is the bestsolution to the beer distribution game. The best solution to the beer distribution game—easy to achieve If each tier in the supply chain would target refilling his stock after delivery to his customer by just passing on the customer’s order to his supplier, the initial stocklevels would cover the unexpectedly higher demand during the lead time of information and material. Figure 5 shows orders (from left to right: the customer, the retailer, the wholesaler, the distributor and thefactory) and stock levels (from left to right: the retailer, the wholesaler, the distributor and the factory) of a simulation in which all tiers followed this strategy. At each tier of the supply chain it takes one period to inform the supplier of the change of demand. It takestwo further periods for the material to be shipped from the supplier’s to the customer’s stock. Thus, at each tier the supply chain can react on the demand change within three periods. During these three periods, tiers are required to meet—according to the demand patternmentioned above—an unexpected demand of four additional units without being able to react on it. The initial stock of 12 units allows them to cover this unexpected demand. Stock level in period one afterdemand change is eight, in period two it is four and in period three it is zero. As soon as the stock is empty, the supply chain is adjusted to the new demand and eight instead of only four units arrive at the stock enabling partners to fulfil orders.

Figure 3. The four-tier supply chain simulated in the beer distribution game.

5. Literature Review

1) Boute et al Studied that :-> A major cause of supply chain deficiencies is the bullwhip problem, which refers to the tendency of replenishment orders to increase in variability as they move up a supply chain. Conventional bullwhip reduction is only one side of the coin, however. In developing a replenishment rule one has to consider the impact on the inventory variance as well.

2) According to Huang et al. research :-> The bullwhip effect refers to the phenomenon of the amplification of demand variability from a downstream site to an upstream site in the supply chain.

3) According to Sterman et al study :-> The Bullwhip effect stems from a non-optimal solution applied by members of the supply chain who see their strategies as a sum of individual strategies rather than a unit.

4) Forrester observed that :-> A small change in the rate of sale at the retail level could result in a much larger change in demand for the manufacturer. The magnitude of the distortion in the demand information is amplified as one travels up through the supply chain.

5) Seokcheon Lee et al found that:-> As supply chains become bigger and dynamically structured involving multiplorganizations with different interests, it is impossible for a single organization to control a whole supply chain. So, decentralization of decision rights is an inevitable facet of managing modern supply chains.

6) J. NIENHAUS et al found that :-> The aspects of human behaviour need to be recognised as further amplifying the bullwhip effect. Humans act as obstacles for information flow in supply chains in practice and by that increase the lead time of information and as a consequence the bullwhip effect.

7). Riddalls and Bennett :-> They successfully shown that --

Disruptions can be costly in supply chain systems and can cause a variety of problems such as long lead-times, stock-outs, inability to meet customer demand and increases in costs and finds that disruptions in an supply chain can lead to unexpected costs when shipping lead-times are long.

8).Goldbergs et al :-> According to him --

Genetic algorithms do not carry out examinations sequentially but search in parallel mode using a multi individual population, where each individual is being examined at the same time.

6. Future Endeavors

1. To study the information distortion in an industry and quantify the Bullwhip Effect in its Supply Chain.

2. To study Beer distribution game online and to develop logics to detect Information distortion & Bullwhip Effect.

3. To study the researches made on Supply chain Management and The Bullwhip Effect.

4. To study and apply a mathematical model to quantify Bullwhip Effect.