bullwhip-effect

The Bullwhip Effect And Why It Matters In Business

The bullwhip effect describes the increasing fluctuations in inventory in response to changing consumer demand as one moves up the supply chain. Observing, analyzing, and understanding how the bullwhip effect influences the whole supply chain can unlock important insights into various parts of it.

Understanding the bullwhip effect

To better understand the bullwhip effect, imagine a person with a long whip in his hand. As the whip is cracked, the parts closest to the handle do not move much. However, the parts further away from the handle move in an increasingly erratic fashion.

The same phenomenon can be observed in distribution channels. Here, the customer is the person holding the whip which moves according to demand. As we move away from the customer, the range of movement increases.

The average supply chain has seven inventory points between the customer and the supplier of raw materials. In order of increasing movement and volatility, the chain might look something like this:

  1. Customer.
  2. Store.
  3. Regional warehouse.
  4. Assembly.
  5. Module manufacturer.
  6. Parts manufacturer.
  7. Ingredient (raw material) manufacturer.

Each of these points endeavors to minimize out-of-stock situations and missed customer orders by keeping extra inventory. Manufacturers in particular experience high uncertainty and low inventory forecast accuracy. This causes them to stockpile inventory as a hedge against variability.

Common causes of the bullwhip effect

Some of the common causes of the bullwhip effect include:

  • Forecast errors. Each point in the supply chain makes a demand forecast based on adjacent links. Errors in forecasting can lead to miscalculations that are magnified as they move up the supply chain.
  • Lead time. This is defined as the time that elapses between when an order is placed and when it is received. A lack of due consideration for lead time can lead to excess inventory which in turn reduces supplier demand.
  • Sales and price discounts. Continual and periodic promotional cycles cause great fluctuations in distribution channel demand. During promotional periods, large amounts of stock move through the chain. Unfortunately, this is always followed by low product demand once the promotion is over.

Minimizing the bullwhip effect

Avoiding the bullwhip effect entirely is unrealistic, but there are several approaches to mitigating or controlling it.

They include:

  • Optimizing inventory management – businesses can decrease the bullwhip effect by using appropriate inventory management software.
  • Maintain smaller, more consistent order sizes – multiple points in the supply chain offer bulk discounts to their customers. This inflating of inventory levels through artificial demand can have serious ramifications for the other players in the chain.
  • Awareness – the reality is that many businesses are ignorant of the bullwhip effect and do not understand the implications of high buffer inventories on demand. Recognition by supply chain managers that a problem exists is an important first step.

Key takeaways:

  • The bullwhip effect occurs in a supply chain when orders sent to manufacturers or suppliers create larger variance than the sales to the end customer.
  • The bullwhip effect is commonly caused by failing to consider product lead times. It is also exacerbated by forecast errors and promotional cycles.
  • The bullwhip effect cannot be entirely avoided. However, businesses can mitigate its effects by using inventory management software and resisting the temptation to offer bulk discounts. An awareness that the effect exists is also crucial.

Read Also: Vertical Integration, Horizontal Integration, Supply Chain, Backward Chaining, Horizontal Market.

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Published by

Gennaro Cuofano

Gennaro is the creator of FourWeekMBA which reached over a million business students, executives, and aspiring entrepreneurs in 2020 alone | He is also Head of Business Development for a high-tech startup, which he helped grow at double-digit rate | Gennaro earned an International MBA with emphasis on Corporate Finance and Business Strategy | Visit The FourWeekMBA BizSchool | Or Get The FourWeekMBA Flagship Book "100+ Business Models"

Bullwhip effect

The bullwhip effect (or whiplash effect) is an observed phenomenon in forecast-driven distribution channels. It refers to a trend of larger and larger swings in inventory in response to changes in demand, as one looks at firms further back in the supply chain for a product. The concept first appeared in Jay Forrester’s Industrial Dynamics (1961) and thus it is also known as the Forrester effect.

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Published by

Gennaro Cuofano

Gennaro is the creator of FourWeekMBA which reached over a million business students, executives, and aspiring entrepreneurs in 2020 alone | He is also Head of Business Development for a high-tech startup, which he helped grow at double-digit rate | Gennaro earned an International MBA with emphasis on Corporate Finance and Business Strategy | Visit The FourWeekMBA BizSchool | Or Get The FourWeekMBA Flagship Book "100+ Business Models"

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