MANAGEMENT SCIENCE Vol. 50, No. 12 Supplement, December 2004, pp. 1875–1886 issn 0025-1909  eissn 1526-5501  04  5012S  1875 inf orms ® doi 10.1287/mnsc.1040.0266 © 2004 INFORMS Information Distortion in a Supply Chain: The Bullwhip Effect Hau L. Lee 1 Department of Industrial Engineering and Engineering Management, Stanford University, Stanford, California 94305 V. Padmanabhan 2 , Seungjin Whang Graduate School of Business, Stanford University, Stanford, California 94305 C onsider a series of companies in a supply chain, each of whom orders from its immediate upstream member. In this setting, inbound orders from a downstream member serve as a valuable informational input to upstream production and inventory decisions. This paper claims that the information transferred in the form of “orders” tends to be distorted and can misguide upstream members in their inventory and production decisions. In particular, the variance of orders may be larger than that of sales, and distortion tends to increase as one moves upstream—a phenomenon termed “bullwhip effect.” This paper analyzes four sources of the bullwhip effect: demand signal processing, rationing game, order batching, and price variations. Actions that can be taken to mitigate the detrimental impact of this distortion are also discussed. Key words : supply chain management; information distortion; information integration; production and inventory management History : Accepted by Marshall Fisher, received March 10, 1994. This paper was with the authors 3 months for 2 revisions. 1. Introduction Recent interest in supply chain management centers around coordination among various members of a supply chain comprising manufacturers, distributors, wholesalers and retailers. There are many examples of the benefits of coordination activities to the indi- vidual members in the supply chain (see, for example, Byrnes and Shapiro 1992, and Kurt Salmon Asso- ciates 1993). One important mechanism for coordination in a supply chain is the information flows among mem- bers of the supply chain. These information flows have a direct impact on the production scheduling, inventory control and delivery plans of individual members in the supply chain. This paper studies the demand information flow in a supply chain and reports the systematic distortion in demand informa- tion as it is passed along the supply chain in the form of orders. The illustration in Figure 1 (based on real data but manipulated to maintain confidentiality) shows a retail store’s sales of a product, alongside the retailer’s orders issued to the manufacturer. The figure clearly highlights the distortion in demand informa- tion. The retailer’s orders do not coincide with the actual retail sales. In this paper the bullwhip effect or whiplash effect refers to the phenomenon where orders 1 Current affiliation: Graduate School of Business, Stanford Univer- sity, Stanford, California. 2 Current affiliation: INSEAD, Fontainebleau, France. to the supplier tend to have larger variance than sales to the buyer (i.e., demand distortion), and the distortion propagates upstream in an amplified form (i.e., variance amplification). The bullwhip phenomenon has been recognized in many diverse markets. Procter & Gamble found that the diaper orders issued by the distributors have a degree of variability that cannot be explained by consumer demand fluctuations alone. At Hewlett- Packard, the orders placed to the printer division by resellers have much bigger swings and variations than customer demands, and the orders to the com- pany’s integrated circuit division have even worse swings. Also, it is often said that the DRAM mar- ket faces a much higher volatility than the computer market. (See Lee et al. 1997 for more evidence of the bullwhip effect.) The distortion of demand information implies that the manufacturer who only observes its immediate order data will be misled by the amplified demand patterns, and this has serious cost implications. For instance, the manufacturer incurs excess raw mate- rials cost due to unplanned purchases of supplies, additional manufacturing expenses created by excess capacity, inefficient utilization and overtime, excess warehousing expenses and additional transportation costs due to inefficient scheduling and premium shipping rates. Trade estimates suggest that these activities can result in excess costs in the range between 12.5% to 25% (Kurt Salmon Associates 1993). 1875