Supply Chain Bullwhip Effect 1

This example illustrates the famous bullwhip effect in a supply chain. This effect is
usually illustrated in a multi-echelon supply chain, where information across
echelons is not fully shared, but as illustrated in this example, it can occur when
there is a single orderer and a single supplier.
The model is quite simple. A retailer experiences periodic demands that are
independent and normally distributed with mean 150 and standard deviation 50.
The retailer uses an order-up-to ordering policy. After receiving any order at the
beginning of a period and subtracting demand in that period, the inventory position
is calculated. This is the sum of net inventory (which can be positive, meaning onhand inventory, or negative, meaning a backlog) and pipeline inventory, the amount
previously ordered but not yet received. The retailer then places an order sufficient
to bring the inventory position up to the order-up-to level. The model assumes that
the supplier always has sufficient inventory to satisfy the order. The order arrives
after a lead time delay. The possible lead times in this example are 1, 2, or 3
periods.
The order-up-to level in any period is essentially the expected demand during lead
time plus safety stock. More specifically, the company uses simple exponential
smoothing to forecast demand. Then expected demand during lead time is the
lead time multiplied by the current demand forecast. The safety stock is the value
usually recommended in the supply chain literature: 1.96 times the standard
deviation of lead-time demand.
The model uses a RiskSimtable function in cell H14 to try nine combinations of lead
time (1, 2, 3) and exponential smoothing constant (0.1, 0.5, 0.9). Note that a larger
smoothing constant leads to forecasts that track demand closely, usually too
closely. That is, the forecasts react too much to random ups and downs in the
demand process. This is a key source of the bullwhip effect, as the simulation
results will indicate.
Four @RISK outputs have been designated. The first two are ratios of standard
devations: of order quantity to demand, and of net inventory to demand. The
bullwhip effect tends to make these ratios greater than 1, sometimes much greater
than 1. The average amount of inventory onhand and the total backlog over 60
periods are also designated as @RISK outputs.
The custom report on the last sheet contains @RISK statistical functions for each of
the outputs for each of the simulations. After you run the simulations, you will see
clearly how the bullwhip effect increases as the lead time and/or the smoothing
constant increases. There is much more variation in orders and net inventory than
there is in the underlying demand process, and the average onhand inventory and
total backlog tend to increase as well.

Note: If the @RISK dice button is toggled to static (white), the first two outputs will
show errors. This is because the standard deviation in each denominator is 0 with
static (non-random) demand. However, this is not a problem when the simulation
runs.