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How to reduce the bullwhip effect: Supply chain partners, data key

Understanding the causes of the bullwhip effect is critical to preventing it. Here's a look at why it happens and ways to close the gap between supply and demand.

The bullwhip effect is one of the most problematic issues in supply chain management.

In a nutshell, buying behavior changes at one end of the supply -- typically at the retailer end -- getting increasingly amplified up the supply chain. Because today's supply chains are so complicated, closing that gap between supply and demand is no small task. But smart supply chain managers and business leaders are making the effort.

Here are five of the most important ways to help reduce the bullwhip effect.

1. Understand bullwhip effect causes

The bullwhip effect is named for its resemblance to exponentially larger waves of a whip.

For instance, a company that sees a spike of 5% in orders may increase its procurement by 10% to keep up with demand. As the order travels up the supply chain, demand grows at each step and the producer of the raw material may increase production by 25% to keep up with demand.

The biggest cause of the bullwhip effect is inefficiency in communicating about the needs of the market, said Michael Goulder, a business professor at John Carrol University.

"The small signal up front gets translated [throughout] the supply chain, and by the end of the whip, it is like, holy crow, this is a huge increase," Goulder said.

The problem comes when the demand quickly evaporates.

Goulder was introduced to the problem early in his career in procurement when he worked for a packaged goods company, and the sales team ran an aggressive promotion trying to move old products. The promotion increased sales, which motivated suppliers to make more product. The company ended up with an 18-month supply of a perishable product and had to declare a restructuring charge. Most of the product got turned into livestock feed or destroyed.

The bullwhip effect was a common occurrence when retailers such as Starbucks would rotate through a new selection of limited-time offers, said JP Montalvo, principal at Montalvo Consulting and the former director of procurement for Wild Flavors, which supplied raw ingredients for food and beverage customers.

Another cause was consumers' growing preference for natural ingredients, which posed a challenge when the raw ingredients were out of season. The company would either end up having too much of one ingredient because they thought demand was growing or too little of other ingredients because a retailer would need a new ingredient in July that is normally harvested in October.

2. Build supply chain partnership trust

Building strong, trusting partnerships with customers and suppliers creates the most success in reducing the bullwhip effect, Montalvo said.

The small signal up front gets translated [throughout] the supply chain, and by the end of the whip, it is like, holy crow, this is a huge increase.
Michael GoulderBusiness professor, John Carrol University

Trust is built over time, which can be a major challenge, particularly if sales and procurement teams come to the table with an adversarial mentality to maintain a negotiation edge.

Supply chain collaboration could start by improving the communications around approximate and exact needs, such as a target delivery date and a drop-dead delivery date, Montalvo said. Trust grows as participants see that partners don't take advantage of more transparent communications. Over time, both suppliers and customers can have better and deeper conversations about the business without worrying they have given away a leverage point.

 "Technology can make [building that trust] easier because it can be used to transmit the information quickly and efficiently, but it has to sit on top of the relationship and trust," Montalvo said.

3. Improve data sharing with supply chain partners

Vendor-managed inventory is another promising approach to reduce the bullwhip effect.

Walmart and other companies are testing this method, Goulder said. With vendor-managed inventory, a retailer delegates to the supplier responsibility for ordering and delivering products. The retailer gives the supplier access to all the relevant data about its products via a constant data stream that is updated daily or more frequently. The manufacturer can look at its own orders, but also the rate of sales in the store. These programs can become even more effective when the retailer can share other supporting data, such as the status of sales and promotions, or information about the location of products within stores that could affect sales.

"They have the ability to take at least one link of this bullwhip effect out of play," Goulder said.

In theory, this type of approach could eventually expand across multiple supply chains, he said.

Some companies are starting to experiment with collaborative planning, forecasting and replenishment (CPFR), Goulder said. This essentially generalizes vendor-managed inventory across multiple participants in a supply chain, but these efforts tend to be less organized. CPFR is a pledge to work and play well together across trading groups. Because CPFR relies on diplomacy and the whims of human nature, sometimes it works well, and sometimes it does not, Goulder said.

4. Consolidate supply chain data

Retailers, manufacturers, suppliers and all supply chain stakeholders are generating data that could help prevent waste and promote efficiency. The problem is getting that data to the right people at the right time.

Big data aggregation improvements and better algorithms could grow together to help prevent the bullwhip effect, Goulder said.

"Eventually, these models could be smart enough to know that the aggregate use of a product is not growing at a rate suggested by a customer's buying behavior," he said.

But these kinds of improvements require organizations to get better at aggregating all of their data into a common platform, said Amanda Wodzenski, principal at Hike 2, a consultancy focused on emerging technology. One big problem is that information for these kinds of algorithms comes from disparate systems, including marketing, sales, production and logistics applications, she said. In addition, many businesses still do their planning with monthly meetings and spreadsheets.

"The more you can understand about customer behavior from a common platform, the more accurately you can predict demand," Wodzenski said.

Companies should look at their different platforms to thoroughly understand all the data sources and identify ways to bring the data to a common platform, she said. This requires understanding where the data is coming from, finding ways to layer analytics on top and then identifying emerging technology that can help.

5. Understand partner processes

Building bridges with other supply chain partners is critical to preventing the bullwhip effect.

Spend more time trying to understand the business processes of customers and suppliers, said Mark Struss, practice director of manufacturing operations at Patina Solutions, a supply chain consultancy. He said customers sometimes know exactly how much of a raw material they need, but don't submit an order early because of the way early purchase orders affect their accounting processes.

"If you have a good relationship with customers, you can ask how their next quarter looks and how to plan," Struss said.

In other cases, the customer may know the magnitude of their future orders, but not the exact composition of them. For example, a shoe company may expect to sell 1 million shoes, but they're not sure which styles will be hot in six months. This information is important to suppliers because they can estimate their needs for factory space and people, even if they are not entirely sure which raw materials to order.

Keeping track of this kind of imprecise information is often easier in spreadsheets than ERP systems, Struss said.

"It would be nice if ERP systems had this kind of forecasting, but a lot of them don't, or it is not used," Struss said.

In his experience, most ERP systems need perfect information or precise part numbers to predict future demand. In many cases, managers can reduce the bullwhip effect by knowing they need to procure so many tons of a raw material, even if they don't know its exact specifications.

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