“Barry is a great friend, I feel honoured since he accepted to write in my blog. This man is from Netherlands working in Mexico since 5 years ago, I am sure that his knowledge, shared in this post, will be useful for all of you. Please enjoy with me his words.” Alan Rodríguez – @AlanRodEsp
First of all I want to have a special thanks to my friend Alan Rodriguez who invited me about one week ago as guest-writer to his blog. As Alan knows I love to read, write and tell about any Supply Chain topic so I´m very grateful for this opportunity. Thank you, Alan!
This is the perfect time of the year to talk about this topic and make Tier suppliers aware of the upcoming new economic situation. We saw at the end of last month that the Federal Reserve System and the American Central Banks have decided to maintain the interest rate for the coming months. Yet, there is no change of the current historical low interest rate and tariff stays on 0 – 0.25 percent (since 2006). The FED still thinks that the US economy is not stable enough to handle a higher interest rate, which is understandable. However the figures in the US were good enough in the past months to increase the interest rate and we have seen also some slight economic improvements during the last couple of months given that the US economy grew +3%. Expectations are that the FED will still increase the interest rate by the end of this year depending on the labor market number the following three months.
The decision to not change the interest rate assume that we, the world, is still in crisis and they will keep spending less money. The FED interest rate number is seen as an international indicator for the global economy. So, since we are “officially” still in crisis and with a good outlook in front of us, it is the perfect time to talk about the “bull whip effect” given that it might have a very dangerous effect on small business, new business and specially suppliers.
For those who have not heard before about the bullwhip effect, I will introduce it to you first. Bullwhip effect is a very important supply chain phenomenon first noted by MIT systems scientist Jay Forrester. There are many topic explanations on the internet about it. Regardless my explanation is when there is an unexpected demand (variation) from the market that effect production and inventory throughout the supply chain, as illustrated below:
We can see at the top on the right illustrated table the “OEM”, the consumer has a very normal and stable demand but suddenly he increases his demand. By increasing the demand, you can see the effect of the bull whip already at the next chain, “Tier 1” level. The Tier 1 had at the beginning of the month a normal inventory level (red stripes), by increasing the demand his inventory is getting under a safety stock level and he is even running out of material, which means he can´t handle the market demand anymore. So, the Tier 1 starts making more production orders (blue line), first to meet the market demand and secondly to balance his inventory and after a certain time of production you can see an increase on the inventory of the retailer and he needs to slow down his production or even stop his production. Therefore, we have created the Bull Whip Effect with a very wide demand variation between first chain, OEM, and last chain, Tier 3.
You can imagine all the changes and extra costs needed when going from a normal production level to a peak production and then going to even stop production. Could you handle these costs if you were a new business? Would you keep this entire inventory at your plant? The situation is even getting worse for the “Tier 2” and “Tier 3” as you can see above.
My explanation of the bullwhip effect was based on the automotive industry because I have to say that it has the most dynamical supply chain. However, the effect is not only common in the car industry; many other industries recognize this problem as well. What I have seen, for example, at another industry was that they had created a new plant and had created with their most important supplier a “wall-to-wall-concept”. The most important supplier had built his plant literally starting with the wall from his customer and had directly accessed to the assembly lines of his customer due to an internal connection. Material was moved from supplier to customer with special made small tractors and was moved directly into the assembly lines. I think that does not solve the bullwhip effect but you can actually reduce it. You only reduce transport time and indirect inventory so the effect will have a lower impact as well. Nevertheless, you still need to keep a small safety stock in case your own supplier lacks on delivery capacity or your production is getting stuck.
I have read a lot about reasons for this problem like; disorganization, lack of communication, free return policies, order batching, price variations, demand information, etc. But the solution might be found in business development with your customer. I think that if you, as a company, get together with your customer and develop a good strategy and get some reasonable KPI´s (Key Performance Indicators) on paper you can reduce the effect if you get your internal processes in order.
Keeping an eye on the Customer Service Level to keep your customer satisfied is also very important. Furthermore, I have worked for a Tier 2 supplier in North Mexico and we had even a 7 week firm demand plus 20 weeks of forecast from the OEM (it should be enough firm demand. Don´t you think?), we also had our safety stock and we still had to charter material directly to our customer, Tier 1 and later to the OEM. Our customer found a quality issue and our plant manager had decided not to touch the safety stock. We had to overwork and make extra costs to meet the demand and yet we had our safety stock untouched. I think we can put bad management under disorganization and add quality issues to the list of probably reasons of the bull whip effect since you create yourself a new variable demand (recover the demand that was rejected and comply with the normal one).
What about the bull whip effect on seasonal products, for example? No doubt, it is complex and interesting at the same time, of how to organize the supply chain for the upcoming Christmas products. You can imagine the peak production here with the bull whip effect to suppliers; there are no fixed demand numbers, maybe you can use the ones from last year to get an average to know at least how much you should produce.
Going back to the beginning, next FED meeting will be at end of October this year and many people are expecting an increase of the interest rate, which means that many people assume we are finally out of the crisis so people start buying and the overall demand increases, which is the perfect base for a global bullwhip effect.
In the end, I think that dealing with supply chains is become an art form as much as a science.
Barry Meijerink: BSC Logistics & Economics
Supply Chain Consultant
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Slack Nigel, Chambers Stuart, Johnston Robert. (2010) Operations Management. Sixth edition.Page 392 – The Bullwhip effect – supply chain dynamics.
Misso, Brent. (2015, April 15). The Bullwhip Effect and Your Supply Chain. Retrieved September 22, 2015, from Entrepreneur: http://www.entrepreneur.com/article/232953
AAL Admin. (02 April, 2012). What is the Bullwhip Effect? Understanding the concept & definition. Retrieved September 22, 2015, from adaptalift: http://www.aalhysterforklifts.com.au/index.php/about/blog-post/what_is_the_bullwhip_effect_understanding_the_concept_definition