Lack of Coordination in Supply Chain

Effect

  • increase
    • manufacturing cost
    • inventory cost
    • replenishment lead time
    • transportation cost
    • labor cost for shipping and receiving
  • decrease
    • level of product availability
    • relationships across the supply chain
    • profitability
  • bullwhip effect
    • reduces supply chain profitability by making it more expensive to provide a given level of product availability

Obstacles

  • incentive obstacles
    • when incentives offered to different stages or participants in a supply chain lead to actions that increase variability and reduce total supply chain profits – misalignment of total supply chain objectives and individual objectives
    • local optimization within functions or stages of a supply chain
    • sales force incentives
  • information processing obstacles
    • when demand information is distorted as it moves between different stages of the supply chain, leading to increased variability in orders within the supply chain
    • forecasting based on orders, not customer demand
    • lack of information sharing
  • operational obstacles
    • actions taken in the course of placing and filling orders that lead to an increase in variability
    • ordering in large lots (much larger than dictated by demand)
    • large replenishment lead times Rationing and shortage gaming
  • pricing obstacles
    • when pricing policies for a product lead to an increase in variability of orders placed
    • lot-size based quantity decisions
    • price fluctuations
  • behavioral obstacles
    • different stages react to the current local situation rather than trying to identify the root causes
    • local analysis, different stages blame each other for the fluctuations, with successive stages becoming enemies rather than partners
    • lack of trust results in opportunism, duplication of effort, and lack of information sharing

Bullwhip Effect

Overview

  • introduction
    • the value of using any type of IT
    • potential availability of more and more information throughout the SC
    • its implications on effective design and management of the integrated SC
    • information changes the way supply chains can and should be effectively managed, and these changes may lead to lower inventories
    • using accurate information effectively does make the design and management of the SC more complex
  • benefits
    • helps the coordination of manufacturing and distribution systems and strategies
    • helps suppliers make better forecasts accounting for promotions/market changes
    • helps reduce variability in supply chain
    • enables lead time reductions
    • enables retailers to react and adapt to supply problems more rapidly
    • enables retailers to better serve their customers by offering tools for locating desired items

The bullwhip effect

  • figures
  • features
    • the increase in variability going upstream in the supply chain
    • distributors’ orders placed to the factory fluctuated much more than retail sales
    • increase in variability as traveling up in the SC is referred to as the bullwhip effect – upstream echelons face higher variability
  • objectives
    • control the increase in variability in SC
    • identify techniques and tools that will control the bullwhip effect
  • factors of increased variability
    • demand forecasting
      • order-up-to points are modified as forecasts change – orders increase more than forecasts
    • inflated orders
      • in case out of stock (e.g. over Christmas)
    • lead time
      • long lead times magnify long cycle time
    • batch ordering
      • volume and transportation discounts
    • price fluctuation
      • promotional sales
      • forward buying

  • quantify the bullwhip effect

    • single retailer, single manufacturer

      • retailer observes customer demand, \(D_t\)
      • retailer orders \(q_t\) from manufacturer
      • L is the lead time
      • Var(Q), the variance of the orders placed by that retailer to the distributor
      • Var(D), the variance of the customer demand seen by the retailer
      • ratio of variability (ratio of safety stock)

      \[\frac{Var(Q)}{Var(D)} \geq 1 + \frac{2L}{p} + \frac{2L^2}{p^2}\]

      • when p is large, and L is small, the bullwhip effect due to forecasting errors negligible

    • multi-stage supply chains

      • stage i places order \(q_i\) to stage i+1
      • \(L_i\) is lead time between stage i and i+1
      • Var(\(Q^k\)) the variance of the orders placed by the k-th stage of the supply chain
      • Var(D) the variance of the customer demand seen by the retailer
      • \(L_i\) is the lead time between stage i and stage i + 1

      • decentralized

        • the variance increases multiplicatively at each stage of the supply chain

        \[\frac{Var(Q^k)}{Var(D)} \geq \prod^{k-1}_{i=1} (1 + \frac{2L_i}{p} + \frac{2L_i^2}{p^2})\]

        • each stage bases orders on previous stage’s demand

      • centralized

        • increasing function of the total lead time between that stage and the retailer

        \[\frac{Var(Q^k)}{Var(D)} \geq 1 + \frac{2 \sum_{i=1}^{k-1} L_i}{p} + \frac{2 \sum_{i=1}^{k-1} L_i^2}{p^2}\]

        • the variance of the orders placed by a given stage of a supply chain is an increasing function of the total lead time between that stage and the retailer
        • centralizing demand information can significantly reduce, but will not eliminate, the bull-whip effect
        • each stage bases orders on retailer’s forecast demand

  • managerial insights

    • exists, in part, due to the retailer’s need to estimate the mean and variance of demand
    • the increase in variability is an increasing function of the lead time
    • the more complicated the demand models, the greater the increase
    • centralized demand information can significantly reduce the bullwhip effect, but will not eliminate it

Methods to cope with bullwhip effect

  • reducing uncertainty
    • centralizing demand information
    • different forecasting methods and different buying practices may contribute to the bullwhip effect
    • even same forecasting method and same ordering policy, the bullwhip effect will continue to exist
      • point-of-sale (POS)
      • sharing information
      • sharing forecasts and policies
  • reducing variability
    • eliminate promotions
    • “everyday low pricing” (EDLP) strategy
  • lead time reduction
    • order lead times vs. delivery lead times
    • EDI
    • cross docking
  • strategic partnerships
    • vendor managed inventory (VMI)
    • data sharing

Distribution Strategies

3 fundamental distribution strategies

  • directly shipped
    • from the supplier or manufacturer to the retail stores or end customer
    • the manufacturer or supplier delivers goods directly to retail stores
      • the retailer avoids the expenses of operating a distribution center \(\uparrow\)
      • lead times are reduced \(\uparrow\)
      • risk-pooling effects are negated because there is no central warehouse \(\downarrow\)
      • the manufacturer and distributor transportation costs increase for sending smaller trucks to more locations \(\downarrow\)
      • retail store requires fully loaded trucks; often mandated by powerful retailers; lead time is critical; manufacturer may be reluctant but may have no choice; prevalent in the grocery industry-lead times are critical because of perishable goods
    • powerful retailers or lead time is critical
  • intermediate inventory storage points
    • typically warehouses and/or distribution centers
    • issues with warehouses
      • manufacturing strategy (make-to-stock vs. make-to-order)
      • number of warehouses
      • inventory policy
      • inventory turn over ratio
      • internal warehouses vs. outside distributor
      • owned by a single firm or by a variety of firms
    • details
      • variety of characteristics distinguish different strategies - length of time inventory is stored at warehouses and distribution centers
      • traditional warehousing strategy
        • distribution centers and warehouses hold stock inventory
        • provide their downstream customers with inventory as needed
      • cross-docking strategy
        • warehouses and distribution centers serve as transfer points for inventory
        • no inventory is held at these transfer points
      • centralized pooling and transshipment strategies
        • may be useful when there is a large variety of different products
  • cross docking
    • warehouses function as inventory coordination points rather than as inventory storage points
    • goods arrive at warehouses from the manufacturer, are transferred to vehicles serving the retailers, and are delivered to the retailers as rapidly as possible
    • goods spend very little time in storage at the warehouse—often less than 12 hours
    • difficulties
      • distribution centers, retailers, and suppliers must be linked with advanced information systems to ensure that all pickups and deliveries are made within the required time windows
      • effective only for large distribution systems that a large number of vehicles are delivering and picking up goods
      • require a significant start-up investment and are very difficult to manager

Selection of distribution strategy

  • factors
    • customer demand and location
    • service level
    • product type
    • osts (including transportation and inventory)
    • demand variability
    • lead time
    • volume requirements
    • capital investment, etc
  • figure

Centralized vs. decentralized management

  • decentralized system
    • each facility identifies its most effective strategy without considering the impact on the other facilities in the supply chain
    • leads to local optimization
  • centralized system
    • ecisions are made at a central location for the entire supply network
    • centralized control leads to global optimization
    • at least as effective as the decentralized system
    • allow use of coordinated strategies
    • if system cannot be centralized - often helpful to form partnerships to approach the a centralized system

Transshipment

  • content
    • the shipment of items between different facilities at the same level in the SC to meet some immediate need
      • rapid transportation options
      • advanced information systems
  • risk pooling
    • view inventory in different retail outlets as part of a large, single pool
  • homogeneous vs. heterogeneous
    • distributor integration
    • e.g., car dealer, traveling agent

Central vs. local facilities

  • safety stock
    • consolidating warehouses: risk pooling
    • the more centralized an operation is, the lower safety stock levels will be
  • overhead
    • operating a few large central warehouses leads to lower total overhead cost relative to operating many smaller ones
  • economies of scale
    • more expensive to operate many small facilities than to operate a few large facilities (same total capacity)
  • lead time
    • can be reduced if a large number of warehouses are located closer to the market
  • service
    • centralized warehouse increases shipping time from the warehouse to the retailer
  • transportation costs
    • number of warehouses \(\uparrow\) (if condition)
    • inbound transportation costs \(\uparrow\)
    • quantity discounts are less likely to apply
  • conclusions
    • it is possible that some products will be stored in a central facility while others will be kept in various local warehouses
    • very expensive products with low customer demand maybe stocked at a central warehouse
    • low-cost products facing high customer demand may be stocked at many local warehouses
    • critical to implement effective distribution strategies regardless of the total level of supply chain integration