Lack of Supply Chain Coordination and the Bullwhip Effect

Supply chain coordination improves if all stages of the chain take actions that are aligned and increase total supply chain surplus. Supply chain coordination requires each stage of the supply chain to share information and take into account the impact its actions have on other stages.

A lack of coordination occurs either because different stages of the supply chain have local objectives that conflict or because information moving between stages is delayed and distorted. Different stages of a supply chain may have conflicting objectives if each stage tries to maximize its own profits, resulting in actions that often diminish total supply chain profits (see Chapters 11, 13, and 15). Today, supply chains consist of stages with different owners. For example, Ford Motor Company has thousands of suppliers, from Goodyear to Motorola, and each of these suppliers has many suppliers in turn. Not only does each stage focus on its own objectives, but information is also often distorted as it moves across the supply chain because complete information is not shared between stages. This distortion is exaggerated by the fact that supply chains today produce a large variety of products. Ford produces different models, with several options for each model. The increased variety makes it difficult for Ford to coordinate information exchange with thousands of suppliers and dealers. The fundamental challenge today is for supply chains to achieve coordina­tion in spite of multiple ownership and increased product variety.

One outcome of the lack of supply chain coordination is the bullwhip effect, in which fluc­tuations in orders increase as they move up the supply chain from retailers to wholesalers to manufacturers to suppliers, as shown in Figure 10-1. The bullwhip effect distorts demand infor­mation within the supply chain, with each stage having a different estimate of what demand looks like.

Procter & Gamble (P&G) has observed the bullwhip effect in the supply chain for Pampers diapers (Lee, Padmanabhan, and Whang, 1997). The company found that raw material orders from P&G to its suppliers fluctuated significantly over time. Farther down the chain, when sales at retail stores were studied, the fluctuations, though present, were small. It is reasonable to assume that the consumers of diapers (babies) at the last stage of the supply chain used them at a steady rate. Although consumption of the end product was stable, orders for raw material were highly variable, increasing costs and making it difficult to match supply and demand.

Hewlett-Packard (HP) also found that the fluctuation in orders increased significantly as they moved from the resellers up the supply chain to the printer division to the integrated circuit division (ibid.). Once again, although product demand showed some variability, orders placed with the integrated circuit division were much more variable. This made it difficult for HP to fill orders on time and increased the cost of doing so.

Studies of the apparel and grocery industries have shown a similar phenomenon: The fluc­tuation in orders increases as one moves upstream in the supply chain from retail to manufactur­ing. Barilla, an Italian manufacturer of pasta, observed that weekly orders placed by a local distribution center fluctuated by up to a factor of 70 in the course of the year, whereas weekly sales at the distribution center (representing orders placed by supermarkets) fluctuated by a fac­tor of less than three (Hammond, 1994). Barilla was thus facing demand from the distribution center that was much more variable than customer demand. This led to increased inventories, poorer product availability, and a drop in profits.

A similar phenomenon, over a longer time frame, has been observed in several industries that are quite prone to “boom and bust” cycles. A good example is the production of memory chips for personal computers. Between 1985 and 1998, at least two cycles occurred during which prices of memory chips fluctuated by a factor of more than three. These large fluctuations in price were driven by either large shortages or surpluses in capacity. The shortages were exacer­bated by panic buying and overordering that was followed by a sudden drop in demand.

In the next section, we consider how lack of coordination affects supply chain performance.

Source: Chopra Sunil, Meindl Peter (2014), Supply Chain Management: Strategy, Planning, and Operation, Pearson; 6th edition.