Friday, June 20, 2014

The Bullwhip Effect and how to become a smarter distributor

The Bullwhip Effect and Your Supply Chain

If you own a business, then you might be aware of the bullwhip effect, Sorry no Indiana Jones involved here. The Bullwhip effect is is an important supply chain phenomenon first noted by MIT systems scientist Jay Forrester. Even if you have never heard of this effect, perhaps you are familiar with the beer distribution game, which is an experiment designed to show the dynamics of managing a supply chain. If you are not please click on the links to learn more. 
To put the bullwhip effect in simple terms, in looking at businesses further back in the supply chain, inventory swings in larger and larger "waves" in response to customer demand (the handle of the whip), with the largest "wave" of the whip hitting the supplier of raw materials.
What causes the bullwhip effect? There are numerous reasons cited for this phenomenon. First of all, there are the more obvious operational factors, some of which you have probably experienced firsthand either through the beer game, or through managing your own business
For example, lead time issues are a common supply-chain challenge. As participants often learn in the game, two overdue shipments arrive about the time customer demand has dried up. But aside from the well-researched operational factors, supply chains are also clearly influenced by human behavior. for today let's assume that human behavior is the major factor in the bullwhip effect.
If that is the case - how can we exploit this to become a smarter distributor?

Example of the bullwhip effect

Let’s look at an example; the actual demand for a product and its materials start at the customer, however often the actual demand for a product gets distorted going down the supply chain. Let’s say that an actual demand from a customer is 8 units, the retailer may then order 10 units from the distributor; an extra 2 units are to ensure they don’t run out of floor stock.
Bullwhip effect exampleThe supplier then orders 20 units from the manufacturer; allowing them to buy in bulk so they have enough stock to guarantee timely shipment of goods to the retailer. The manufacturer then receives the order and then orders from their supplier in bulk; ordering 40 units to ensure economy of scale in production to meet demand.  Now 40 units have been produced for a demand of only 8 units; meaning the retailer will have to increase demand by dropping prices or finding more customers by marketing and advertising.

Human behavior in relation to perceived risk is a particularly interesting topic.
First of all, fear is a significant motivating factor in human behavior, The fear of loss, or of being wrong, is also a key human factors issue with supply-chain management.
Supply-chain managers who can calmly make decisions and act according to a plan while competitors panic, do nothing or become too greedy, typically do not have a problem. People who act out of fear or greed along with the herd of reactive people in the marketplace will often be wrong, will not benefit and may do real harm to their business.
This "fear factor" builds upon a second issue, which has to do with decisions under seemingly ambiguous and anxiety-provoking circumstances. For generations, people have wracked their brains trying to find market, commodity and equity "bottoms," or the point at which it is time to buy and "go long."
With the bullwhip effect, which models herd behavior, it may be useful to face supply-chain risk and decision-making like an old stock trader. Pressing past nervous indecision, the effective manager will stoically acquire some inventory while others sit on their hands or take drastic discounting or liquidation measures due to slack demand.
When product demand picks up, those that maintained their "safety stock" and then added cheap inventory on "dips" will benefit from favorable margins on a small bump up in demand. Such positioning allows one to take a chunk of the competition's sales while they remain underwater on their ill-timed, high-priced inventory purchases.

Where and how do you find these dips/opportunities? 

By using the MDS Sales Analysis Tools you can visualize Sales Cycles for an Item using Trend Graphs and up to three years of Sales Data. 

As an item dips you can see the bullwhip effect in action and understand that the sales of the item will likely come back.  A contrarian stance isn't about blindly doing the opposite. Rather, it is about using psychology and Data Analytics  to gain leverage from understanding typical group behavior, such as that we see with the bullwhip effect.  When it makes sense, based upon customer and supplier data, as well as sound logistical planning and experience, taking a contrarian approach offers a hedging strategy that will tame volatility and make the bullwhip effect work for you. 

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