The bullwhip effect describes the amplification of demand variability as one moves upstream in the supply chain. It typically starts with small fluctuations in consumer demand that are magnified at each subsequent stage due to ordering and inventory management practices.
A recent research by Vector indicated that nearly all Indian auto OEMs rely on demand forecasts to anticipate market needs and plan production and distribution. These forecasts are based on historical sales data, market trends, and predictive analytics. However, the forecasts are inaccurate due to complex and unpredictable factors like competitor dynamics, fast-changing consumer preferences, biases in modelling assumptions, and decreasing accuracy over longer time horizons. With a forecast accuracy of only 60-80%, this can lead to overestimation or underestimation of demand.
Target-driven Inventory push: In addition to forecasts, auto OEMs set inventory targets or quotas for dealerships. These targets are intended to ensure adequate stock availability at the retail level to meet customer demand promptly. However, when coupled with inaccuracies of the forecast-based inventory creation, this can amplify inventory imbalances.
When forecasts overestimate future demand or when inventory levels take time to adjust to changing slowdown in market demand, as was the case recently, the result is often excess inventory at dealerships. This surplus ties up capital in unsold vehicles, increases storage costs, and will require incentives or discounts to clear out slow moving stock. Moreover, it strains relationships between OEMs and dealerships, complicates inventory management efforts, and diminishes overall operational efficiency.
Mitigating bullwhip effect: The pull-based replenishment which leverages strategic buffers at aggregated locations can significantly mitigate the bullwhip effect and build more resilient supply chains. This involves 3 steps.
1.Building buffers
The key to mitigating variability in the supply chain (in addition to the demand variability, there can be supply variability as well) lies in establishing buffers at critical points within the supply chain, such as central warehouses (CWH) and supplier nodes. These buffers serve to replenish inventory based on consumption rather than rigid forecasts. By adopting a pull-based approach, suppliers respond to daily inventory depletions, ensuring a more responsive and fluid supply chain.
2.Implementing execution-based priority system
Implementing an execution-based priority system is essential to effectively manage demand and capacity fluctuations, This system utilizes depletion in buffer stock to signal production and dispatch priority through a color-coding mechanism (e.g. red- high priority, yellow- medium priority, green- low priority). This enables swift and efficient responses to changing demand patterns, minimizing the risk of overreacting to demand fluctuations.
3.Adjusting buffer norms
The same colour-based system can be used to adjust inventory norms based on sales rates, increasing them when sales go up and also for preparing for known sales changes like seasons, promotions, etc. This method, enabled by end-to-end IT integration, enhances transparency by tracking priority zones and dynamically adjusting buffer norms based on demand.
Conclusion
The adoption of a “pull” system based on buffers offers a robust solution to the chronic problem of inventory variability in the supply chain and the consequent bullwhip effect. By strategically integrating buffers and implementing execution-based priority management, automotive supply chains can harmonize operations across all stages. This approach not only safeguards against inventory pile-ups during sales downturns but also enhances overall supply chain resilience and responsiveness. The expected benefits are 100% availability at dealerships, the ability to meet customer expectations faster, higher sales, a 50% reduction in inventory not only for the dealerships but also in the OEM’s supply chain, and the elimination of the need to liquidate excess inventory through discounts.
By doing so, automotive OEMs can navigate market uncertainties with confidence, optimize operational efficiency, and foster stronger partnerships with dealerships.
(Authored by Sumit Sharma, Partner, Vector Consulting Group. Views are personal.)
