Beer game is a simulation activity created by professors of MIT in 1960 to demonstrate the bullwhip effect of supply chains. The game assumes a supply chain of beer with a single manufacturer, distributor, retailer and a customer to portray the change in variability of the order as it pass through the upstream of supply chain. The phenomenon where order variability increase as it moves upstream in the supply chain is described as bullwhip effect (Xuan Wang, 2015).
The term “bullwhip effect” was first coined by Procter and Gamble (P&G) to explain the order variance amplification phenomenon between P&G and its suppliers in 1990. Order variance amplification along with demand amplification and forecaster effect were terms which were used in the old literature to describe bullwhip effect phenomenon (Towill, 2002).
Lee at el defines bullwhip effect phenomenon as,
“ Information transferred in the form of orders tend to be distorted and can misguide upstream members in their inventory and production decisions, the variance of (replenishment) order can be larger than that of sales ( to end customer) and the distortion tends to increase as one moves upstream” (Towill, 2002).
The figure above shows the bullwhip effect in an electronic products supply chain. As can be seen from the figure, an increase in customer order increases retailer’s order to wholesaler to a greater extent than the increase in customer order. Further, the wholesaler’s order to manufacturer observes a far more increases than retailer’s order to wholesaler and the effect continuous as it moves the upstream of supply chain. This increase in order variance as the order moves the upstream of supply chain holds true for customer demand decline scenarios as well.
What causes bullwhip effect?
1. Demand forecasting updating
Accurate demand forecasting has been a complex task. Various demand forecasting techniques are used in companies but all these demand forecasting methods are based on historical demand data of the company. Hence a change in demand is perceived as signal of change in future demand. So, product scheduling, capacity planning, inventory control and materials requirement planning as changes according to the new signal and this signal processing is one of the major contributor to bullwhip effect (Hau L Lee, 1997).
For example, if your supply chain manager at a retail shop and your company uses moving average to forecast the demand. The daily demand data is continuously added and future demand are continuously updated. The order you place to the supplier includes requirement to replenish the stock to meet future demand as well as necessary safety stock. This causes more order fluctuations than the demand data (Hau L Lee, 1997).
2. Batching Order
Instead of ordering frequently, companies accumulates demand before ordering for inventory due to substantial time and cost involved in it. Even if economics of transportation is considered, the logistic companies as well as suppliers give best prices for full truck loads (FTL) or full container loads (FCL). This type of batch ordering can take two forms; periodic ordering and push ordering (Hau L Lee, 1997).
Consider a particular product of retailers which uses monthly periodic ordering. The wholesaler faces high demand at the end of every month but no demand at all during the month. This pattern amplifies the variability and contributes highly to the bullwhip effect. In push ordering, suppliers face demand surges at the end of a quarter or a year. This ordering patters is further deviant from the consumption patterns of its customers and thus contributes to bullwhip effect (Hau L Lee, 1997).
3. Price fluctuations
Promotions in terms of trade discounts, quantity discounts, coupons or any other such incentive distorts the buying patter of the supply chain. Retailers or wholesalers buy from its suppliers during the promotion which are very far from the consumption patterns of the consumer. As can be observed from figure below, the retails sales and shipment orders from the manufacturer. When sales are seasonal as the forward sales concept used in grocery sales industry, the shipments from manufacturers to distributors does not reflect the retail sales patterns. Hence, it often leads to more orders from manufacturers than actual sales of the product. Such seasonal sales often creates huge pile of inventories, factories overtime at sometimes while be idle at others and also increases damage products.
4. Rationing and shortage gaming
When demand is more than the supply, manufacturers rations its products to customers. The retailers or wholesalers exaggerate real demand for the goods and order in excess to cater to the full needs of its customers. When demand falls, the orders decrease and order cancellations pour in. This shortage gaming gives suppliers little information about the final demand for the product and hence leads to bullwhip effect.
A rationing and shortage gaming was recently experienced by Hewlett-Packard for its LaserJett III printer. When they started rationing, the orders surged and managers could not understand if the orders reflect real demand or just phantom orders. When demand cooled down, the resellers reduced orders and cancelled many and resulted in excess inventory and unnecessary production capacity.
Ways to eliminate bullwhip effect
Information sharing, channel alignment and operational efficiency are vital to mitigate the bullwhip effect. Information sharing implies communicating demand information with suppliers on a timely manner and channel alignment is the coordination in pricing, transportation, inventory planning and ownership between the upstream and downstream of the supply chain. Cost and lead time minimization attempts are referred to as operational efficiency. These principles are used in the following strategies to mitigate bullwhip effect.
Avoid multiple demand forecast
Bullwhip effect occurs when a players in the supply chain forecast demand for its goods or service based on the order places by the immediate downstream player in the supply chain. This creates a multiple forecast for demand. This can be eliminated by communicating the actual demand data from the downstream player to the upstream players in the supply chain allowing the upstream players to forecast its demand based on the same raw data.
Break order batches
The bullwhip effect created from batch ordering can partly be addressed from information sharing as explained above. However, devising strategies to would allow smaller batch ordering or frequent ordering are crucial to completely eliminate bullwhip effect. Companies chose batch ordering due the substantial administrative as well as transportation cost involved in it. Administration cost of ordering can be minimized by Electronic Data Interchange (EDI) systems. Companies order assorted products to make a truck load to manufacturer to reduce the cost of transportation. Thus, a truck load contains different products from the supplier. Composite distribution and third party logistics can also help to make small batch replenishment economical.
Reducing frequency and level of wholesale discounts can assist in reducing bullwhip effect in forward buying contracts practiced in grocery industry. P&G, Kraft and Pillsbury has adopted everyday low price (EDLP) and value pricing strategies over the years and were able to realize highest profit margins.
Eliminate gaming in shortage situations
Apportioning the products based on past sales records during the times of shortages reduces the chances for the retailers to exaggerate their real needs. Further, limited information on the suppliers supply capacity increases uncertainty of the retailers and tends to order more than required. Hence sharing this information would alleviate customer anxiety. Over the years, some manufacturers have also taken a proactive approach to solve this problem by encouraging the customers to place order well in advance of the season allowing timely changes production capacity according to the advance orders.
The bullwhip effect can cost a company in millions in terms of operational cost and inventory cost. When companies operate in this globalized markets, eliminating unnecessary cost due to bullwhip effect becomes critical to be competitive and get enough skin in the game. However, despite the long history of literature on bullwhip effect, this problem can be traced in many companies even today. Perhaps further researches based on bullwhip effect based on different supply chain could be helpful.
Hau L Lee, V. P. (1997). The bullwhip effect in supply chains . MIT sloan management review , 11.
Towill, P. M. (2002). Diagnosis and reduction in bullwhip effect in supply chains . Supply chain management : An international journal , 16.
Xuan Wang, S. M. (2015). The bullwhip effect : progress, trends and directions . European journal of operations research , 11.