Describe the impact of forecasts based on orders rather than actual customer demand

Question

What will be an ideal response?

Answer 1

Answer: When stages within a supply chain make forecasts that are based on orders they receive, any variability in customer demand is magnified as orders move up the supply chain to manufacturers and suppliers. In supply chains that exhibit the bullwhip effect, the fundamental means of communication between different stages are the orders that are placed. Each stage views its primary role within the supply chain as one of filling orders placed by its downstream partner. Thus, each stage views its demand to be the stream of orders received and produces a forecast based on this information. In such a scenario, a small change in customer demand becomes magnified as it moves up the supply chain in the form of customer orders. Consider the impact of a random increase in customer demand at the retailer. The retailer may interpret part of this random increase to be a growth trend. This interpretation will lead the retailer to order more than the observed increase in demand because the retailer expects growth to continue into the future and thus orders to cover for future anticipated growth. The increase in the order placed with the wholesaler is thus larger than the observed increase in demand at the retailer. Part of the increase is a one-time increase. The wholesaler, however, has no way to interpret the order increase correctly. The wholesaler simply observes a jump in the order size and infers a growth trend. The growth trend inferred by the wholesaler will be larger than that inferred by the retailer (recall that the retailer had increased the order size to account for future growth). The wholesaler will thus place an even larger order with the manufacturer. As we go further up the supply chain, the order size will be magnified. Now assume that periods of random increase are followed by periods of random decrease in demand. Using the same forecasting logic as earlier, the retailer will now anticipate a declining trend and reduce order size. This reduction will also become magnified as we move up the supply chain.

The fact that each stage in a supply chain forecasts demand based on the stream of orders received from the downstream stage results in a magnification of fluctuations in demand as we move up the supply chain from the retailer to the manufacturer.