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Analytics Magazine

Was It Something I Said: The Bullwhip Effect

Summer 2008

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Vijay MehrotraBy Vijay Mehrotra

I had a guest speaker last month – a veteran Indian entrepreneur who had spent his entire career in the garment industry. In his informal and highly engaging style, he spoke to my students about off-shore manufacturing and how the business had evolved over the last 30+ years. During the question and answer period, one of my undergrads asked the speaker where his factories were located. After a very slight hesitation, the speaker replied that he had sold all of his factories several years ago, and had since then been focused on creating sourcing agreements to provide product to large retailers by contracting manufacturing out to factories owned by others. “Why did you get out of the export manufacturing business?” was the immediate follow-up question.

Once again the speaker hesitated. Finally, with a wisp of regret, he said that as a factory owner he had been negotiating with buyers for a long, long time, and that he had finally come to accept that in such negotiations, “the buyer always wins the game, especially when there is always another lower cost alternative out there somewhere.” Is this just another a manifestation of The Bullwhip Effect [1], in which the variability of demand is amplified through the supply chain? Certainly the Bullwhip’s symptoms – most notably a host of management challenges for supply chain participants who are far removed from the actual customers – are part of this story. But somehow the academic math, at least the stuff that I’ve seen, fails to capture the power dynamics that my speaker was describing: the party that owns the customer relationship has the strongest bargaining position, and this advantage is even bigger when the would-be supplier has already made heavy investments that must somehow be recouped.

I was still thinking about this stuff when I received an e-mail from a reader/colleague named Andrew Schaefer. Schaefer is an associate professor of industrial engineering at the University of Pittsburgh, and after reading my column on the Netflix Prize [2], he had written me expressing his opinion that “the value of the prize should be substantially greater than $1,000,000.”

My reaction to his note was violently mixed. On one hand, I kind of agreed with Andrew. Ever since I had heard about the Netflix Prize, there was a part of me that felt the whole thing was exploitive, a clever way to get a lot of brainpower working feverishly and for free on a very hard problem. One might think of it as a kind of a lottery, in which the seemingly large grand prize entices many people to pay for a ticket while most participants ultimately end up with nothing.

On the other hand, I had a sneaking suspicion that the Netflix people had perhaps priced their “product” correctly after all. How high should the value of the Prize be? There’s no easy way to tell, but for the people who conceived of and launched the Prize, the objective was to set a bounty high enough to engage talented people to pursue it, rather than provide fair compensation for successful achievement. While this may seem unfairly low – certainly from the perspective of the mathematicians who ultimately win the prize – indeed this is just basic business decision-making of the type that we O.R. people routinely recommend to our clients. Revenue management, if you will, only in this case we are the customers rather than the analysts.

Professor Schaefer also closed his e-mail with an offhand suggestion for anyone who was successful in winning the Netflix Prize: “If you solved the problem, incorporate and sell the company to the highest bidder (e.g. Amazon, Blockbuster, Wal-Mart) or license the software.” Though I’m sure it was inadvertent, this final comment managed to get under my skin in a much deeper way.

Why? I can’t quite put my finger on it. Maybe it was because of my well-established irritation with the way we O.R.-types envision the importance of our role in business. Our mental model is much like Saul Steinberg’s famous New Yorker cover [3] entitled, “A View of the World from 9th Avenue” in which Manhattan Island takes up roughly half of the world’s land mass. For most of us in O.R., the solving of a clean, well-defined technical problem is our Manhattan, and we are only dimly aware of the location and significance of the upstream activities like problem-definition, data analysis and project funding, and downstream activities such as systems implementation, business process design and change management that surround our spot on the map and enable us to contribute to the creation of actual business value. Our biases – that what we do is hard and the rest of it is easily replaceable, if not downright trivial – are both persistent and absurd.

More likely, it was because of my own experience as an entrepreneur. My partners and I had gone into business with our own heavy dose of naïveté, assuming that good people doing good technical work would have no problem at all plotting their own course to stardom. We learned, however, that when your piece of the puzzle is relatively far from the final customer, you are subject to both the variability in demand that the Bullwhip phenomenon predicts and the power plays that my guest speaker described so vividly. The reality was more difficult, and more gut-wrenching, than most people who haven’t gone through it ever imagine.

I’ve been out of the game for a while now, but my guest speaker’s poignant comments had been a recent reminder of just how hard it really is to make a business go. You never really forget.

Vijay Mehrotra (vjm@sfsu.edu) is a faculty member in the Decisions Sciences Group in the College of Business at San Francisco State University and an operations management consultant.

References

1. Lee, H.L., Padmanabhan, V. and Whang, Seungjin, 1997, “The Bullwhip Effect in Supply Chains,” Sloan Management Review, Vol. 38, No. 3, pp. 93-102.
2. www.lionhrtpub.com/orms/orms-2-07/frsomething.html.
3. www.thenewyorkerstore.com/assets/2/50326_l.jpg.

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