Hau Lee’s Bullwhip Effect and Other Research Examines Supply Chain Management

Hau Lee photoHau Lee links theory and practice building a large corporate fan base. He even creates businesses to solve the problems his research uncovers.

by Maria Shao

In 1972, Hau L. Lee, a Hong Kong University student and son of a construction foreman and a homemaker, won a scholarship for an unusual course of study. He would spend 4½ months on a passenger ship. On the World Campus Afloat, Lee and other international students journeyed to countries rich and poor, including the United States, Japan, India, Sri Lanka, Indonesia, Ghana, South Africa, and the Fiji Islands. While at sea, they took classes on subjects such as economics and geography. While docked, they visited museums, universities, and other sites in 13 countries.

It was an eye-opener for the 19-year-old Lee. He had never been outside the British colony, and his family could never have afforded such a trip. “I had just finished freshman year and was immediately thrown into this opportunity to see what the world was like. That helped me to always remember that the world is global. It planted the seed for me to have a global interest in business,” recalls Lee, now a professor at the Graduate School of Business.

He has been studying — and explaining — the global economy from a front-row seat ever since.

Today, the Thoma Professor of Operations, Information and Technology is considered by some the world’s foremost academic expert on global supply chain management. Lee, age 57, is an authority on how businesses can gain advantage by strategically managing their supply networks, which include the behind-the-scenes flows of materials, information, and money needed in producing goods and services.

 

Haul Lee bullwhip photo

Hau Lee demonstrates how a small movement of the bullwhip’s handle creates large waves at the tip.
Photos by Frederic Larson

 

At Stanford since 1983, Lee has played a major role in the birth of modern supply chain management. His key contribution: promoting a holistic perspective on supply chains that are complex and global. It’s an integrated view that’s highly relevant to today’s interconnected economy, where outsourcing and offshoring are the norm.

An energetic, amiable man who was once a competitive bridge player, Lee says modern supply chain management is all about the “three M’s — multiple flows, multiple companies, and multiple disciplines.”

Lee’s signature idea is the “bullwhip effect,” a concept he co-developed in the 1990s, which has become a basic tenet in both academia and industry. When a person cracks a bullwhip, the small movements at the wrist produce huge waves at the other end of the whip, which describes how information on demand becomes increasingly exaggerated and distorted as it moves up the supply chain from customer to manufacturer to supplier, driving up costs and hurting efficiency.

By most accounts, Lee has been unusually successful at linking theory and practice. “Very few academics have that talent,” says Chung-Yee Lee, chair professor of industrial engineering and logistics management at the Hong Kong University of Science and Technology.

Many companies, including Cisco Systems, Microsoft, and Safeway, are among Hau Lee’s fans, collaborators, research subjects, and consulting or training clients. He even spent a sabbatical year working full time at Hewlett-Packard, and he founded the Stanford Global Supply Chain Management Forum, a leading academic-industry consortium that promotes research and collaboration. Although he is not an engineer, Lee is held in such high regard by the profession that he was selected to be a member of the prestigious National Academy of Engineering.

“Without exaggeration, he is the father of supply chain management. While the term was used earlier by others, he is the one who gave the identity and validity to the new field,” says Seungjin Whang, a close collaborator of Lee’s and coauthor of the bullwhip effect who is the Jagdeep and Roshni Singh Professor of Operations, Information and Technology at the business school.

In decades past, supply chain management focused more narrowly on managing manufacturing. Product design, logistics (meaning transport and warehousing), distribution, retailing, and recycling or product disposal were examined separately. In the early 1990s, Lee and others began espousing an integrated view of functions in the so-called “value chain” of economic activity.

The research and case studies Lee has developed and taught cover seemingly every aspect of managing global supply networks. His case studies, for example, have examined HP’s past global inventory problems with inkjet printers; Cisco’s global collaboration in developing and outsourcing production of a new telecom router; Starbucks’ “green” coffee-buying practices; Zappos.com’s offerings of a wide selection of shoes and strong customer service; Renault’s optimization of customs and duties in developing economies; and IDS Group’s “value chain logistics” in distributing its customers’ goods throughout Asia.

Lee’s work emphasizes the importance of information sharing and collaboration. “The major change was an increased understanding that the way a company performs is also very much determined by its suppliers and customers,” says Jan C. Fransoo, professor of operations management and logistics at Eindhoven University of Technology in the Netherlands.

Adds Corey Billington, former Hewlett-Packard vice president of supply chain management: “Hau has been instrumental in pioneering the view that the world is a connected place — and that we stand to gain more from collaborating than fighting. His biggest contribution is to create an analytical framework and context to allow companies to thrive in a ‘flat’ world.” Billington, cofounder of consulting firm e3 Associates, has worked extensively with Lee and is a former professor of operations management and procurement at the IMD business school in Switzerland.

Hau Lee on boat photo

A 19-year-old Lee got his first look at the world aboard a ship that served as a floating campus taking students to 13 countries. The experience fostered an interest in global business.
Photo courtesy of Hau Lee

Lee grew up under modest circumstances. But he did well enough academically to land at the elite Queen’s College for boys, the first secondary school founded in Hong Kong by the British colonial government. He went on to Hong Kong University, graduating in 1974 with a bachelor’s degree in economics and statistics. Lee pursued further studies in England, where he earned a master’s degree in operational research from the London School of Economics in 1975. He later received master’s and PHD degrees in operations research from the Wharton School at the University of Pennsylvania.

After getting his doctorate in 1983, Lee received job offers from numerous U.S. business schools and one engineering school —
Stanford’s. He says he took a “risk” in joining Stanford’s faculty of industrial engineering and engineering management. But, he adds, “I thought since I had never been an engineer, I needed to know something about technology. I wanted to learn how technology and business interface.” Ultimately, Lee received an endowed chair in engineering and began teaching in Stanford’s business school in 1998. He moved full time to the business faculty in 2002.

A sabbatical from Stanford in 1989–90 proved to be a key turning point. He made the unusual choice, for an academic, of going to work for a company. HP’s central manufacturing operations provided a real-world experience that helped Lee “recognize that the supply chain is holistic,” he says. “It’s not just solving a distribution or a manufacturing problem.”

In the classroom, Lee’s energy and theatrical flair are obvious — not surprising for someone who has taken singing lessons and enjoys watching musicals. He bobs, cracks jokes, diagrams ideas on the board. He has worn Crocs to class when teaching about the maker of the brightly colored, whimsical foam shoes. Students named him winner of the MBA Distinguished Teaching Award in 2007.

Colleagues also enjoy Lee’s presence. “Hau is a gentleman and a scholar,” says Billington. “Of course, he’s a brilliant scholar. [But] there are a lot of smart people, some of whom you wouldn’t care to have dinner with.”

Today, Lee lives in Silicon Valley with his wife, Lyn, whom he first met in Hong Kong. Like him, she pursued graduate studies at the University of Pennsylvania. They married in Philadelphia, where Lee became a Christian, baptized Jan. 1, 1978. They have two daughters, one a new graduate of Stanford and the other beginning her sophomore year at the school.

 

Hau Lee in China photo

Hau Lee has lunch with students at Heshan No. 1 school in Guangdong Province while accompanying MBA students on a study trip to China. Lee estimates that about half his work relates to China, the manufacturing center of the world.
Photo by Hannah Wright

 

Some of Lee’s ideas have become basic principles in supply chain management. He is cited most often for his work on the bullwhip effect, a phenomenon that has bedeviled companies in many industries. His work sheds light on the causes and effects of demand information being amplified as it is conveyed upstream from customer to retailer, distributor, manufacturer, and suppliers. People at each level distrust the information they are receiving, so they tend to over- or under-order. This can lead to excessive inventory, even more inaccurate demand forecasting at a higher level, products being out of stock, and too little or too much production capacity.

Lee and two Stanford colleagues — Whang and V. “Paddy” Padmanabhan (now at INSEAD-Singapore) — published a paper in 1997 that analyzed the bullwhip effect and suggested how to counteract it. A subsequent bullwhip paper was voted in 2004 among the 10 most influential in the history of the supply chain journal Management Science.

The three reached their insights after interviewing companies where they heard many stories of missed demand forecasts. At Procter & Gamble, maker of Pampers diapers, managers complained that while babies used the disposable diapers at a steady rate, orders showed increasingly wide swings as they moved up from consumer to retailer, distributor, P&G, and P&G’s materials suppliers. P&G employees described the problem as a bullwhip, and the scholars picked up on the term.

Lee says the contribution he and his colleagues made was to “identify” and “explain” the bullwhip effect as a “systems problem,” reflecting ineffective incentives and measures of performance. They were the first ones “to use simple models to explain why things happen this way and to illustrate the fact these things were happening because of rational decision-making.”

The phenomenon is common in many industries but varies widely, Lee says. Researchers normally measure disparity between actual demand and orders in standard deviations. This “bullwhip ratio” (defined as the standard deviation of orders divided by the standard deviation of demand) can range from a fraction to double-digit figures, depending on such variables as the industry and stage in a supply chain.

Introducing the bullwhip effect in a recent class, Lee reached behind the lectern and pulled out a genuine leather whip. He asked: “Do we have anyone good at cracking the bullwhip?” One student, in bare feet and a T-shirt, ambled down to the front of the classroom to demonstrate. Crack! Crack! Guffaws and gasps all around from the 65 students. Lee then made his point: When you snap a bullwhip, you create small waves near the handle, which become large waves near the tip of the whip. Similarly, “a small hiccup is translated into a big swing” in market demand as you go farther upstream in the supply chain, Lee explained.

The class discussed the case of Italian pasta maker Barilla, which was being whipsawed by distorted demand information. Eventually, the company came up with a system to take over inventory management at a large distributor’s site. The lessons from Barilla, according to Lee: Don’t trust the information coming in. Find ways to collaborate. Use incentives to foster collaboration.

“The skills you learn in this class are quickly applicable to a lot of businesses. What we learned today, you could walk into a company and show how to cut inventory costs,” declared Amos Underwood, MBA Class of 2011, the student who cracked the whip. “It’s informative yet jovial,” he says of the course.

“He has real-life examples. He’s been around the block. It’s great to be learning from the expert,” added Ashish Jhina, also in the Class of 2011.

Another of Lee’s key ideas is “postponement,” a practice widespread in technology manufacturing today. Instead of making finished products ahead of time and stocking them in inventory (made to stock), a company produces a nearly complete “plain vanilla” version. Configuration and completion of the product are delayed, sometimes until an order is actually received (made to order). This can reduce inventory needs, make manufacturing more flexible and efficient, and improve customer service. But it also can require adopting a new product design mindset.

Lee has been advocating postponement in manufacturing since his sabbatical, when he helped HP’s inkjet printer division solve problems with excessive, mismatched inventory. The problems were worst in Europe, where the printers needed to be “localized” to meet unique needs in a dozen European countries. HP and Lee’s solution: build mostly complete printers at the factory and let local distribution centers add the power supplies, manuals, software, paper trays, and packaging appropriate for each country. Thus, the “point of differentiation” and the “personality” of the product were postponed, Lee explains.

The HP experience taught Lee that design and manufacturing must work closely. That is, products should be designed not just for performance but for optimizing the manufacturing supply chain, a concept known as “design for manufacturability.”

With Lee’s input, HP’s inkjet group was able to cut its inventory investment by 18% and save tens of millions of dollars, recalls Billington, HP’s former vice president of supply chain services. In addition, HP adopted a “design for localization” strategy throughout its business. Lee continued to be affiliated with the company for a decade or so working on supply chain strategies.

In 1995, Lee founded the Stanford Global Supply Chain Management Forum, so researchers and practitioners could collaborate and share ideas and best practices. As director, he makes pitches for grants, leads conferences, and comes up with ideas for research. Corporate members include Cisco, Dow Chemicals, HP, Intel, Safeway, and Toyota.

He also has cofounded software companies. After observing grocery chains struggling to forecast demand and replenish inventory, he cofounded Evant in 1994 to offer retailers software for managing multi-level supply chains. When some forecasts went awry because grocers made ad hoc pricing decisions, he and consultant Michael Neal founded DemandTec in 1999 to provide software for retailers and consumer goods makers to optimize merchandising and marketing. DemandTec’s technology correlates sales, demand, and other data to provide insights that guide pricing and promotion decisions. A retailer using the software might see that parents of newborns are less price-sensitive about diapers than parents of older babies, so it might price newborn diapers with higher profit margins than toddler diapers. DemandTec went public in 2007 and now has about $80 million in yearly revenue from customers including Best Buy, Wal-Mart, Nestlé, and Procter & Gamble. In 2004, Lee and Neal started SignalDemand, a private company that sells software and services for “process” manufacturers, such as food makers.

In these companies, Lee generally has served as chief scientist by developing the theory and the math. “Early on, when you have a strategy in mind and know what values you want to add but haven’t figured out the models, he’s a wonderful guy to have at the table. He’s nimble and very pragmatic,” says Neal, chief executive of SignalDemand. Supply chain software often involves crunching many terabits of “dirty” real-world data from customers and suppliers, Neal says. “You need a lot of mathematical horsepower to cleanse the data. Solving those problems is his strength. Then doing something useful and productive with that data is how he excels.”

As a supply chain expert, Lee has a realistic perspective on a global economy in which developing countries are increasingly important. “These new economies are your suppliers. They’re your future markets. They’re an important source of innovation and new product design,” says Lee, who makes a dozen short overseas trips a year and has logged 2.5 million miles on United Airlines.

He estimates that about half his work, including teaching cases, relates to China, the manufacturing center of the world. He serves on the boards of two Hong Kong-based companies — Esquel, a producer of men’s premium cotton shirts with extensive operations in China, and IDS, the logistics services company operating throughout Asia.

Last year, Lee was a driving force in launching the Cisco-Fudan-Stanford Supply Chain Leadership Institute in China. After Cisco decided to open an executive education program for Chinese supply chain executives, Lee spearheaded Stanford’s winning bid to become Cisco’s U.S. partner and then helped choose Fudan University of Shanghai as the Chinese partner. So far, more than 180 Chinese executives, from industries including steel, pharmaceuticals, banking, and silk making, have taken the one-week sessions held in Shanghai and Shenzhen.

“It’s an outstanding opportunity for us to develop supply chain leadership skills in China, an opportunity to educate our own ecosystem” of suppliers and customers, says Jeff Gallinat, vice president of global manufacturing operations at Cisco.

Lee led in designing the curriculum and even teaches classes in Mandarin, although his native Chinese dialect is Cantonese. “Hau is a critical part of the program’s success,” Gallinat says. “He delivers the goods always.”

Fudan sees the institute as a way to improve China’s competitiveness. “Supply chain management is quite young in China. We still have a huge space to improve our capability,” says Yin Zhiwen, associate dean of Fudan’s School of Management. Lee’s name draws students. “He’s like a big hero” among supply chain practitioners, says Yin, also a specialist in operations research.

Last year, Lee invited Yossi Sheffi, director of the MIT Center for Transportation and Logistics, to spend a week in Shanghai teaching. Sheffi, who like Lee is considered among the elite in the field, says his busy schedule means he typically declines many invitations to teach or speak in various parts of the world. But “when Hau invites me,
I go. There’s nobody else in the world that I would have flown to
China for,” Sheffi says. “He has the rare combination of research
ability, collegiality, and humanity.”

Continuing to push the envelope, Lee is now looking at how to create socially responsible and environmentally sustainable supply networks. In recent years, he has turned his attention toward topics such as manufacturing pollution, sustainable agriculture, and treatment of workers in developing countries. The Stanford supply chain forum, for instance, has a research program focused on social and environmental responsibility.

Pulling out a pad of paper to diagram his life’s work, Lee sketches a square with four squares within. The first square is for mature-economy companies with conventional profit-making objectives; another, for mature-economy organizations with broader goals such as environmental and social responsibility; another, for new-economy companies with conventional objectives; and the fourth, for new-economy organizations with environmental and social goals.

“I’ve spent all my life here,” he says, pointing to the first square. “I’d like to do more in this domain,” he adds, pointing to the last square.

For Hau Lee, that would be like coming full circle from when he first saw the world from aboard ship.