RESEACH BRIEF: The Bullwhip Effect and Information Sharing across the Supply Chain

By Paula Fallas, dfpaula@vt.edu

In today’s conditions it is easy to think that different elements across supply chain cooperate to share information, that can potentially increase efficiency throughout the value stream. This should be true especially provided that technology can aid in such communications. Even though there is a wide range of information regarding the consequences of lack of cooperation across a supply chain it isn’t practiced regularly.

In the wood fiber supply chain, a Supplier/Consumer Relationship study conducted in 2012 showed that suppliers throughout the United States experienced a lack of cooperation between them and the customer mills. This lack of cooperation can be associated to information sharing. For example, in the Mid-South region, “suppliers cite a significant lack of joint planning that could be beneficial to both their business and the customer mills attempting to reduce costs” (Taylor, 2012). Similarly, the Southeastern region reported cooperation issues such as the lack of long-term wood orders (Taylor, 2012). Both of these concerns reflect that planning or effective demand forecasting are restricted due to the industry’s characterized business practices. The issues stated above reflect just a minimum reality of challenges to overcome.

To demonstrate the power of information sharing, it is of interest to understand and determine what the bullwhip effect is, what contributes to this effect and what are ways to decrease it.

Figure 1 shows how variability in orders fluctuate depending on each element of the supply chain. Across time both suppliers and retailers observed that even if customer demand for certain products presents low variation, orders increase in quantity and in variation moving up throughout the supply chain. The increase in variability migrating throughout each link in a supply chain is called the bullwhip effect (Simchi-Levi, Kaminsky and Simchi-Levi, 2015).

Figure 1. The Bullwhip Effect (Source: (Moyaux, T., Chaib-draa, B. and D’Amours, S, 2003).

 

 

 

 

 

Table 1 describes the main factors contributing to the bullwhip effect.

Table 1. Main Factors contributing to the increase in variability

 

 

Demand Forecasting

Traditional inventory management techniques usually have fluctuations. Most of these techniques depend on estimates of the mean and standard deviation which depend on the quantity of data observed.
 

Lead Time

For example, in both safety stocks and base stock levels, the lead time and the review period are taken into consideration. This implies that a variation in lead time will in effect increase variability.
 

 

 

Batch Ordering

The effect of batch ordering can be easily explained through elements of the supply chain that are taking advantage of economies of scale. For example if there is a discounted price of transportation a batch will be ordered, increasing holding cost. This would be followed by a longer period without ordering. This increases variability.
 

Price Fluctuation

Similar to batch ordering price fluctuation stimulates stocking up when prices are low. Forward buying is used to imply that retailers purchase large quantities and small quantities depending on market conditions.
 

Inflated Orders

This is observed when the product is suspected to be in short supply by retailers and distributors. This generates unbalanced orders, when the period is over the standard orders are in place again.

Source: (Simchi-Levi, Kaminsky and Simchi-Levi, 2015)

The bullwhip effect can also be explained as a coordination problem between different elements of a supply chain (Moyaux, Chaib-draa and D’Amours, 2003). Therefore, how can the interactions between autonomous companies affect the bullwhip effect? More specifically how can a centralized supply chain or a decentralized supply chain affect this phenomen? A centralized supply chain is referred as a single decision maker and a decentralized is several decision makers, with different intents, interests, and information. A simplified example of Simchi-Levi et al. (2015) clarifies this question.

Considering a supply chain with a single retailer and manufacturer, where a periodic review inventory policy is implemented with a fixed lead time and a review period of 1. The order-up-to point in period t is calculated below from the demand observed, where z is a statistically obtained safety factor.

Figure 2. Order-up-to level
Source: (Simchi-Levi, Kaminsky and Simchi-Levi, 2015)

In Figure 2 the daily consumer demand and standard deviation are estimated using the moving average forecasting technique (the arrows point to both of these parameters in Figure 2). Each period (p) for which these parameters are calculated depends upon previous periods. Therefore, for each different period of time (t) the average and standard deviation are re-calculated. The consequence is each period having a different order up to level, therefore a variation in inventory is present (Simchi-Levi et al., 2015).

This model demonstrates that by increasing the lead-time (L) and decreasing p the bullwhip effect rises, under the conditions previously mentioned. In the model below the variance of customer demand is which is divided by variance of orders of a retailer (placed to a manufacturer).

Equation 1. Bullwhip Effect
Source: (Simchi-Levi, Kaminsky and Simchi-Levi, 2015)

With the information stated above it is intuitive to realize that without information sharing or cooperation within a supply chain the bullwhip effect increases. The manufacturer’s demand is calculated based on each previous period’s customer orders which are obtained from the retailer. These orders defer from the real customer demand. Therefore, variability can increase across the supply chain. When the demand information is known throughout each stage of the supply chain the forecasts become more accurate (Simchi-Levi et al., 2015).

Achieving coordination in a supply chain is not an easy task, and business practices in the wood industry make it more evident. Studies have been conducted in the forest supply chain to reduce the bullwhip effect. A coordination mechanism was investigated by Moyaux et al. (2013) which utilized tokens (communication resource) to communicate between autonomous agents. Figure 2 illustrates the model of the forest supply chain used in this study.

Figure 3. Model of Forest Supply Chain
Source: (Moyaux, T., Chaib-draa, B. and D’Amours, S, 2003).

This is based on the principle that there can be two different orders communicated, using two different tokens. The first being the real time demand and the second to manage fluctuation inside the supply chain (the difference of products required by each company to maintain its inventory and the real demand). After multiple experiments a centralized supply chain with the use of tokens gives the best result, out of multiple combinations of experiments, considering total inventories, standard deviation of orders and total backorders. In general, the token based ordering is better than others Moyaux et al. (2013).

This research brings hope that better cooperation can be achieved even if full cooperation (centralized supply chain) cannot be obtained in challenging industries such as the wood fiber supply industry. Parameters that affect the variation such as lead time and forecasting methods must be improved through more cooperative relationships throughout the companies. There is still a considerable amount of work in order to achieve optimal or improved supply chains, but strategic partnerships between members is a crucial beginning.

Bibliography

  • Moyaux, T., Chaib-draa, B. and D’Amours, S. (2003). Multi-Agent coordination based on tokens. Proceedings of the second international joint conference on Autonomous agents and multiagent systems – AAMAS ’03.
  • Simchi-Levi, D., Kaminsky, P. and Simchi-Levi, E. (2015). Designing and managing the supply chain. 1st ed. Boston: McGraw-Hill/Irwin.
  • Taylor, D. (2012). Mid-South Region Report. Supplier/Consumer Relationship Study. [online] Wood Supply Research Institute, p.6. Available at: http://www.wsri.org/tech-papers/MidSouthReport.pdf [Accessed 28 Apr. 2017].
  • Taylor, D. (2012). Southeast Region Report. Supplier/Consumer Relationship Study. [online] Wood Supply Research Institute, p.6. Available at: http://www.wsri.org/tech-papers/SoutheastReport.pdf [Accessed 28 Apr. 2017].

 

 

 

RESEARCH BRIEF: Strategic Management for competitive advantage: Theories and practice

by Gaurav Kakkar. Email at kakkarg@vt.edu

Performance is the crux of any business and strategic management is the epicenter governing that performance and creating value for customers, owners and stakeholders. Strategic management is the way managers funnel firm’s functions and actions to fulfil market demand. It is a framework to assess internal and external factors to a firm, integrate activities to learn, adapt and create value both in present and into the future (Amason, 2011). It can be defined in multiple ways. Chandler (1962) defines it as “the determination of the basic long-term goals and objectives of an enterprise, and the adoption of courses of action and the allocation of resources necessary for carrying out the goals”. According to Andrews (1987), strategy is the “pattern of objectives, purposes or goals and the major policies and plans for achieving these goals, stated in such a way as to define what business the company is in or is to be in and the kind of the company it is or is to be”. Both these definitions concentrate on the enterprise itself while defining the strategy. Hofer & Schendel (1978) incorporated external factors while defining the strategy as “the fundamental pattern of present and planned resource deployment and environmental interactions that indicate how the organization will achieve its objectives”. According to Kenichi Ohmae (1982), business strategy is all about competitive advantage with the purpose to “enable a company to gain, as efficiently as possible, a sustainable edge over its competitors”. Gilbert et. al. (1988) defined business strategy as “a set of important decisions derived from a systematic decision making process, conducted at the highest levels of the organization”. And the most recent explanation in the list of prominent attempts to define strategy was by Hoskisson et. al (2008). According to them, it is “an integrated and coordinated set of commitments and actions designed to exploit core competencies and gain competitive advantage”. While these definitions vary in approaches and perspectives, they all describe creation of superior value to achieve competitive market advantage by a firm. Strategic management thus aim at positing the firm within an attractive and manageable environment making it a unifying force guiding the firm to success in the competitive environment. But the next question would be how can the management of Forest products industry in the United States can use these definitions and design their own strategies. The following section of this article discuss prominent theories of strategic management and their applications

1. The resource-based view of the firm

This theoretical perspective emerged during the late 20th century and claims that companies can be seen as bundles of resources, that resources are heterogeneously distributed across companies, and that the market for resources is imperfect (i.e., resource differences persist over time) (Eisenhardt & Martin, 2000). These resources include tangible and intangible assets, capabilities, organizational processes, attributes, information, knowledge etc. that are under firm’s control. As a consequence, firms can create and sustain competitive advantage by acquiring and leveraging resources that are valuable, rare, inimitable and non-substitutable (Barney, 2001; Barney, 1991; Grant, 1991). Despite being most widely accepted approach for achieving competitive advantage, it is also criticized as vague in nature when identifying key resources affecting success (Priem & Butler, 2001). Figure 1 shows the theoretical framework of the approach.

Figure 1. Framework of resource-based view of the firm (Stendahl, 2009).

2. The organizational capabilities approach

This theory opens up the “black box” of resource-based view and explains how resources and capabilities create value and facilitate competitive advantage for firms. Barney (2001) states: “resources are considered valuable if they contribute to either differentiation or cost advantages for a firm in a certain market context.” The term ‘capabilities’ refers to the firm’s capability to distribute and re-assemble its resources to improve productivity (Makadok, 2001) and realize its strategic goals (Teng & Cummings, 2002). Figure 2 shows the theoretical framework of the approach. Korhonen and Niemela (2005) further strengthened this theory by providing a useful overview of the major differences between resources and capabilities:

Figure 2 Resources, infrastructure and organizational capabilities (Stendahl, 2009).

  1. Whereas resources are either tangible or intangible, capabilities combine both: capabilities are clusters of tangible, input resources and knowledge based, intangible resources.”
  2. “Unlike resources, capabilities have an operational, process dimension – they are not factor stocks, but they are factor flows: capabilities present what a firm can do, they are activities, organizational rather than individual skills.”
  3. “Capabilities often take a routine-like form and are path-dependent: if a company were to be dissolved, its capabilities would disappear as well.”

 

 

 

Figure 3 Framework of contingency based strategic fit (Ginsberg & Venkatraman, 1985)

3. Strategic Fit and contingency perspective

This theory of business policy design is based on concept of matching organizational resources with the corresponding environmental context (Chandler, 1962). According to this perspective, market competition and technological development continuously erodes key success factors of an industry. Thus the firm would eventually lose its value over time. Collins (1994) recommended the constant renewal of competitive advantages of the firm making the firm an adaptive system evolving to environmental change. Accordingly, in addition to achieving a strategic fit with present conditions, companies must simultaneously aim for strategic fit of tomorrow, that is, they must develop a feedback mechanism to adapt and learn. Figure 3 shows the theoretical framework of the approach.

4. The dynamic capability view

Figure 4 Resource management process through Dynamic approach (Sirmon, Hitt, & Ireland, 2007)

This theory builds on the adaptive nature of contingency perspective and suggests that cross-functional capabilities in a firm are dynamic in nature. According to Eisenhardt and Martin (2000), Dynamic capabilities “create value for firms within dynamic markets by manipulating resources into new value-creating strategies”. These capabilities developed through learning mechanisms help the firm in not only achieving differentiation and/or cost leadership but gives it the potential to continuously reinvent. The details of a dynamic capability are often idiosyncratic and pathdependent, but the main features are more common (Eisenhardt & Martin, 2000). This theory attempts to prepare the firm for volatile market conditions by enhancing its existing resources and competitive advantages. Figure 4 shows the theoretical framework of the approach.

Creating value is inherent to every firm while translating available inputs to desired outputs. But value creation is never easy. Customers can learn and change without warning, competitors can take over with something of better value. The suppliers would want to increase their bargain power. Changing demographics, economic and technological conditions and unforeseen catastrophizes can undermine any competitive advantage of the firm. To summarize, it is important for the firm to develop sustainable strategies in order to sustain volatile market conditions and maintain its competitive advantage. Strategy is about when and where to go and how to get there in the best way. The theories introduced in this article are amongst the most commonly employed for strategic management by businesses all around the world. It is the firm’s responsibility to put these theories to practice based on its product range and market segment, The management should also include product development and resource management decisions into the long term strategy design when translating these theories to principles and practice.

References

  • Amason, A. C. (2011). Strategic management: From theory to practice. New York: Routledge.
  • Andrews, K. R. (1987). The concept of Corporate Strategy. Homewood, IL: Irwin.
  • Barney, J. (1991). Firm resources and sustained competitive advantage. Journal of Management, 99-120.
  • Barney, J. (2001). Is the resource-based view a useful perspective for strategic management research? Yes. Academy of Management Review, 41-56.
  • Chandler, A. (1962). Strategy and structure: chapters in the history of American enterprise. Cambridge, MA: MIT Press.
  • Collis, D. (1994). Research note – how valuable are organizational capabilities. . Strategic Management Journal, 67-73.
  • Eisenhardt, K. M., & Martin, J. A. (2000). Dynamic Capabilities: What are they? Strategic Management Journal, 1105-1121.
  • Gilbert, D. R., Harlman, E., Mauriel, J. J., & Freeman, R. E. (1988). A logic for Strategy. Cambridge, MA: Ballinger Publishing.
  • Ginsberg, A., & Venkatraman, N. (1985). Contingency Perspectives of the Organizational Strategy: A Critical Review of the Empirical Research. The Academy of Management Review, 421-434.
  • Grant, R. (1991). The resource-based theory of competitive advantage: implications for strategy formulation. California Management Review, 114-135.
  • Hofer, C. W., & Schendel, D. (1978). Strategy Formulation: Analytical Concepts. St. Paul: West Publishing.
  • Hoskisson, R. E., Hitt, M. A., Ireland, R. D., & Harrison, J. D. (2008). Competing for Advantage (2nd ed.). Mason, OH: Thomson/South-Western.
  • Makadok, R. (2001). Toward a synthesis of the resource-based and dynamic-capability views of rent creation. Strat. Manage. J., 387-401.
  • Ohmae, K. (1987). The Mind of the Strategist: The Art of Japanese Business. New York: McGraw-Hill.
  • Priem, R., & Butler, J. (2001). Is the resource-based “view” a useful perspective for strategic management reserach? Academy of Management Review, 22-40.
  • Sirmon, D., Hitt, M., & Ireland, R. (2007). Managing firm resources in dynamic environments to create value: Looking inside the black box. Academy of Management Review, 273-292.
  • Stendahl, M. (2009). Product Development in the Wood Industry (Doctotal Thesis). Uppasala: Swedish University of Agricultural Sciences.
  • Teng, B. S., & Cummings, J. L. (2002). Trade-offs in managing resources and capabilities. Acad. Manage.Executive J., 81-91.