Information Distortion in a Supply Chain - The Bullwhip Effect

"The bullwhip effect" has become infamous as one of the worst and most widespread forces capable of paralysing supply chains. INSEAD Chaired Professor of Marketing, Paddy Padmanabhan, Hau Lee and Seungjin Whang of Stanford present a study considered among the Top Ten Most Influential Papers by the INFORMS Membership of Management Science in 2004.

by Paddy Padmanabhan, Hau Lee and Seungjin Whang

As a blight on the fortunes of countless companies, the bullwhip effect could hardly be more infamous. A Google search would return more than 10,000 references. The term has become a catchphrase for commercial mishaps, from the Y2K-related over-ordering of 2000, to the negative impact of certain technological innovations.

The effect has come to be seen as one of the worst and most widespread forces capable of paralysing supply chains. Industry studies such as Efficient Consumer Response (ECR) and Efficient Foodservice Response (EFR) have determined that the bullwhip effect is the most harmful systemic dysfunction that can thwart virtually any supply chain process.

Among the most respected authorities on the causes and consequences of the effect, INSEAD Chaired Professor of Marketing Paddy Padmanaban and co-authors Hau Lee and Seungjin Whang of Stanford offer a comprehensive analysis of the bullwhip effect's harmfulness, and what countermeasures companies have recently implemented. This study is considered among the Top Ten Most Influential Papers chosen by the INFORMS Membership of Management Science in 2004.

The phenomenon is strictly defined as "the amplification of demand variability from a downstream site to an upstream site". But this clinical definition hardly conveys the scale of disruption that can ensue. The authors were first exposed to the term when conducting research at Proctor & Gamble In what has become a famous example, P&G executives were stumped as to why demand would fluctuate so wildly for what would seem to be inherently stable commodities, such as diapers. Further scrutiny made the authors aware that the effect -regardless of the many different names it had accrued - was evident in countless, and often completely unrelated major corporations.

Building on their initial research, the authors have concluded that the bullwhip effect is not a consequence of exogenous shocks. Rather, it is the endogenous outcome of a given firm's policies, as well as the business processes and industry characteristics that both shape and drive behaviour within and between the different entities that make up the supply chain. They describe the factors that most influence the creation of the effect, and identify the four main forces that contribute to it: demand signal processing, order batching, price fluctuations, and shortage gaming.

As a telling example, they briefly consider the dire consequences for Cisco System's 2001 write-off of $2.1 billion worth of inventory, largely blamed on shortage gaming on the part of its contract manufacturers. After thorough contemplation of these and similar fiascos, the authors find that two general approaches - information systems and collaboration - are now being widely used in attempting to counter the bullwhip effect.

The study details further recent research that has been conducted on the four commonly accepted causes of the effect. It concludes by listing some leading MNCs that the authors feel have made major inroads in countering the worst aspects of the bullwhip effect. It ends with calls for further empirical research in key areas to be conducted, so that better estimates can be made in the magnitude of the effect in various industries, and so that a clearer picture might emerge as to why containment of the effect seems to have been far easier in some sectors than in others.

Managment Science, Winter 2004

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