SMR029

MIT
Massachusetts
Institute of Technology

Spring 1997

Volume 38
Number 3

Hau L. Lee,
V. Padmanabhan & The Bullwhip Effect in Supply Chains
Seungjin Whang

Reprint 3837

This document is authorized for use only in Sara Flores's IEU_3 BBA_SCM-NBA.3.M.C&D_2024/2025 - Supply Chain Management -- OPE at IE Business School from Sep 2024 to Feb 2025
 MIT
Reprints

To order reprints, or request

a free reprint index, please
contact:
Sloan Management Review
Reprints, E60-100
77 Massachusetts Avenue
Cambridge, MA 02139-4307

Telephone: 617-253-7170
Fax: 617-258-9739
E-mail: smr@mit.edu

Copyright Permission

To request permission to
copy one or more articles,
please contact:
Sloan Management Review
Permissions, E60-100
77 Massachusetts Avenue
Cambridge, MA 02139-4307

Telephone: 617-258-7485
Fax: 617-258-9739
E-mail: pfitzpat@mit.edu

This document is authorized for use only in Sara Flores's IEU_3 BBA_SCM-NBA.3.M.C&D_2024/2025 - Supply Chain Management -- OPE at IE Business School from Sep 2024 to Feb 2025
 The Bullwhip Effect in Supply
Chains
Hau L. Lee • V. Padmanabhan • Seungjin Whang

Distorted information from one end over time. However, when they examined the orders
from the reseller, they observed much bigger swings.
of a supply chain to the other can Also, to their surprise, they discovered that the orders
from the printer division to the company’s integrated
lead to tremendous inefficiencies: circuit division had even greater fluctuations.
excessive inventory investment, poor What happens when a supply chain is plagued with
a bullwhip effect that distorts its demand information
customer service, lost revenues, as it is transmitted up the chain? In the past, without
being able to see the sales of its products at the distri-
misguided capacity plans, ineffective bution channel stage, HP had to rely on the sales or-
transportation, and missed ders from the resellers to make product forecasts, plan
capacity, control inventory, and schedule production.
production schedules. How do Big variations in demand were a major problem for
exaggerated order swings occur? What HP’s management. The common symptoms of such
variations could be excessive inventory, poor product
can companies do to mitigate them? forecasts, insufficient or excessive capacities, poor cus-
tomer service due to unavailable products or long back-

N
ot long ago, logistics executives at Procter & logs, uncertain production planning (i.e., excessive revi-
Gamble (P&G) examined the order pat- sions), and high costs for corrections, such as for expe-
terns for one of their best-selling products, dited shipments and overtime. HP’s product division
Pampers. Its sales at retail stores were fluctuating, but was a victim of order swings that were exaggerated by
the variabilities were certainly not excessive. However, the resellers relative to their sales; it, in turn, created
as they examined the distributors’ orders, the execu- additional exaggerations of order swings to suppliers.
tives were surprised by the degree of variability. When In the past few years, the Efficient Consumer Re-
they looked at P&G’s orders of materials to their sup- sponse (ECR) initiative has tried to redefine how the
pliers, such as 3M, they discovered that the swings grocery supply chain should work.1 One motivation
were even greater. At first glance, the variabilities did for the initiative was the excessive amount of invento-
not make sense. While the consumers, in this case, ry in the supply chain. Various industry studies found
the babies, consumed diapers at a steady rate, the de- that the total supply chain, from when products leave
mand order variabilities in the supply chain were am- the manufacturers’ production lines to when they ar-
plified as they moved up the supply chain. P&G rive on the retailers’ shelves, has more than 100 days of
called this phenomenon the “bullwhip” effect. (In
some industries, it is known as the “whiplash” or the Hau L. Lee is the Kleiner Perkins, Mayfield, Sequoia Capital Professor
“whipsaw” effect.) in Industrial Engineering and Engineering Management, and professor
of operations management at the Graduate School of Business, Stanford
When Hewlett-Packard (HP) executives examined University. V. Padmanabhan is an associate professor of marketing, and
the sales of one of its printers at a major reseller, they Seungjin Whang is an associate professor of operations information and
found that there were, as expected, some fluctuations technology, also at Stanford.

SLOAN MANAGEMENT REVIEW/SPRING 1997 LEE ET AL. 93

This document is authorized for use only in Sara Flores's IEU_3 BBA_SCM-NBA.3.M.C&D_2024/2025 - Supply Chain Management -- OPE at IE Business School from Sep 2024 to Feb 2025
 Figure 1 Increasing Variability of Orders up the Supply Chain

Consumer Sales Retailer's Orders to Manufacturer

20 20

15 15
Order Quantity

Order Quantity
10 10

5 5

0 0
Time Time

Wholesaler's Orders to Manufacturer Manufacturer's Orders to Supplier

20 20

15 15
Order Quantity

Order Quantity
10 10

5 5

0 0
Time Time

inventory supply. Distorted information has led every distributors’ warehouses, and store warehouses along
entity in the supply chain — the plant warehouse, a the distribution channel have inventory stockpiles.
manufacturer’s shuttle warehouse, a manufacturer’s And in the pharmaceutical industry, there are duplicat-
market warehouse, a distributor’s central warehouse, ed inventories in a supply chain of manufacturers such
the distributor’s regional warehouses, and the retail as Eli Lilly or Bristol-Myers Squibb, distributors such
store’s storage space — to stockpile because of the as McKesson, and retailers such as Longs Drug Stores.
high degree of demand uncertainties and variabili- Again, information distortion can cause the total in-
ventory in this supply chain to exceed 100 days of sup-

T
ply. With inventories of raw materials, such as integrat-
he ordering patterns share a ed circuits and printed circuit boards in the computer
common, recurring theme: the industry and antibodies and vial manufacturing in the
pharmaceutical industry, the total chain may contain
variabilities of an upstream more than one year’s supply.
site are always greater than those In a supply chain for a typical consumer product,
of the downstream site. even when consumer sales do not seem to vary much,
there is pronounced variability in the retailers’ orders
to the wholesalers (see Figure 1). Orders to the manu-
ties. It’s no wonder that the ECR reports estimated a facturer and to the manufacturers’ supplier spike even
potential $30 billion opportunity from streamlining more. To solve the problem of distorted information,
the inefficiencies of the grocery supply chain.2 companies need to first understand what creates the
Other industries are in a similar position. Computer bullwhip effect so they can counteract it. Innovative
factories and manufacturers’ distribution centers, the companies in different industries have found that they

94 LEE ET AL. SLOAN MANAGEMENT REVIEW/SPRING 1997

This document is authorized for use only in Sara Flores's IEU_3 BBA_SCM-NBA.3.M.C&D_2024/2025 - Supply Chain Management -- OPE at IE Business School from Sep 2024 to Feb 2025
 can control the bullwhip effect and improve their sup- The outcomes of the beer game are the conse-
ply chain performance by coordinating information quence of many behavioral factors, such as the players’
and planning along the supply chain. perceptions and mistrust. An important factor is each
player’s thought process in projecting the demand pat-
tern based on what he or she observes. When a down-
Causes of the Bullwhip Effect
stream operation places an order, the upstream man-
Perhaps the best illustration of the bullwhip effect is ager processes that piece of information as a signal
the well-known “beer game.”3 In the game, partici- about future product demand. Based on this signal,
pants (students, managers, analysts, and so on) play the upstream manager readjusts his or her demand
the roles of customers, retailers, wholesalers, and sup- forecasts and, in turn, the orders placed with the sup-
pliers of a popular brand of beer. The participants pliers of the upstream operation. We contend that de-
cannot communicate with each other and must make mand signal processing is a major contributor to the
order decisions based only on orders from the next bullwhip effect.
downstream player. The ordering patterns share a For example, if you are a manager who has to de-
common, recurring theme: the variabilities of an up- termine how much to order from a supplier, you use a
stream site are always greater than those of the down- simple method to do demand forecasting, such as ex-
stream site, a simple, yet powerful illustration of the ponential smoothing. With exponential smoothing,
bullwhip effect. This amplified order variability may future demands are continuously updated as the new
be attributed to the players’ irrational decision making. daily demand data become available. The order you
Indeed, Sterman’s experiments showed that human be- send to the supplier reflects the amount you need to
havior, such as misconceptions about inventory and replenish the stocks to meet the requirements of future
demand information, may cause the bullwhip effect.4 demands, as well as the necessary safety stocks. The fu-
In contrast, we show that the bullwhip effect is a ture demands and the associated safety stocks are up-
consequence of the players’ rational behavior within dated using the smoothing technique. With long lead
the supply chain’s infrastructure. This important dis- times, it is not uncommon to have weeks of safety
tinction implies that companies wanting to control the stocks. The result is that the fluctuations in the order
bullwhip effect have to focus on modifying the chain’s quantities over time can be much greater than those in
infrastructure and related processes rather than the de- the demand data.
cision makers’ behavior. Now, one site up the supply chain, if you are the
We have identified four major causes of the bull- manager of the supplier, the daily orders from the man-
whip effect: ager of the previous site constitute your demand. If you
1. Demand forecast updating are also using exponential smoothing to update your
2. Order batching forecasts and safety stocks, the orders that you place
3. Price fluctuation with your supplier will have even bigger swings. For an
4. Rationing and shortage gaming example of such fluctuations in demand, see Figure 2.
Each of the four forces in concert with the chain’s As we can see from the figure, the orders placed by the
infrastructure and the order managers’ rational deci- dealer to the manufacturer have much greater variabili-
sion making create the bullwhip effect. Understanding ty than the consumer demands. Because the amount of
the causes helps managers design and develop strate- safety stock contributes to the bullwhip effect, it is in-
gies to counter it.5 tuitive that, when the lead times between the resupply
of the items along the supply chain are longer, the fluc-
Demand Forecast Updating tuation is even more significant.
Every company in a supply chain usually does product
forecasting for its production scheduling, capacity plan- Order Batching
ning, inventory control, and material requirements In a supply chain, each company places orders with an
planning. Forecasting is often based on the order histo- upstream organization using some inventory monitor-
ry from the company’s immediate customers. ing or control. Demands come in, depleting inven-

SLOAN MANAGEMENT REVIEW/SPRING 1997 LEE ET AL. 95

This document is authorized for use only in Sara Flores's IEU_3 BBA_SCM-NBA.3.M.C&D_2024/2025 - Supply Chain Management -- OPE at IE Business School from Sep 2024 to Feb 2025
 load (FTL) and less-than-truckload rates, so compa-
Figure 2 Higher Variability in Orders from Dealer to nies have a strong incentive to fill a truckload when
Manufacturer than Actual Sales
they order materials from a supplier. Sometimes, sup-
pliers give their best pricing for FTL orders. For most
60 items, a full truckload could be a supply of a month
50 or more. Full or close to full truckload ordering would
Orders Placed thus lead to moderate to excessively long order cycles.
40
Quantity

In push ordering, a company experiences regular

30
surges in demand. The company has orders “pushed”
20
Actual Sales on it from customers periodically because salespeople
10 are regularly measured, sometimes quarterly or annu-
0 ally, which causes end-of-quarter or end-of-year order
Time
surges. Salespersons who need to fill sales quotas may
“borrow” ahead and sign orders prematurely. The
tory, but the company may not immediately place U.S. Navy’s study of recruiter productivity found
an order with its supplier. It often batches or accu- surges in the number of recruits by the recruiters on a
mulates demands before issuing an order. There are periodic cycle that coincided with their evaluation
two forms of order batching: periodic ordering and cycle.7 For companies, the ordering pattern from their
push ordering. customers is more erratic than the consumption pat-
Instead of ordering frequently, companies may terns that their customers experience. The “hockey
order weekly, biweekly, or even monthly. There are stick” phenomenon is quite prevalent.
many common reasons for an inventory system based When a company faces periodic ordering by its
on order cycles. Often the supplier cannot handle fre- customers, the bullwhip effect results. If all customers’
quent order processing because the time and cost of order cycles were spread out evenly throughout the
processing an order can be substantial. P&G estimat-

A
ed that, because of the many manual interventions
needed in its order, billing, and shipment systems, lthough some companies
each invoice to its customers cost between $35 and claim to thrive on
$75 to process.6 Many manufacturers place purchase
orders with suppliers when they run their material re- high-low buying
quirements planning (MRP) systems. MRP systems practices,most suffer.
are often run monthly, resulting in monthly ordering
with suppliers. A company with slow-moving items
may prefer to order on a regular cyclical basis because week, the bullwhip effect would be minimal. The pe-
there may not be enough items consumed to warrant riodic surges in demand by some customers would be
resupply if it orders more frequently. insignificant because not all would be ordering at the
Consider a company that orders once a month same time. Unfortunately, such an ideal situation rarely
from its supplier. The supplier faces a highly erratic exists. Orders are more likely to be randomly spread
stream of orders. There is a spike in demand at one out or, worse, to overlap. When order cycles overlap,
time during the month, followed by no demands for most customers that order periodically do so at the
the rest of the month. Of course, this variability is same time. As a result, the surge in demand is even
higher than the demands the company itself faces. more pronounced, and the variability from the bull-
Periodic ordering amplifies variability and contributes whip effect is at its highest.
to the bullwhip effect. If the majority of companies that do MRP or dis-
One common obstacle for a company that wants tribution requirement planning (DRP) to generate
to order frequently is the economics of transportation. purchase orders do so at the beginning of the month
There are substantial differences between full truck- (or end of the month), order cycles overlap. Periodic

96 LEE ET AL. SLOAN MANAGEMENT REVIEW/SPRING 1997

This document is authorized for use only in Sara Flores's IEU_3 BBA_SCM-NBA.3.M.C&D_2024/2025 - Supply Chain Management -- OPE at IE Business School from Sep 2024 to Feb 2025
 execution of MRPs contributes to the bullwhip effect,
or “MRP jitters” or “DRP jitters.” Figure 3 Bullwhip Effect due to Seasonal Sales of Soup

Price Fluctuation 800

700
Estimates indicate that 80 percent of the transactions Shipments from
600
between manufacturers and distributors in the grocery

Weekly Quantity
500 Manufacturer to
Retailers'
industry were made in a “forward buy” arrangement 400
Distributors
Sales
in which items were bought in advance of require- 300
ments, usually because of a manufacturer’s attractive 200
price offer.8 Forward buying constitutes $75 billion to 100
$100 billion of inventory in the grocery industry.9 0
1 52
Forward buying results from price fluctuations in Weeks
the marketplace. Manufacturers and distributors peri-
odically have special promotions like price discounts, sales, with higher sales in the winter (see Figure 3).
quantity discounts, coupons, rebates, and so on. All However, the shipment quantities from the manufac-
these promotions result in price fluctuations. Addi- turer to the distributors, reflecting orders from the
tionally, manufacturers offer trade deals (e.g., special distributors to the manufacturer, varied more widely.
discounts, price terms, and payment terms) to the dis- When faced with such wide swings, companies often
tributors and wholesalers, which are an indirect form have to run their factories overtime at certain times
of price discounts. For example, Kotler reports that and be idle at others. Alternatively, companies may
trade deals and consumer promotion constitute 47 have to build huge piles of inventory to anticipate big
percent and 28 percent, respectively, of their total pro- swings in demand. With a surge in shipments, they
motion budgets.10 The result is that customers buy in may also have to pay premium freight rates to trans-
quantities that do not reflect their immediate needs; port products. Damage also increases from handling
they buy in bigger quantities and stock up for the fu- larger than normal volumes and stocking inventories
ture. for long periods. The irony is that these variations are
Such promotions can be costly to the supply chain.11 induced by price fluctuations that the manufacturers
What happens if forward buying becomes the norm? and the distributors set up themselves. It’s no wonder
When a product’s price is low (through direct discount that such a practice was called “the dumbest market-
or promotional schemes), a customer buys in bigger ing ploy ever.”12
quantities than needed. When the product’s price re- Using trade promotions can backfire because of the
turns to normal, the customer stops buying until it has impact on the manufacturers’ stock performance. A
depleted its inventory. As a result, the customer’s buy- group of shareholders sued Bristol-Myers Squibb
ing pattern does not reflect its consumption pattern, when its stock plummeted from $74 to $67 as a result
and the variation of the buying quantities is much big- of a disappointing quarterly sales performance; its ac-
ger than the variation of the consumption rate — the tual sales increase was only 5 percent instead of the an-
bullwhip effect. ticipated 13 percent. The sluggish sales increase was
When high-low pricing occurs, forward buying reportedly due to the company’s trade deals in a previ-
may well be a rational decision. If the cost of holding ous quarter that flooded the distribution channel with
inventory is less than the price differential, buying in forward-buy inventories of its product.13
advance makes sense. In fact, the high-low pricing
phenomenon has induced a stream of research on Rationing and Shortage Gaming
how companies should order optimally to take ad- When product demand exceeds supply, a manufacturer
vantage of the low price opportunities. often rations its product to customers. In one scheme,
Although some companies claim to thrive on the manufacturer allocates the amount in proportion
high-low buying practices, most suffer. For example, to the amount ordered. For example, if the total supply
a soup manufacturer’s leading brand has seasonal is only 50 percent of the total demand, all customers

SLOAN MANAGEMENT REVIEW/SPRING 1997 LEE ET AL. 97

This document is authorized for use only in Sara Flores's IEU_3 BBA_SCM-NBA.3.M.C&D_2024/2025 - Supply Chain Management -- OPE at IE Business School from Sep 2024 to Feb 2025
 receive 50 percent of what they order. Knowing that IBM, hampered by an overstock problem the previous
the manufacturer will ration when the product is in year, planned production too conservatively. Other an-
short supply, customers exaggerate their real needs alysts referred to the possibility of rationing: “Retailers
when they order. Later, when demand cools, orders — apparently convinced Aptiva will sell well and afraid
will suddenly disappear and cancellations pour in. This of being left with insufficient stock to meet holiday
seeming overreaction by customers anticipating short- season demand — increased their orders with IBM,
ages results when organizations and individuals make believing they wouldn’t get all they asked for.”18 It was
sound, rational economic decisions and “game” the unclear to IBM how much of the increase in orders
potential rationing.14 The effect of “gaming” is that was genuine market demand and how much was due
customers’ orders give the supplier little information to resellers placing phantom orders when IBM had to
on the product’s real demand, a particularly vexing ration the product.
problem for manufacturers in a product’s early stages.
The gaming practice is very common. In the 1980s,
How to Counteract the Bullwhip Effect
on several occasions, the computer industry perceived
a shortage of DRAM chips. Orders shot up, not be- Understanding the causes of the bullwhip effect can
cause of an increase in consumption, but because of help managers find strategies to mitigate it. Indeed,
anticipation. Customers place duplicate orders with many companies have begun to implement innovative
multiple suppliers and buy from the first one that can programs that partially address the effect. Next we ex-
deliver, then cancel all other duplicate orders.15 amine how companies tackle each of the four causes.
More recently, Hewlett-Packard could not meet the We categorize the various initiatives and other possible
demand for its LaserJet III printer and rationed the remedies based on the underlying coordination mech-
product. Orders surged, but HP managers could not anism, namely, information sharing, channel align-
discern whether the orders genuinely reflected real ment, and operational efficiency. With information
market demands or were simply phantom orders from sharing, demand information at a downstream site is
resellers trying to get better allocation of the product. transmitted upstream in a timely fashion. Channel
When HP lifted its constraints on resupply of the alignment is the coordination of pricing, transporta-
LaserJets, many resellers canceled their orders. HP’s tion, inventory planning, and ownership between the
costs in excess inventory after the allocation period upstream and downstream sites in a supply chain.
and in unnecessary capacity increases were in the mil- Operational efficiency refers to activities that improve
lions of dollars.16 performance, such as reduced costs and lead time. We
During the Christmas shopping seasons in 1992 use this topology to discuss ways to control the bull-
and 1993, Motorola could not meet consumer de- whip effect (see Table 1).
mand for handsets and cellular phones, forcing many
distributors to turn away business. Distributors like Avoid Multiple Demand Forecast Updates
AirTouch Communications and the Baby Bells, an- Ordinarily, every member of a supply chain conducts
ticipating the possibility of shortages and acting de- some sort of forecasting in connection with its plan-
fensively, drastically overordered toward the end of ning (e.g., the manufacturer does the production plan-
1994.17 Because of such overzealous ordering by retail ning, the wholesaler, the logistics planning, and so on).
distributors, Motorola reported record fourth-quarter Bullwhip effects are created when supply chain mem-
earnings in January 1995. Once Wall Street realized bers process the demand input from their immediate
that the dealers were swamped with inventory and downstream member in producing their own forecasts.
new orders for phones were not as healthy before, Demand input from the immediate downstream mem-
Motorola’s stock tumbled almost 10 percent. ber, of course, results from that member’s forecasting,
In October 1994, IBM’s new Aptiva personal com- with input from its own downstream member.
puter was selling extremely well, leading resellers to One remedy to the repetitive processing of consump-
speculate that IBM might run out of the product be- tion data in a supply chain is to make demand data at a
fore the Christmas season. According to some analysts, downstream site available to the upstream site. Hence,

98 LEE ET AL. SLOAN MANAGEMENT REVIEW/SPRING 1997

This document is authorized for use only in Sara Flores's IEU_3 BBA_SCM-NBA.3.M.C&D_2024/2025 - Supply Chain Management -- OPE at IE Business School from Sep 2024 to Feb 2025
 both sites can update their forecasts
with the same raw data. In the com- Table 1 A Framework for Supply Chain Coordination Initiatives
puter industry, manufacturers request Causes of Information Channel Operational
sell-through data on withdrawn stocks Bullwhip Sharing Alignment Efficiency
from their resellers’ central warehouse.
Although the data are not as complete Demand • Understanding • Vendor-managed • Lead-time reduction
Forecast system dynamics inventory (VMI) • Echelon-based
as point-of-sale (POS) data from the Update • Use point-of-sale • Discount for infor- inventory control
resellers’ stores, they offer significantly (POS) data mation sharing
• Electronic data • Consumer direct
more information than was available interchange (EDI)
when manufacturers didn’t know what • Internet
happened after they shipped their • Computer-assisted
ordering (CAO)
products. IBM, HP, and Apple all re-
quire sell-through data as part of their Order • EDI • Discount for truck- • Reduction in fixed
Batching • Internet ordering load assortment cost of ordering by
contract with resellers. • Delivery appoint- EDI or electronic
Supply chain partners can use elec- ments commerce
tronic data interchange (EDI) to share • Consolidation • CAO
• Logistics out-
data. In the consumer products indus- sourcing
try, 20 percent of orders by retailers of
Price • Continuous • Everyday low price
consumer products was transmitted Fluctuations replenishment (EDLP)
via EDI in 1990. In 1992, that fig-
19
program (CRP) • Activity-based
ure was close to 40 percent and, in • Everyday low cost costing (ABC)
(EDLC)
1995, nearly 60 percent. The increas-
ing use of EDI will undoubtedly fa- Shortage • Sharing sales, • Allocation based
Gaming capacity, and on past sales
cilitate information transmission and inventory data
sharing among chain members.
Even if the multiple organizations
in a supply chain use the same source demand data to tor, companies such as Texas Instruments, HP, Motorola,
perform forecast updates, the differences in forecasting and Apple use VMI with some of their suppliers and, in
methods and buying practices can still lead to unnec- some cases, with their customers.
essary fluctuations in the order data placed with the Inventory researchers have long recognized that
upstream site. In a more radical approach, the up- multi-echelon inventory systems can operate better
stream site could control resupply from upstream to when inventory and demand information from down-
downstream. The upstream site would have access to stream sites is available upstream. Echelon inventory
the demand and inventory information at the down- — the total inventory at its upstream and downstream
stream site and update the necessary forecasts and re- sites — is key to optimal inventory control.20
supply for the downstream site. The downstream site, Another approach is to try to get demand informa-
in turn, would become a passive partner in the supply tion about the downstream site by bypassing it. Apple
chain. For example, in the consumer products indus- Computer has a “consumer direct” program, i.e., it
try, this practice is known as vendor-managed inven- sells directly to consumers without going through the
tory (VMI) or a continuous replenishment program reseller and distribution channel. A benefit of the pro-
(CRP). Many companies such as Campbell Soup, gram is that it allows Apple to see the demand patterns
M&M/Mars, Nestlé, Quaker Oats, Nabisco, P&G, for its products. Dell Computers also sells its products
and Scott Paper use CRP with some or most of their directly to consumers without going through the dis-
customers. Inventory reductions of up to 25 percent are tribution channel.
common in these alliances. P&G uses VMI in its dia- Finally, as we noted before, long resupply lead times
per supply chain, starting with its supplier, 3M, and its can aggravate the bullwhip effect. Improvements in
customer, Wal-Mart. Even in the high-technology sec- operational efficiency can help reduce the highly vari-

SLOAN MANAGEMENT REVIEW/SPRING 1997 LEE ET AL. 99

This document is authorized for use only in Sara Flores's IEU_3 BBA_SCM-NBA.3.M.C&D_2024/2025 - Supply Chain Management -- OPE at IE Business School from Sep 2024 to Feb 2025
 able demand due to multiple forecast updates. Hence, is preserved. P&G has given discounts to distributors
just-in-time replenishment is an effective way to miti- that are willing to order mixed-SKU (stock-keeping
gate the effect. unit) loads of any of its products.24 Manufacturers
could also prepare and ship mixed SKUs to the distrib-
Break Order Batches utors’ warehouses that are ready to deliver to the stores.
Since order batching contributes to the bullwhip effect, “Composite distribution” for fresh produce and
companies need to devise strategies that lead to smaller chilled products uses the same mixed-SKU concept to
batches or more frequent resupply. In addition, the make resupply more frequent. Since fresh produce and
counterstrategies we described earlier are useful. When chilled foods need to be stored at different tempera-
an upstream company receives consumption data on a tures, trucks to transport them need to have various
fixed, periodic schedule from its downstream cus- temperatures. British retailers like Tesco and Sainsbury
tomers, it will not be surprised by an unusually large use trucks with separate compartments at different
batched order when there is a demand surge. temperatures so that they can transport many products
One reason that order batches are large or order fre- on the same truck.25
quencies low is the relatively high cost of placing an The use of third-party logistics companies also helps
order and replenishing it. EDI can reduce the cost of make small batch replenishments economical.26 These
the paperwork in generating an order. Using EDI, companies allow economies of scale that were not fea-
companies such as Nabisco perform paperless, com- sible in a single supplier-customer relationship. By
puter-assisted ordering (CAO), and, consequently, cus- consolidating loads from multiple suppliers located
tomers order more frequently. McKesson’s Economost near each other, a company can realize full truckload
ordering system uses EDI to lower the transaction economies without the batches coming from the same
costs from orders by drugstores and other retailers.21 supplier. Of course, there are additional handling and
P&G has introduced standardized ordering terms

T
across all business units to simplify the process and dra-
matically cut the number of invoices.22 And General he simplest way to control the
Electric is electronically matching buyers and suppliers
throughout the company. It expects to purchase at least
bullwhip effect caused by
$1 billion in materials through its internally developed forward buying and diversions
Trading Process Network. A paper purchase order that is to reduce both the frequency
typically cost $50 to process is now $5.23
Another reason for large order batches is the cost of and the level of wholesale price
transportation. The differences in the costs of full discounting.
truckloads and less-than-truckloads are so great that
companies find it economical to order full truckloads,
even though this leads to infrequent replenishments administrative costs for such consolidations or multi-
from the supplier. In fact, even if orders are made with ple pickups, but the savings often outweigh the costs.
little effort and low cost through EDI, the improve- Similarly, a third-party logistics company can utilize
ments in order efficiency are wasted due to the full- a truckload to deliver to customers who may be com-
truckload constraint. Now some manufacturers induce petitors, such as neighboring supermarkets. If each
their distributors to order assortments of different prod- customer is supplied separately via full truckloads,
ucts. Hence a truckload may contain different prod- using third-party logistics companies can mean mov-
ucts from the same manufacturer (either a plant ware- ing from weekly to daily replenishments. For small
house site or a manufacturer’s market warehouse) customers whose volumes do not justify frequent full
instead of a full load of the same product. The effect is truckload replenishments independently, this is espe-
that, for each product, the order frequency is much cially appealing. Some grocery wholesalers that receive
higher, the frequency of deliveries to the distributors FTL shipments from manufacturers and then ship
remains unchanged, and the transportation efficiency mixed loads to wholesalers’ independent stores use lo-

100 LEE ET AL. SLOAN MANAGEMENT REVIEW/SPRING 1997

This document is authorized for use only in Sara Flores's IEU_3 BBA_SCM-NBA.3.M.C&D_2024/2025 - Supply Chain Management -- OPE at IE Business School from Sep 2024 to Feb 2025
 gistics companies. In the United Kingdom, Sainsbury explicit accounting of the costs of inventory, storage,
and Tesco have long used National Freight Company special handling, premium transportation, and so on
for logistics. As a result of the heightened awareness that previously were hidden and often outweigh the
due to the ECR initiative in the grocery industry, we benefits of promotions. ABC therefore helps compa-
expect to see third-party logistics companies that fore- nies implement the EDLP strategy.28
cast orders, transport goods, and replenish stores with
mixed-SKU pallets from the manufacturers. Eliminate Gaming in Shortage Situations
When customers spread their periodic orders or re- When a supplier faces a shortage, instead of allocating
plenishments evenly over time, they can reduce the products based on orders, it can allocate in proportion
negative effect of batching. Some manufacturers coor- to past sales records. Customers then have no incentive
dinate their resupply with their customers. For exam- to exaggerate their orders. General Motors has long
ple, P&G coordinates regular delivery appointments used this method of allocation in cases of short supply,
with its customers. Hence, it spreads the replenish- and other companies, such as Texas Instruments and
ments to all the retailers evenly over a week. Hewlett-Packard, are switching to it.
“Gaming” during shortages peaks when customers
Stabilize Prices have little information on the manufacturers’ supply
The simplest way to control the bullwhip effect caused situation. The sharing of capacity and inventory infor-
by forward buying and diversions is to reduce both the mation helps to alleviate customers’ anxiety and, conse-
frequency and the level of wholesale price discounting. quently, lessen their need to engage in gaming. But
The manufacturer can reduce the incentives for retail sharing capacity information is insufficient when there
forward buying by establishing a uniform wholesale is a genuine shortage. Some manufacturers work with
pricing policy. In the grocery industry, major manufac- customers to place orders well in advance of the sales
turers such as P&G, Kraft, and Pillsbury have moved season. Thus they can adjust production capacity or
to an everyday low price (EDLP) or value pricing strat- scheduling with better knowledge of product demand.
egy. During the past three years, P&G has reduced its Finally, the generous return policies that manufac-
list prices by 12 percent to 24 percent and aggressively turers offer retailers aggravate gaming. Without a
slashed the promotions it offers to trade customers. In penalty, retailers will continue to exaggerate their
1994, P&G reported its highest profit margins in twenty- needs and cancel orders. Not surprisingly, some com-
one years and showed increases in market share.27 Simi- puter manufacturers are beginning to enforce more
larly, retailers and distributors can aggressively negotiate stringent cancellation policies.
with their suppliers to give them everyday low cost
(EDLC). From 1991 to 1994, the percentage of trade !
deals in the total promotion budget of grocery products
dropped from 50 percent to 47 percent. We contend that the bullwhip effect results from ration-
From an operational perspective, practices such as al decision making by members in the supply chain.
CRP together with a rationalized wholesale pricing Companies can effectively counteract the effect by thor-
policy can help to control retailers’ tactics, such as di- oughly understanding its underlying causes. Industry
version. Manufacturers’ use of CAO for sending or- leaders like Procter & Gamble are implementing inno-
ders also minimizes the possibility of such a practice. vative strategies that pose new challenges: integrating
Activity-based costing (ABC) systems enable com- new information systems, defining new organizational
panies to recognize the excessive costs of forward buy- relationships, and implementing new incentive and
ing and diversions. When companies run regional measurement systems. The choice for companies is
promotions, some retailers buy in bulk in the area clear: either let the bullwhip effect paralyze you or find
where the promotions are held, then divert the prod- a way to conquer it. ◆
ucts to other regions for consumption. The costs of
such practices are huge but may not show up in con- References
ventional accounting systems. ABC systems provide 1. This initiative was engineered by Kurt Salmon Associates but pro-

SLOAN MANAGEMENT REVIEW/SPRING 1997 LEE ET AL. 101

This document is authorized for use only in Sara Flores's IEU_3 BBA_SCM-NBA.3.M.C&D_2024/2025 - Supply Chain Management -- OPE at IE Business School from Sep 2024 to Feb 2025
 pelled by executives from a group of innovative companies like Procter 12. Sellers (1992).
& Gamble and Campbell Soup Company. See: 13. Ibid.
Kurt Salmon Associates, “ECR: Enhancing Consumer Value in the 14. Lee et al. (1997).
Grocery Industry (Washington, D.C.: report, January 1993); and 15. L. Lode, “The Role of Inventory in Delivery Time Competition,”
F.A. Crawford, “ECR: A Mandate for Food Manufacturers?” Food Management Science, volume 38, number 2, 1992, pp. 182-197.
Processing, volume 55, February 1994, pp. 34-42. 16. Personal communication with Hewlett-Packard.
2. J.A. Cooke, “The $30 Billion Promise,” Traffic Management, volume 17. K. Kelly, “Burned by Busy Signals: Why Motorola Ramped up
32, December 1993, pp. 57-59. Production Way Past Demand,” Business Week, 6 March 1995, p. 36.
3. J. Sterman, “Modeling Managerial Behavior: Misperception of 18. Rory J. O’Connor, “Rumor Bolsters IBM Shares,” San Jose Mercury
Feedback in a Dynamic Decision-Making Experiment,” Management News, 8 October 1994, p. 9D.
Science, volume 35, number 3, 1989, pp. 321-339. 19. M. Reid, “Change at the Check-Out,” The Economist, volume
4. Sterman (1989); and 334, 4 March 1995, pp. 3-18.
P. Senge, The Fifth Discipline: The Art and Practice of the Learning 20. A. Clark and H. Scarf, “Optimal Policies for a Multi-Echelon
Organization (New York: Doubleday/Currency, 1990). Inventory Problem,” Management Science, volume 6, number 4, 1960,
5. For a theoretical treatment of this subject, see: pp. 465-490.
H.L. Lee, P. Padmanabhan, and S. Whang, “Information Distortion 21. E.K. Clemons and M. Row, “McKesson Drug Company — A
in a Supply Chain: The Bullwhip Effect,” Management Science, 1997, Strategic Information System,” Journal of Management Information
forthcoming. Systems, volume 5, Summer 1988, pp. 36-50.
6. M. Millstein, “P&G to Restructure Logistics and Pricing,” Super- 22. Millstein (1994).
market News, 27 June 1994, pp. 1, 49. 23. T. Smart, “Jack Welch’s Cyber-Czar,” Business Week, 5 August
7. V. Carroll, H.L. Lee, and A.G. Rao, “Implications of Salesforce 1996, pp. 82-83.
Productivity, Heterogeneity and Demotivation: A Navy Recruiter Case 24. G. Stern, “Retailers of P&G to Get New Plan on Bills, Shipment,”
Study,” Management Science, volume 32, number 11, 1986, pp. 1371- Wall Street Journal, 22 June 1994.
1388. 25. Reid (1995).
8. Salmon (1993). 26. H.L. Richardson, “How Much Should You Outsource?,” Trans-
9. P. Sellers, “The Dumbest Marketing Ploy,” Fortune, volume 126, 5 portation and Distribution, volume 35, September 1994, pp. 61-62.
October 1992, pp. 88-93. 27. Z. Schiller, “Ed Artzt’s Elbow Grease Has P&G Shining,” Business
10. P. Kotler, Marketing Management: Analysis, Planning, Implementation, Week, 10 October 1994, pp. 84-86.
and Control (Englewood Cliffs, New Jersey: Prentice Hall, 1997). 28. R. Mathews, “CRP Moves Towards Reality,” Progressive Grocer,
11. R.D. Buzzell, J.A. Quelch, and W.J. Salmon, “The Costly Bargain volume 73, July 1994, pp. 43-44.
of Trade Promotion,” Harvard Business Review, volume 68, March-
April 1990, pp. 141-148. Reprint 3837
Copyright © 1997 by the
SLOAN MANAGEMENT REVIEW ASSOCIATION.
All rights reserved.

102 LEE ET AL. SLOAN MANAGEMENT REVIEW/SPRING 1997

This document is authorized for use only in Sara Flores's IEU_3 BBA_SCM-NBA.3.M.C&D_2024/2025 - Supply Chain Management -- OPE at IE Business School from Sep 2024 to Feb 2025