Episode 12

Supplier bullwhip effect – Why it happens and the way out?

Category :  Manufacturing & Supply Chain

Supplier Bullwhip is basically an ill effect of a supply chain practice of OEMs who use a combination of monthly forecasting and daily expediting to manage their assembly lines. The Tier 1, 2 and 3 suppliers are the ones who bear the brunt of it, further upstream the supplier, more severe the effect, which also means that the smallest guy in the chain is the worst hit. But it all does come back to the OEMs too indirectly.

We have either mentioned or discussed the supplier bullwhip effect in many of our previous episodes, especially the ones around the supply chain and operations solutions.

Transcript
Shubham Agarwal : In the previous podcast we discussed implementation of JIT in OEMs and its impact on its partners- Suppliers and Dealerships. During the discussion we touched upon a phenomena Supplier Bull Whip Effect which adversely impacts the suppliers working capital due to pile up of inventories across tiers of suppliers. We promised to discuss the same in detail in the upcoming podcast where we will try to understand how The Bull Whip generates from OEMs and how it impacts the suppliers.
For this we again have with us Achal Saran Pande etc………..So Achal kindly explain how the Supplier Bull Whip effect generates in the OEM supply chain?
Achal Saran Pande : In the previous podcast, I mentioned that the OEMs plants are assembly plants and therefore they are prone to A plant effect which essentially means that the vehicle will not get made even if one part is missing. Given that the vehicle requires thousands of parts and subassemblies it becomes a big challenge for the OEM purchase team to ensure availability of parts and sub assemblies at the right time in right quantities.
To overcome this challenge and to safeguard supplies the OEM purchase team/ OEM buyers deploy 3 types of tactics/actions. The first is schedule inflation, the second is multi-sourcing and the third is safety stock concept. Supplier Bull Whip effect is an outcome of their first tactic which is schedule inflation.
Shubham Agarwal : So Achal what is schedule inflation?
Achal Saran Pande : For ease of understanding lets take an example and I would request the listeners to open up the minds in order to visualize. Further explanation will require some imagination to understandLets take an example

Suppose I am a supplier and you are a buyer of a particular product. You ask me to supply 100 units of the same. But instead of supplying 100 units I supply 90 units. The next time you ask me to supply 110 units again but instead of supplying 110 units I supply you 100 units again , again falling short by say 10 no.s. So every-time the quantity u ask to supply I fall short of say 10 units. Based on such an experience what will you do to next time to ensure that you have the desired quantity delivered to you?

Shubham Agarwal : If every time I fall short of about 10 units, there next time I place an order I shall increase the order size 10 units more than my actual requirementCorrect !! This is exactly what happens between OEMs and their tier 1 suppliers, between Tier 1 and Tier 2 suppliers and finally between Tier 2 and Tier 3 suppliers. This is an outcome of a supply chain de-risking tactic commonly known as schedule inflation. This is very common and deployed across most OEMs and their channel partners. The process of schedule inflation generates fictitious schedules across supply side channel partners
Shubham Agarwal : Achal can you elaborate more on schedule inflation and what do you mean by fictitious schedules?I would urge the listeners to visualize a typical supply side of the OEM. It has 3 entities – OEM- Tier 1 supplier – Tier 2 supplier – Tier 3 supplier. Imagine it as a ladder with the OEM on top and tiers 3 suppliers the last leg. Now consider an OEM buyer who has experienced shortages from a very unreliable supplier. the supplier has failed to supply the schedule quantities either in terms of quantity or in time or both. Such supply failures may arise due to supplier’s internal inefficiencies or environment uncertainties. Having experienced the unreliability in supplies from a particular supplier, the buyer inflates the schedule at part level. The amount of inflation depends upon the buyer’s perception of reliability. At part level the inflation varies from 10% to 30%, may be more in some cases at part level. The part schedule of a relatively reliable supplier can be inflated as much as 10% and for a relatively unreliable supplier can go upto 30%-40% of part schedule. Even for a particular unreliable supplier he can inflate schedules part-wise depending on how frequently the supplier has failed on that particular part.
Now imagine a situation where the OEM inflates the schedule by 30% for a particular part. SO OEMs actual requirement is say 100 , the buyer of the OEM provides schedule to Tier 1 supplier of 130 units.
Tier 1 supplier also has a buyer who has its own set of assumptions about reliability of Tier 2 supplier and inflates say with another 30% on the part schedule received from the OEM. So schedule of 130 is inflated further by 30% so the schedule to tier 2 is 130%*130 = 169
Now Tier 2 also has a buyer who again has his own perceptions and measurements for his Tier 3 supplier and therefore inflates the schedule further by 30% and therefore the schedule to Tier 3 supplier becomes 130*130*130=220 units.Now imagine a situation where the real demand of the OEM was 100 but tier 2 got 169 and tier 3 got 220 units. Eventually the material that will flow in the supply chain is 100 while the rest will lie as inventory across the supply chain. In some cases would result in non moving inventory and obsolescence. This is how non moving inventory gets created in the supply chain. This phenomenon gets aggravated in situations where model change or part change happens at OEMs. In such a case dead inventory gets generated immediately. The inventory accumulated at Tier 3 supplier is the highest and this phenomena is known as Bull Whip Effect. Just like the whip used to drive the bull the whipping impact is the largest at the end, which in our case is tier 3 supplier. U can imagine it as though the whip is held by OEM and the impact is severe at Tier 3 suppliers
Shubham Agarwal : Is Supplier Bull Whip an Inventory Whip only. Does it impact other operational aspects of the supply chain. what are the other operational implications?
Achal Saran Pande : It has serious implications on other operational parameters such as capacity. Imagine against the actual requirement of 100 tier 2 and 3 are generating much more across parts. To do this they would require much higher capacities implying a higher capex only to generate inventories. Their ROCE return on capital employed will be very poor and even after having so much of capacity , they are still unreliable. This is the irony. That is why many times you would observe that there is a conflict between suppliers and OEMs where the OEM perceives that the suppliers don’t have capacity and push them to invest more whereas the suppliers across tiers say that we are already sitting on huge capacities
Imagine a tier 3 supplier or tier 2 also which has a small business and is expected to invest much more in capacity building and at the same time struggle with huge inventories. its a catch 22 situation which will eventually lead to its death
So it is not only the inventory whip I as talking about but in addition it is a capacity whip as well. Therefore the more I move across tier 1, Tier 2 and down to Tier 3 suppliers you would observe inventories bloating and capacity stealing (explain) or wastage increasing
Shubham Agarwal : Do suppliers take any evasive measures or counter measures because with their experience when they know that the schedules are inflated?Yes. Some wise suppliers in order to protect themselves from the bullwhip deploy countermeasures. This is known as Schedule Deflation. Based on past trends mixed up with their intuitions they incorporate corrections to the received schedule. For example if a supplier has received a schedule of 169 units he may take a call to tone down the schedule at his end to say 130 and release it for production. It is a judicious call and the suppliers walk on a tight rope while doing this to prevent their fall on either side – Shortages and Excesses
Shubham Agarwal : So Achal how do the suppliers come out of this problem?To come out of this situation the entire back end of the OEM – Suppliers across tiers have to respond to the actual demand/consumption and therefore the entire supply side will have to plan accordingly. They have to stop planning as per monthly schedules (which as we discussed are inflated) and deploy mechanisms to ensure real time consumption monitoring /tracking and aligning/changing internal processes to respond to this consumptions. This can be covered in detail in the next podcast.
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