SUPPLY CHAIN MANAGEMENT

Supply Chain Coordination

Chapter 10

PGP Term III

— Prof. Yash Daultani

Supply Chain Performance

 Supply chain performance depends on the actions taken by all of the
organizations in the supply chain; one weak link can negatively affect every
other location in the chain.
 While everyone supports in principle the objective of optimizing the supply
chain’s performance, each firm’s primary objective is the optimization of its
own performance (local optimization).
 Unfortunately, self-serving behavior by each member of the supply chain
can lead to less than optimal supply chain performance (global
optimization).
 The firms in the supply chain can benefit from better operational
coordination.
 SC Coordination Challenges
 Bullwhip Effect
 Incentive Conflicts

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Supply Chain Structure

Tier 2 M 8 days to prepare shipment

7 days review Suppliers 2 days for transit
2 days to transmit order
Tier 1 3 days to prepare shipment
2 days for transit
7 days review Suppliers
2 days to transmit order 1 day from receipt to issue
Factory 26 days for manufacturing
1 day for transit
1 day to transmit order
Factory 2 days from receipt to issue
1 day to prepare shipment
10 days review
Warehouse 7 days for transit
2 days to transmit order
2 days from receipt to issue
Distributors 1 day to prepare shipment
7 days review 3 days for transit
2 days to transmit order O Retailers 2 days from receipt to issue

Customers

Bullwhip Effect
The magnification of variability in orders in the supply-
chain

Retailer’s Orders Wholesaler’s Orders Manufacturer’s Orders

Time Time Time

A lot of …can lead to …can lead to

retailers each greater variability even greater
with little for a fewer number variability for a
variability in of wholesalers, single
their orders…. and… manufacturer.

2
 What is the bullwhip effect?
 Demand variability increases as you move up the supply chain from
customers towards supply

Equipment Tier 1 Supplier Factory Distributor Retailer Customer

3
Demand Fluctuations at Different Stages of a
Supply Chain

When a stage in
the supply chain
amplifies the
volatility of its
orders relative to
its demand, it is
called the
bullwhip effect

P&G coined the

term to describe
the pattern they
observed in their
diaper supply
chain in 1990s

Barilla’s Cortese Distribution Center Orders and

Shipments

4
Sample Stockouts and Inventory Level

Consequences of the bullwhip effect

 Inefficient production or excessive inventory.

 Low utilization of the distribution channel.

 Capacity jerks

 High transportation costs.

 Poor customer service due to stockouts.

 Poor quality

5
 Quantifying Bullwhip effect
Bullwhip effect is present in a supply chain if the variability of
demand at one level of the supply chain is greater than the
variability of demand at the next downstream level in supply chain,
where variability is measured with the coefficient of variation

A single supplier
and 20 retailers,
each with one store.
Let’s focus on a
single product, a
product in which
daily demand has a
Poisson distribution
with mean 1.0 unit
at each retailer

Causes of the bullwhip effect

 Order synchronization

 Order batching

 Trade promotions and forward buying

 Reactive and over-reactive ordering

 Shortage gaming

6
 Order synchronization
 Customers order on the same
order cycle, e.g., first of the
month, every Monday, etc.

 The graph shows simulated

daily consumer demand (solid
line) and supplier demand
(squares) when retailers order
weekly: 9 retailers order on
Monday, 5 on Tuesday, 1 on
Wednesday, 2 or Thursday and
3 on Friday.

 MRP Jitters…Hockey stick

phenomenon

Order batching
 Retailers may be required to order
in integer multiples of some batch
size, e.g., case quantities, pallet
quantities, full truck load, etc.

 Due to the batch quantity

requirement, the retailer’s order
quantity in a period generally does
not match the retailer’s demand in
that period

 The graph shows simulated daily

consumer demand (solid line) and
supplier demand (squares) when
retailers order in batches of 15
units, i.e., every 15th demand a
retailer orders one batch from the
supplier that contains 15 units.

7
Trade promotions and Forward Buying
 Supplier gives retailer a temporary discount (on the wholesale price), called
a trade promotion.
 Forward buying - Retailer purchases enough to satisfy demand (much
more than needed) until the next trade promotion (or not?).

Example: Campbell’s Chicken Noodle Soup over a one year period:

Total shipments and consumption One retailer’s buy

Reactive and over-reactive ordering

 Each location forecasts demand to determine shifts in the demand process.

 How should a firm respond to a “high” demand observation?

 Is this a signal of higher future demand or just random variation in
current demand?
 Hedge by assuming this signals higher future demand, i.e. order more
than usual.

 Rational reactions at one level propagate up the supply chain.

 Unfortunately, it is human to over react, thereby further increasing the

bullwhip effect.

8
Shortage gaming
 Setting: Hot-selling product, 1 supplier with limited capacity, multiple
retailers
 Retailers submit orders for delivery in a future period.
 Supplier produces. If supplier production is less than orders, orders are
rationed, i.e., retailers are “put on allocation”.

 … to secure a better allocation, the retailers inflate their orders, i.e., order
more than they need…

 … So retailer orders do not convey good information about true demand …

 This can be a big problem for the supplier, especially if retailers are later
able to cancel a portion of the order:
 Orders that have been submitted that are likely be canceled are called
phantom orders.
 Product returns?

Strategies to combat the bullwhip effect

 Information sharing: (POS data)
 Collaborative Planning, Forecasting and Replenishment (CPFR)

 Smooth the flow of products

 Coordinate with retailers to spread deliveries evenly.
 Reduce minimum batch sizes.
 Smaller and more frequent replenishments (EDI).

 Eliminate pathological incentives

 Every day low price (EDLP)
 Restrict returns and order cancellations
 Order allocation based on past sales in case of shortages
 Turn-and-earn in Auto industry

 Vendor Managed Inventory (VMI): delegation of stocking decisions

 Used by Barilla, P&G/Wal-Mart and others.

9
An antidote to the bullwhip effect
 Is there any force in a supply chain that counteracts the bullwhip
effect?

 Yes: If demand is seasonal (i.e., there are anticipated peaks and valleys in
demand), then use production smoothing:
 If the firm’s orders are correlated with its production, the firm’s suppliers
will see orders that are smoother than the firm’s demand.

Demand exceeds
production, drawing
Production down inventory
Quantity

Production exceeds
demand, building
Demand inventory

Time

Without Decoupling Point

10
With Decoupling Point

Vendor Managed Inventory (VMI)

 Inventory that is managed by the vendor (supplier)

 Inventory ownership generally remains with the vendor

 The vendor determines when to replenish and how much to replenish

 The best case for VMI is when the vendor can do a better job of
managing the inventory than the customer.

 Sometimes, the reality is customers tend to choose to use VMI

because it relieves them of the burden and responsibility of managing
the inventory.

 Covers a wide range of tasks related to managing inventory. A specific

VMI program may cover a single task, all tasks, or any combination.

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 VMI Variations
 Vendor shows up at customer’s facility, physically reviews inventory
levels
 immediately replenishes with inventory he has with him (actually physically
stocks the inventory on the customer’s shelves).
 places an order for replenishment inventory that will be delivered at a later
date. Depending on delivery method, the vendor may do the physical
restocking or may leave it for the customer to do.

 Customer periodically (daily, weekly, etc) provides vendor with current

inventory levels. Vendor reviews inventory levels and creates
replenishment orders. Replenishment orders are shipped to customer.
Customer performs all physical tasks.

 Vendor has direct access to customer’s inventory system and can get
real-time information related to on-hand levels, open orders, forecasts,
production schedules, etc. Vendor makes replenishment decisions
based on this data and ships orders to customer.

Collaborative Planning, Forecasting and

Replenishment (CPFR)

12
Barilla’s Cortese Distribution Center Orders and
Shipments

Barilla
 Manufacturer of “fresh” and
“dry” pasta products
 Largest pasta manufacturer in the
world with >1000 SKUs
 Very stable demand at retail
level

DC
DC
North DC
DC
Central DC DC
Factory
Customers

South
Central DC
DC
DC
DC
DC
DC

13
 The Bullwhip effect at Barilla pasta
Max order size 900

Downstream variability at DC: mean

Upstream variability is much higher
demand is about 300, the std. dev.
(std. dev = 227), mean demand is
is about 75
same

Min order size 9

Causes of the problem

 Transportation discounts

 Volume discounts (2%-3% for FTL)

 Promotions - 10-12 canvass periods (each has 4-5 weeks

promotion)

 No minimum or maximum order quantities

 Product proliferation

 Long order fulfilment lead times

 Poor customer service rates (high 6-7% stockout rates)

 Sales compensation system

 Poor communication

14
VMI’s impact on the DC

VMI’s impact on the DC’s order volatility

Start of VMI
Quintals/week (100 kg)

Time

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