Example: The beer game

Example: The beer game
Material
Supplier
(2) (2) (2) (2)
Factory Distributor Wholesaler Retailer
(n)
Material Flow
Orders
Delay in Filling Orders
Consumer
Demand

For each period
• Fill the orders in the backlog file
• Receive material from supplier
• Place order with supplier
• Receive order -- adjust the backlog

Operating cost penalties
• There are two operating costs:
• 0.50 per unit inventory per period
(this is the carrying cost)
• 1.00 per unit unsatisfied demand
(this is to ensure good service)

Variability
Higher variability in orders placed by retailer than actual sales

Bullwhip effect
Supplier
Manufacturer
Distributer/
Wholesaler
Retailer
Consumer
Sales
Sales
Sales
Sales
Sales
Time
Time
Time
Time
Time
Increase in variability as we move up in the supply chain.

What are the reasons?

Reasons
• Demand Forecast Updating - each
company in a supply chain forecasts
demand myopically (i.e. based on past
demand from their own direct
customers)
• Order Batching - companies placing
orders on upstream suppliers usually do
so periodically to save on
transportation/ transaction costs.

Reasons continued
• Price Fluctuation - frequent price changes
(both up and down) lead buyers to purchase
large quantities when prices are low and
avoid buying when prices are high.
• Rationing and Shortage Gaming - cyclical
industries face alternating periods of
oversupply and undersupply. When buyers
know that a shortage is imminent and
rationing will occur, they often increase the
size of their orders (and vice-versa).

Multi-stage supply chains
Consider a multi-stage supply chain:
• Stage i places order q k to stage k+1.
• L k
is lead time between stage k and k+1.
• Demand has mean D and standard deviation σ
q o =D q 1 q 2
Retailer
Stage 1
Manufacturer
Stage 2
L 1 L 2
Supplier
Stage 3

Variability as a function of stages
Var(q k )/σ 2 σ 2
30
25
k=5
20
15
10
5
0
k=3
0 5 10 15 20 25

Impact of batch ordering
• Why batch ordering?

Impact of batch ordering
• Why batch ordering?
• Fixed ordering costs
• P&G estimates that the cost of placing an order with manual
interventions is $35-$75
• Transportation costs
• Ordering FTL vs. LTL
• Sales quotas or incentives
• “push” ordering or “forward” buying
• If the retailer uses batch ordering, the wholesaler will see
spikes in orders in certain periods followed with no orders for
several periods
• A distorted and highly variable pattern of orders at the
upstream channel

Variable pricing
• Price fluctuations cause forward buying
• Price/quantity discounts, Rebates, Trade deals
• Customers buy in quantities that do not reflect their immediate needs
• Variation of the buying quantities is larger than the variation of the
consumption rate
• Possible remedy: Everyday low pricing
Order Quantity
800
600
400
200
Bullwhip Effect due to Seasonal Sales of
Soup
Shipments from
Manufacturer to
Distributors
Retailers’ Sales
0
1 Weeks
52

Inflated orders (rationing game)
• During shortage periods manufacturers allocate products to
customers proportional to order size
• e.g., if total supply is 50% of total orders, all customers receive
50% of what they order
• Inflated or duplicate orders during shortage periods
• Returns and cancellations later
• Customer orders give little info to the supplier
• Example: Motorola cell phones
• Shortage during Christmas season
• Excess ordering in the following year, record 4th quarter earnings
• Channels swamped with inventory, stock tumbled almost 10%
• Possible remedy: allocation based on past sales

Information sharing
• Demand (sales data, forecasts)
• New stores
• Promotions
• Inventory levels, product quantities
available for purchase
• e.g., Sears, Okuma Corporation
• Production and distribution schedules
• more accurate lead times
• Order status/tracking

Bypassing channels (common
access to demand information)
Traditional
retailer
Farm Importer Wholesaler Florist Customer
8-12 days
PUSH
PULL
Direct
from farms
Farm
Proflowers.com
Customer
1-2 days
PUSH
PULL

Access to demand information
in supply chains
• Bypassing a downstream site in the supply chain
• e.g., Dell Computers, Proflowers.com
• Information sharing
• The partners are given access to a system that has
the shared information in it
• e.g., Wal-Mart RetailLink system
• One partner transmits shared information to the other
partner
• Shared information is stored in an “information hub”

Collaborative forecasting
• Include multiple factors about future demand
• past sales, pricing, promotions, new products
• Who controls or has information about these
factors?
• E.g., retailer may control pricing, promotions,
products from other competitors
• Collaborative forecasting
• an iterative forecasting process in which all
participants in the supply chain collaborate to arrive at
an agreed upon forecast
• e.g., Wal-Mart and Warner-Lambert (CPFR)
• eliminate 2 weeks of inventory; cut cycle times in half

Vendor Managed Inventory
• Both parties must understand and agree
the stocking plan the manufacturer will be
using.
• Frequency of replenishment (daily?
once/twice per week?), replenishment
quantity, etc.
• The Distributor sends the manufacturer
• POS history file, usually 1-2 years.
• Information on the status and stock level of
every item they have

Incentive Alignment
• Incentive problems occur due to:
• Hidden actions by partner firms
• Informational asymmetries
• Poorly designed incentive schemes

Hidden action example
• Sears sells both Whirlpool and Kenmore
(their private-label brand) washing
machines
• Whirlpool is relying of Sear’s salespeople
• Whirlpool can’t easily track effort of
salespeople pushing their brand compared
to Kenmore
• This hidden action makes it difficult for
Whirlpool to determine proper incentives

Information asymmetries
• Many partners are reluctant to share their
data
• Vendor for a manufacturer may be reluctant to
share cost data
• Company may be fearful to share certain
design data with contract manufacturer
• When there is hidden data in a supply
chain, it can hurt efficiency

Poorly designed schemes
• Example: Grocery store has a vendor
managed inventory relationship with a
dairy farm for milk
• Store allocates shelf space for milk provider
• Store pays provider at delivery
• Provider has responsibility for stocking
• Q: What will be the impact of this policy?
• Q: What might eliminate this problem?

How to tackle incentive problem?
• Acknowledge when this is a problem
• Common with new initiatives since this can
modify incentives of key stakeholders
• Find the cause
• Hidden action, hidden information, badly
designed incentive
• Redesign incentives
• Contracting, revealing information,
independent party (intermediaries)

1. Contracting
• Most straight forward approach
• Contracts can “unhide” actions
• Blockbuster example
• Q: What could be done with the Whirlpool/
Sears case?
• Difficulty – impossible to contract against
all conditions

Example – Tweeter and Bryn Mawr
• Bryn Mawr (acquired by Tweeter in 1996) seller
of electronics
• Bryn Mawr deducted full value of stolen goods
from manager’s pay
• Result – kept impulse-based purchases locked up
(e.g., batteries, audiotapes, etc.)
• Sacrificed sales for shrink reduction
• Tweeter changed contract – paid managers
based on % of profits, and profits increased
significantly

2. Revealing hidden information
• Tracking and monitoring
• Use of agents to collect data (third party,
spy) such as a “mystery shopper”

3. Intermediary
• Has become more prevalent with
outsourcing since contracts can be hard to
enforce in certain countries
• Fear of contractors engaging in behavior such
as bribery, child labor, etc.
• Intermediary can help align incentives
between parties

Li & Fung example
• Created a network of factories in Asia
• Enforce a code of ethics for participation
• Wage, hygienic work conditions, etc.
• Monitors suppliers through use of chief
compliance officer
• Cuts companies off if make unreasonable
demands of suppliers or don’t take delivery
• Their size helps them to do this and that they
account for about half of volume for their
suppliers

Conclusions
• Incentives are key to supply chain
performance
• Although issues are challenging to
address, companies should spend time
studying this problem in their supply
chains