Charter 3

THE VALUE OF INFORMATION

Mã MH : 704015
Bộ môn: KDQT- [Link]
GV : Phạm Thị Ngân
 Learning objectives

Probability and Perfect Information;

The Expected Value of Information;
Expected value of Imperfect Information;
Value of information in Complex Problems;
Value of information and Experts.

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 Main contents

3.1 Introduction
3.2 The Bullwhip Effect
3.3 Information Sharing and Incentives
3.4 Effective Forecasts
3.5 Information for the Coordination of Systems

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 4.1 Introduction
❖ Value of using any type of
information technology
❖ Potential availability of more
and more information
throughout the supply chain
❖ Implications this availability on
effective design and
management of the integrated
supply chain
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 3.1 Introduction

• Information
– Helps reduce variability
– Helps improve forecasts
– Enables coordination of systems and strategies
– Improves customer service
– Facilitates lead time reductions
– Enables firms to react more quickly to changing
market conditions

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 3.1 Introduction(cont)

Type of information
• Supplier information
• Manufacturing
information
• Distribution and retailing
information
• Demand information

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 3.2 The Bullwhip Effect
• The bullwhip effect is a
distribution channel phenomenon
in which forecasts yield supply
chain inefficiencies.
• It refers to increasing swings in
inventory in response to shifts in
customer demand as one moves
further up the supply chain.

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 4-Stage Supply Chain
FIGURE 5-5:
The supply
chain

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 Effect of Order Variability

The increase in variability in the supply

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chain Chương 3: The Value of Information 10
 Factors that Contribute to the
Variability - Demand Forecasting

❖ Periodic review policy

• Characterized by a single parameter, the base-stock level.
• Base-stock level =
Average demand during lead time and review period +
a multiple of the standard deviation of demand during lead
time and review period (safety stock)

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 Factors that Contribute to the
Variability - Demand Forecasting
❖ Estimation of average demand and demand variability
done using standard forecast smoothing techniques.
❖ Estimates get modified as more data becomes
available
❖ Safety stock and base-stock level depends on these
estimates
❖ Order quantities are changed accordingly increasing
variability

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 Factors that Contribute to
the Variability – Lead Time
❖ Increase in variability magnified with increasing lead time.
❖ Safety stock and base-stock levels have a lead time
component in their estimations.
❖ With longer lead times:
– a small change in the estimate of demand variability
implies
– a significant change in safety stock and base-stock
level, which implies: significant changes in order
quantities and leads to an increase in variability

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 Factors that Contribute to the
Variability – Batch Ordering
❖ Retailer uses batch ordering, as with a (Q,R) or a
min-max policy
❖ Wholesaler observes a large order, followed by several
periods of no orders, followed by another large order, and
so on.
❖ Wholesaler sees a distorted and highly variable pattern of
orders.
❖ Such pattern is also a result of:
– Transportation discounts with large orders
– Periodic sales quotas/incentives
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 Factors that Contribute to the
Variability – Price Fluctuations
❖ Retailers often attempt to stock up when
prices are lower.
– Accentuated by promotions and discounts at
certain times or for certain quantities.
– Such Forward Buying results in:
• Large order during the discounts
• Relatively small orders at other time periods

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 Factors that Contribute to the
Variability – Inflated Orders
❖ Inflated orders during shortage periods
❖ Common when retailers and distributors suspect that a
product will be in short supply and therefore anticipate
receiving supply proportional to the amount ordered.
❖ After period of shortage, retailer goes back to its standard
orders
– leads to all kinds of distortions and variations in
demand estimates

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 Increasing Variability of Orders
Up the Supply Chain

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 We conclude…

• Order variability is amplified up the supply chain;

upstream echelons face higher variability.
• What you see is not what they face.

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 What are the Causes…
• Demand forecasting
– Min-max inventory level
– Order-up-to level
– Orders increase more than forecasts

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 What are the Causes…
• Long cycle times
– Long lead times magnify this effect;
– Impact on safety stock
– Product life cycle
• Batch ordering
– Volume & transportation discount

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 What are the Causes… (cont’d)
• Price fluctuation
– Promotional sales
– Forward buying
• Inflated orders
– Orders placed increase during shortage periods
– IBM Aptiva orders increased by 2-3 times when
retailers thought that IBM would be out of stock over
Christmas

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 What are the Causes… (cont’d)
• Single retailer, single manufacturer.
– Retailer observes customer demand, Dt.
– Retailer orders qt from manufacturer.

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 4.2.1 Quantifying the Bullwhip
• Consider a two-stage supply chain:
– Retailer who observes customer demand
– Retailer places an order to a manufacturer.
• Retailer faces a fixed lead time
– order placed at the end of period t
– Order received at the start of period t+L.

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 Quantifying the Bullwhip(cont)
• Retailer follows a simple periodic review policy
– retailer reviews inventory every period
– places an order to bring its inventory level up to a
target level.
– the review period is one

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 Quantifying the Bullwhip

❖ Base-Stock Level = L x AVG + z x STD x √L

❖ Order up-to point =
❖ If the retailer uses a moving average technique,
–

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 Quantifying the Bullwhip Effect
❖ Quantifying the Increase in Variability
– Var(D), variance of the customer demand seen by the
retailer,Var(Q), variance of the orders placed by that
retailer to the manufacturer

– When p is large and L is small, the bullwhip effect is

negligible.
– Effect is magnified as we increase the lead time and
decrease p.

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 Var(q)/Var(D):
For Various Lead Times

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 3.2.2 Impact of Centralized Information
on Bullwhip Effect
• Centralize demand information within a supply chain
– Provide each stage of supply chain with complete
information on the actual customer demand;
– Creates more accurate forecasts rather than orders
received from the previous stage.

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 Variability with Centralized Information

❖ Var(D), variance of the customer demand seen by the

retailer
❖ Var(Qk), variance of the orders placed by the kth stage to its
❖ Li, lead time between stage i and stage i + 1

• Variance of the orders placed by a given stage of a supply

chain is an increasing function of the total lead time
between that stage and the retailer
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 Variability with Decentralized
Information
• Retailer does not make its forecast information available
to the remainder of the supply chain
• Other stages have to use the order information

• Variance of the orders:

– becomes larger up the supply chain
– increases multiplicatively at each stage of the supply
chain.
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 Managerial Insights

• Variance increases up the supply chain in both

centralized and decentralized cases
• Variance increases:
– Additively with centralized case
– Multiplicatively with decentralized case
• Centralizing demand information can significantly
reduce the bullwhip effect
– Although not eliminate it completely!!

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 Increase in Variability for
Centralized and Decentralized
Systems

Increase in variability for centralized and decentralized

systems

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 3.2.3 Ways to Cope with the
Bullwhip Effect
• Reducing uncertainty
– Centralizing demand information
– Bullwhip inherent in use of various forecasting techniques
• Reducing variability
– Use of EDLP(Every Day Low Pricing) strategy (Payless)

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 Ways to Cope with the
Bullwhip Effect
• Lead time reduction
– Order lead time (time to produce and ship)
– Information lead time (time to process order)
– Efficient network distribution design
• Strategic partnership
– Vendor managed inventory (VMI); Sharing of customer
information;Collaborative forecasting

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 Cross-Docking Operation

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 3.3 Information Sharing And
Incentives
❖ Centralizing information will reduce variability
❖ Upstream stages would benefit more
❖ Unfortunately, information sharing is a problem in many
industries
❖ Inflated forecasts are a reality
❖ Forecast information is inaccurate and distorted
Forecasts inflated such that suppliers build capacity
Suppliers may ignore the forecasts totally

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 Contractual Incentives to Get True
Forecasts from Buyers
❖ Capacity Reservation Contract
– Buyer pays to reserve a certain level of capacity at the
supplier
– A menu of prices for different capacity reservations
provided by supplier
– Buyer signals true forecast by reserving a specific
capacity level

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 Contractual Incentives to Get True
Forecasts from Buyers
❖ Advance Purchase Contract
– Supplier charges special price before building capacity
– When demand is realized, price charged is different
– Buyer’s commitment to paying the special price
reveals the buyer’s true forecast

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 3.4 Effective Forecasts

❖ Retailer forecasts
– Typically based on an analysis of previous sales at the
retailer.
– Future customer demand influenced by pricing,
promotions, and release of new products.
– Including such information will make forecasts more
accurate.

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 Effective Forecasts
❖ Distributor and manufacturer forecasts
– Influenced by factors under retailer control.
– Promotions or pricing.
– Retailer may introduce new products into the stores
– Closer to actual sales – may have more information

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 Effective Forecasts(cont)
❖ Cooperative forecasting systems
– Sophisticated information systems
– iterative forecasting process
– all participants in the supply chain collaborate to arrive
at an agreed-upon forecast
– All parties share and use the same forecasting tool

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 3.5 Information for the
Coordination of Systems
• Many interconnected systems
– manufacturing, storage, transportation, and retail
systems
– the outputs from one system within the supply chain are
the inputs to the next system
– trying to find the best set of trade-offs for any one stage
isn’t sufficient.
– need to consider the entire system and coordinate
decisions

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 3.5 Information for the
Coordination of Systems
• Systems are not coordinated
– each facility in the supply chain does what is best for
that facility
– the result is local optimization.

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 Key words
Bullwhip effect Collaborative forecasting;
Lead-time Supplier information
Coordination of Systems Manufacturing information
Information system Distribution and retailing
interconnected systems information
local optimization Demand information;
trade-offs retailer
Centralizing demand
information

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