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Module SCM102: Supply Chain Strategies I: Aligning Strategies; Efficiency and Cost Savings
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|  | Counteracting Information Distortion: Keeping Safety Stocks Steady |
We stated earlier that too-rapid adjustment of safety stocks can exacerbate the Bullwhip Effect by overcompensating for small order quantity changes that may not be meaningful. How would this work? Suppose weekly sales were averaging 100 units, and then sales increased to 105 units in a given week. This is a 5% increase in sales, and might be expected to result in a 5% increase in orders if there were no bullwhip effect. But if the "optimal" safety stock level was immediately recalculated and updated, it would increase somewhat, since demand over the replenishment lead time would now be forecasted at the 105/week rate, higher than before. Then our replenishment order would have to cover two needs: (1) our apparent sales rate is now 5% higher; and (2) we need to order even more, in order to bring our actual safety stock in line with a new, higher target safety stock level. Need #1 could lead to a 5% increase in order size and need #2 would make it even larger, thus causing the Bullwhip Effect. The following table summarizes this data:
| Average Sales: | 100 units/week |
| Sales Increase: | 5% to 105 units |
| Forecast Increase: | 5% to 105 units |
| Initial Safety Stock: | 200 units (2 weeks' supply) |
| Revised Safety Stock: | 210 units (5% increase) |
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Inventory generally consists of safety stock and cycle stock. Cycle stock is the inventory that you plan to sell based on demand forecasts, while safety stock provides an additional buffer for excess demand or delayed shipments from your suppliers. Since your forecasted demand was 100 units every week and your safety stock was 2 weeks' supply, assume your total inventory was 100 units of cycle stock plus 200 units of safety stock, or 300 units. When you received an order for 105 units, or 5% higher than forecast, you depleted your entire cycle stock of 100 units to fill that order, and you still had demand for 5 more units. These remaining units are called forecast error, and you shipped the remaining 5 units from your safety stock.
The revised safety stock calculation is as follows:
| Initial Safety Stock: | 200 units |
| Forecast Error: | - 5 units |
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| Current Safety Stock: | 195 units |
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| Then for replenishment: |
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Replenishment for Forecasted Future Demand:
(replenish cycle stock to new forecast of 105) | +105 units |
Replenishment for Safety Stock Adjustment:
(to bring safety stock to new level of 210) | +15 units |
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| Total Replenishment Order: | 120 units |
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From the table above, the replenishment order will be 105 units (for the new forecast) plus 15 more for the safety stock adjustment, for a total of 120. This means that a 5% increase in sales has led to a 20% increase in orders - the Bullwhip Effect! On the flip side of this, if weekly sales dropped from 100 to 95, the effect is exactly the reverse, and the subsequent replenishment order would be more than 5% lower if again safety stocks are recalculated immediately, thus creating the Bullwhip Effect on the downside also. The remedy here is to keep safety stocks steady and let them handle what might be random fluctuations in sales, and not update them unless and until there has really been a significant and persistent change in the sales rate.
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