Your One Size Fits Most Supply Chain Answer: Little Wiggles Make Big Wiggles

Whether you are a student of supply chain management or an industry practitioner, you’ve no doubt encountered a few questions that leave you stumped. No worries. I’ve got you covered. Regardless of the question, here’s the answer: Because little wiggles make big wiggles.

Got it?

Why do you have so much inventory?

Because little wiggles make big wiggles.

Why are you out of stock?

Because little wiggles make big wiggles.

Why did you make/order more (less) than you needed? 

Because little wiggles make big wiggles.

That answer obviously won’t get you off the hook, but, in many cases, it will be at least part of the answer and it will start you in the right direction toward developing a more complete response and solution. 

The reality that little wiggles make big wiggles represents one of the foundational challenges facing supply chain managers: The bullwhip effect. Jay Wright Forrester, a pioneer of systems dynamics at MIT, came up with this theory in the 1960s while trying to explain fluctuations in areas like production, inventories, staffing, and profit at General Electric. The managers at GM would make perfectly rational decisions based on the incentives and information they had, but those decisions led to significant unintended consequences in other areas of the business. Like a bullwhip cracking, a little wiggle in one place would make for big wiggles down the line.

With the increasing complexities of global supply chains, understanding and managing against the bullwhip effect is just as important today as ever. In fact, recent research by Oliver Yao, Robert Bray, Yongrui Duan, and Jiazhen Huoreveals found that “on average, a decrease in the bullwhip effect ratio by 1 can translate to inventory cost savings of $26 and stockout reduction of 0.15 days for a product during a year.”

The goal for supply chain managers in dealing with this is simply to reduce the number of fake (artificially, unnecessarily introduced) wiggles, but so much of our behavior does just the opposite. This is why one of the first exercises I do with my students is the beer distribution game. It’s been around for decades, primarily because it allows students to experience the core challenges of managing supply chains. Each week, we refer back to it, whether the topic is planning, sourcing, manufacturing production, distribution, or customer service. 

For the record, there’s no real beer involved in the beer distribution game. We use poker chips to represent cases of beer. Here are the basics: Five players represent different links in the supply chain—a retailer, a distributor, a wholesaler, a brewery (or factory), and a raw materials provider. Each places orders from the player directly downstream in the supply chain. The hand-written order slip is their only form of communication, and the orders are filled using the poker chips. You want four cases of beer? You get four chips.

In an effort to minimize costs and maximize customer service, the players usually make logical decisions designed to give them just enough inventory without ending up with stale beer on hand. As in real-life scenarios, they typically add a little to their orders for some cushion. But after a few rounds (so to speak) of the ordering cycle, each player runs out of inventory because of delays in the fulfillment process. They get frustrated with each other and order even more. When the supply begins to catch up with the orders, cases of beer start pouring into each link in the chain. Back-orders are filled, and the participants stop placing orders, which creates all-new frustrations throughout the supply network.

Why can’t they order the right amount of beer and consistently keep their inventory at the optimum level? You guessed it. Because little wiggles make big wiggles.

The Causes of the Wiggles

When it comes to the bullwhip effect, the causes are well-known:

Poor forecasting: Decision-makers in supply chains update demand forecasts partly by creating a mental model of how the supply chain functions and the demand patterns they observe. When every downstream member places an order, the upstream members readjust the demand forecast and then place an order to the upstream partner in the supply chain. These orders get processed and then finally reach the manufacturer as overall demand for the product. Here, the final product demand that reaches the manufacturer is exaggerated. Because it’s not the actual product demand, it creates big wiggles in the manufacturers’ product scheduling, capacity planning, inventory management, and procurement.

Poor forecasting is bad for the supply chain because it causes you to order or make more or less than actual consumer demand. It introduces artificial demand into the supply chain – a fake little wiggle.

Price fluctuation: Distributors periodically have various schemes and promotions like rebates and coupons to increase customer demand for the product. The buying patterns of the customer during such periods does not reflect buying needs; it’s a seasonal condition. Promotions can also be an incentive for buying more than the demand requirements. These promotions result in some form of price fluctuations, which force the customer to buy more than required or to wait for a favorable price before reordering or buying.

Let’s say you need some socks. The department store has them on sale – buy one pack, get the second for half price. You only need one pack, but you take the deal and end up with plenty of extras to account for the ones that disappear in the laundry. The variation in your buying pattern is much higher than the variation in the consumption rate. In other words, you have more socks than you can wear. This yields temporary benefits for one player in the supply chain, but creates the bullwhip effect and increased costs upstream.

Price discounting can contribute to the bullwhip effect when supply members overbuy and stockpile inventories to take advantage of a price break, followed by a sell-down period and zero ordering. This practice leads to increased inventory carrying costs for the customer, lower margins for the supplier, and increased uncertainty in true demand patterns.

Order batching: Every supply chain member places orders with an upstream member using some inventory replenishment mechanism. As demand depletes inventory, a company or a supply chain entity may not order continuously, but instead will accumulate inventory replenishment requirements from its supplier. The wholesaler/retailer doesn’t place an order with the upstream member as soon as it gets information about the depleting quantity of product. The managers involved follows his own style of order placing. He might order weekly or monthly, rather than ordering frequently as required to reduce the cost per order. As order cycles of disparate customers tend to randomly overlap, the result is a more erratic demand pattern than the actual demand seen by the customers.

Rationing and hoarding: In anticipation of low supply, some buyers rush to order more inventory in larger amounts at one time. The supplier ends up rationing, while the buyer ends up hoarding. It’s like having a run on a bank. A seller might attempt to limit order quantities by delivering only a percentage of the order placed, but the buyer, knowing that the seller is delivering only a fraction of the order placed, might then attempt to game the system by ordering even larger quantities. Rationing and gaming create distortions and artificial demands throughout the supply chain.

Long and variable lead times: Increases in variability is magnified with increasing lead times. To calculate safety stock levels and reorder points, managers multiply estimates of the average standard deviation of the daily customer demand by the lead time. With longer lead times, a small change in the estimate of demand variability implies a significant change in safety stock, reorder level, and thus order quantities. This results in multiplicative rather than additive variations. Those little wiggles are amplified even more.

Reducing the Bullwhip

Knowing the causes of the bullwhip effect can help supply chain managers minimize the number of little wiggles that create big problems, but only if the managers take proactive action. The solutions are easy to say but hard to do, which is why we spend much of the semester diving into the nuances of the fixes. Here's a high-level summary of the tips:

• Reduce length and variability of lead-time by practicing lean supply chain management. All the fake wiggles that cause the bullwhip effect are wastes, and lean SCM principles seek to eliminate those wastes. In the meantime, and since there will always be variability in lead-time, it is important to apply appropriate production smoothing schedules. Many companies, such as auto manufacturers, have been able to significantly smooth production despite the presence of a noticeable bullwhip effect.
• Minimize the introduction of artificial demand in the system that is created by unnecessarily fluctuating prices, batching orders, and creating policies and processes that incentivize rationing and hoarding. One time a student assumed this point meant, in her words "Marketing (promotions) is evil!" That was a pivotal learning for me as a teacher... course correction was needed. Promotions and price fluctuations may be helpful for marketing purposes and in some cases to strategically counteract the bullwhip effect. Indeed, number one in any supply chain decision is to deeply understand the customer and flow value to them in the way they want. This often calls for a number of marketing promotions to communicate that value and price changes to tailor the value to each appropriate customer segment. The key is to (a) apply good forecasting management practices and models to improve forecast accuracy and (b) share and collaborate on these demand management plans across the supply chain.
• Improve, share, and collaborate on sales data, demand forecasting, inventory levels, order status, and production/delivery schedules upstream and downstream. An area that is often overlooked is aligning new product development and the product portfolio internally and externally upstream and downstream. Poorly aligned new product and product portfolio practices typically correspond with SKU proliferation, which is especially exacerbating to the bullwhip effect. More varieties of products split demand and increase variability at the SKU level. Supply chain managers should gather customers and suppliers to work closely with new product functions to align resource allocation across a balanced product mix.
• Use enabling technologies. Blockchain, for instance, offers the possibility of real-time, accurate information about products as they move throughout supply chains. I wrote about this more extensively in a book I co-authored, Integrating Blockchain Into Supply Chain Management. Blockchain potentially can have a positive impact on the planning, forecasting, budgeting and staffing required to manage costs and services associated with inventory.

Little wiggles in the supply chain are inevitable. There is too much unpredictability and too much complexity to totally eliminate fake wiggles. But the more adept you are at spotting them and reducing them, the more efficiently and profitably you can manage your supply chain.