How IKEA tamed the bullwhip effect
Imagine four business professionals: John, Karl, Lisa and Helen. John sells the amazing latest technology product X, through his knowledgeable analytic team, he receives a demand forecast for the upcoming month of 15 units. John knows that this product enjoyed quite a success lately so, to be safe he orders 20 units, 15 as forecasted and 5 as safety stock. Lisa, who works in the distribution center of product X, looks at the orders and sees that John wants 20. Now, Lisa, who is very committed to achieve great results, sends an order for 30 units to the manufacturer, being able to avail quantity discount for bulk orders. At this point, we find Karl and Helen who are responsible for the manufacturing planning of product X. They discuss about what to do and decide to order materials for producing 60 units, in this way they can bring down manufacturing and order cost, as well as aim for a one time delivery.
If we now take a step back and visualize this simple chain it will look like this:
Now, the above is what is called a bullwhip effect.
The Bullwhip effect occurs when coordination along the chain is lacking and fluctuations of orders increase as they move upstream. The results are lost control and major distortion of what the actual customer demand looks like (Chopra, 2018). This can happen for several reasons but the most common can be recognized as follow:
1 Information sharing is delayed, insufficient or distorted;
2 Players along the chain work towards individual objectives (own profit/cost minimization) without looking further in the process. This behavior often prevents a beneficial alignment of the entire supply chain;
3 Dealing with an extremely high variety of products makes the coordination harder, as focusing on a unique strategy is difficult.
If we look again at the simple example above, we can pinpoint how the bullwhip effect would increase costs in each stage of the chain. Manufacturers may build more capacity to satisfy the increased amount of orders, as well as holding more raw material inventory. Replenishment lead time will increase, and so will transport costs (by increasing transport capacity or having more shipments per single order) and occasionally labor costs. Finally, relationships between the players are at stake, with a blame spiral that worsen business bonds.
IKEA is a well-known low-cost furniture manufacturer. It has around 355 stores in 29 countries, each of them holds the outstanding amount of 9,500 products. How does IKEA manage its wide product portfolio, while keeping costs down and consumers happy? I found many strategies deployed by the furniture giant, let’s explore the most interesting ones together.
If you are a fan like me, you will have found your hands going through the glossy pages of IKEA catalog. IKEA is committed to a yearly catalog (or even longer periods if you think of best seller products like the Billy or the Kallax), remarkably decreasing the variability that could come from managing such a high volume portfolio.
What I find particularly brilliant is the merging of three concepts: showroom, wholesaler and retailer. As many of you are familiar with the IKEA stores, you always have a floor that shows you most of the furniture available, you can lay on a bed, touch that tempting fabric and imagine to flip a delicious frittata behind that shiny kitchen counter. This floor is a great way to increase retention, to involve the customer and to make them feel already in their future home. Whether you go there to just buy a potato peeler or to shop for your entire new room, you will get out with a nice and dreamy feeling. Just right after the showroom you get down to the wholesale area where all different small objects are located and further on you enter in the warehouse where you can get your disassembled furniture. This particular setting is aimed to reduce what is called the “cost-per-touch”. And what is that? Simply, think of any product, every time it gets moved, loaded and unloaded, it is “touched” by a party involved in the chain and that in a way or another brings up costs, namely labor, inventory and transport costs. The former, at IKEA, is reduced by having the customer retrieving her/his own piece of furniture and building them at home with a practical do it yourself manual. The second and the latter are reduced by cutting a step or better merging the final two step of the chain.
Last but not least, these days it seems never enough to stress the importance of data for smooth functioning of supply chain activities. Not any data is useful of course, but here is where companies are playing the ultimate competitive game, being able to correctly collect and prepare the right data for analysis is what gives a company a fast start. IKEA has a proprietary system that shares the data collected from its POS. Now, you can also see that this is much easier when the company has proprietary wholesale and retail shops. This said, it is also rather difficult to maintain such network with your own resources. Hence, IKEA has an extensive network of suppliers and strives to maintain long term relationships by actively working with them on improvements aimed to lower costs. This kind of commitment is full of obstacles but the payoff is much higher. Working closely allows to build trust, which lead as well to information sharing.
These practices makes it easier to create an accurate production planning, clarify what to keep in stock and results into higher visibility on the downstream of your chain to prevent disruptive waves on the upstream part of the chain. To conclude, in its stores, IKEA managed to tame the bullwhip effect thanks to better goal alignment and less steps in the chain, providing almost real-time data on sales, which provides better insight in inventory management. This success does not come easily, and even if IKEA is virtuous in implementing these best practices, many challenges remain. After all, supply chains are evolving at light-speed and as many other aspects in business: it remains a matter of the survival of the fittest.
Ambastha, M. (n.d.). knowledge. Retrieved from Fibre2fashion: https://www.fibre2fashion.com/industry-article/7852/the-bullwhip-effect?page=3
Fangzheng, T. (2013, February 12). Supply cahin management. Retrieved from http://cmuscm.blogspot.com/2013/02/how-to-control-bullwhip-effect-in.html
M., A. (2015, December 9). Retrieved from harvard business school: https://rctom.hbs.org/submission/ikeas-business-and-operating-models-a-match-made-in-heaven/#
Tradegecko. (2018, July 2). Blog. Retrieved from Tradegecko: https://www.tradegecko.com/blog/ikeas-inventory-management-strategy-ikea