Taming the Bullwhip Effect

"The best laid plans of mice and men..."

Supply and Actual Demand

Sales personnel place last-minute changes to orders before the end of a quarter or a period for which they are measured for sales commissions. If the salespeople find that they have not met their target to qualify for the bonus, they get one of the indirect channel partners, such as a distributor or retailer, to place an additional order that would qualify them for their sales commission. The indirect channel partner cooperates with the salesperson, knowing that in times of short supply they can count on the salesperson to provide them with more than their allocated share of product. These types of gaming situations result either in significant quantities of returns or shortages for the less connected indirect channel partner.

The pricing and promotion policies followed within a firm are another factor that distresses supply chains. Frequent markdowns and sales to move product from distribution channels create havoc on the supply chains. The demand signals fed into the SCP systems from clearance sales and price markdowns not only train the customer to wait for such events before buying, but also compound the overstocking problem by getting the supply chain to overreact to the sudden stock shortage situation caused by a clearance sale. Certain strategies can dispose of excess inventory without causing the bullwhip effect. For example, you can rationalize demand signals from clearing excess inventories before you enter the data into SCM systems. In this area, the sales and marketing function can have an adverse impact on the realization of ROI from SCM systems.

Changing the sales commission and incentive structures and educating the marketing and finance functions on the impact of their pricing and promotion policies can help fight the bullwhip effect. In the past, it was difficult for the IT or supply chain manager to make a case for changing this behavior. The typical response from the salesperson would be, "If you don't fill this unplanned order, we will lose this customer. Do you want that on your head?" Rest assured, anyone who valued his or her career would not argue. However, the findings from the Georgia Tech study give some ammunition for changing age-old sales commission, pricing, and promotion practices. The effect on the firm's valuation provides a powerful argument.

Potential Remedies

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You are fighting for a lost cause if you try to sell the idea of changing sales commission practices by touting the benefits from SCM implementation. It is tough to measure the benefits because efficiency gains are spread across all supply chain partners. Efficiency improvements from SCM system implementation will never be able to compare to the cachet of improving your sales by 15 percent. You are more likely to succeed by using the threat of a possible decline in the firm's valuation.

A simple remedy is to count only the money realized from a sale toward the commission targets of the sales staff. Of course, your sales executives would object and argue that they would lose their top performers. The "intelligent" manager can now demonstrate that those top performers in sales actually hurt the firm due to supply chain disruptions. Another approach would be to space out sales targets evenly over shorter periods to avoid the bullwhip effect.

Similarly, there are strategies to move product from store shelves without sending false demand signals up the supply chain. What was lacking before was a compelling and quantifiable reason for implementing these strategies. The Georgia Tech study goes a long way to make a quantifiable case for changing the sales practices that disrupt the supply chain.

Ram Reddy, [ramreddy@tacticagroup.com], is the author of From Supply Chains to Virtual Integration (McGraw-Hill, 2001). He is the president of Tactica Consulting Group (www.tacticagroup.com), a technology and business strategy consulting firm.

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