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.

Bullwhip effect examples

To illustrate the bullwhip effect, we will discuss one hypothetical and one real-world example below.

Bread company

Suppose you own a bakery that sells 2,000 loaves of bread to a supermarket each week.

One week, however, the supermarket places an order for 4,000 loaves of bread.

In response, you conclude that demand is increasing and order double the amount of flour you normally would from the supplier.

Sensing that other bakeries may be in the same position, the supplier also increases the amount of flour they purchase from the flour mill.

As one moves up the supply chain, it is clear that the potential for flour to flood the market is amplified.

Conversely, now consider the same scenario where there is too little flour in the market.

For the sake of this article, assume that you didn’t purchase more flour in response to rising demand from supermarkets or, by extension, consumers.

A clear and immediate problem would develop where the bread company could not meet demand.

In an attempt to compensate, you would then place a more substantial order from the flour supplier who is also unable to meet demand.

In this case, an error in forecasting how many loaves of bread may be sold is also amplified as one moves up the supply chain.

In the worst-case scenario, the flour supply may not normalize until the following year’s wheat harvest.

COVID-19 and the bullwhip effect

In response to news of COVID-19 lockdowns, consumers flooded supermarkets and stockpiled essential items such as toilet paper and antibacterial soap.

Supply chains attempted to boost production due to the unprecedented demand, but as retailers panicked and placed larger orders, the effect on wholesalers, distributors, and suppliers was even more substantial.

In Australia, for example, toilet paper manufacturer Kimberly-Clark moved to 24/7 production in an attempt to meet demand.

While production increases have been effective to some extent, the bullwhip effect caused excess inventory across the entire supply chain.

This is because actual consumption remained more or less the same despite the substantial increase in demand.

When the world started to emerge from the pandemic in 2022, demand for many consumer packaged goods (CPGs) started to decrease.

According to Hitendra Chaturvedi of the W.P. Carey School of Business at Arizona State University, decreased demand for certain products led to a situation “where panic demand caused the system to churn more stock which has no buyer.

The pandemic-induced bullwhip effect has exposed severe vulnerabilities within global supply chains.

To avoid the cost associated with holding excess inventory in the future, digitization of the supply chain is key.

One of the most important initiatives is the centralization of information so that every member of the supply chain has access to accurate, real-time data during periods of market volatility. 

In fact, some companies are already using cloud-based logistics and enhanced warehouse management to access tracking, reporting, and rerouting features in a single platform.

Key takeaways:

  • The bullwhip effect occurs in a supply chain when orders sent to manufacturers or suppliers create a 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.

Connected Business Concepts

Vertical Integration

vertical-integration
In business, vertical integration means a whole supply chain of the company is controlled and owned by the organization. Thus, making it possible to control each step through customers. in the digital world, vertical integration happens when a company can control the primary access points to acquire data from consumers.

Backward Chaining

backward-chaining
Backward chaining, also called backward integration, describes a process where a company expands to fulfill roles previously held by other businesses further up the supply chain. It is a form of vertical integration where a company owns or controls its suppliers, distributors, or retail locations.

Supply Chain

supply-chain
The supply chain is the set of steps between the sourcing, manufacturing, distribution of a product up to the steps it takes to reach the final customer. It’s the set of step it takes to bring a product from raw material (for physical products) to final customers and how companies manage those processes.

Data Supply Chains

data-supply-chain
A classic supply chain moves from upstream to downstream, where the raw material is transformed into products, moved through logistics and distribution to final customers. A data supply chain moves in the opposite direction. The raw data is “sourced” from the customer/user. As it moves downstream, it gets processed and refined by proprietary algorithms and stored in data centers.

Horizontal vs. Vertical Integration

horizontal-vs-vertical-integration
Horizontal integration refers to the process of increasing market shares or expanding by integrating at the same level of the supply chain, and within the same industry. Vertical integration happens when a company takes control of more parts of the supply chain, thus covering more parts of it.

Decoupling

decoupling
According to the book, Unlocking The Value Chain, Harvard professor Thales Teixeira identified three waves of disruption (unbundling, disintermediation, and decoupling). Decoupling is the third wave (2006-still ongoing) where companies break apart the customer value chain to deliver part of the value, without bearing the costs to sustain the whole value chain.

Entry Strategies

entry-strategies-startups
When entering the market, as a startup you can use different approaches. Some of them can be based on the product, distribution, or value. A product approach takes existing alternatives and it offers only the most valuable part of that product. A distribution approach cuts out intermediaries from the market. A value approach offers only the most valuable part of the experience.

Disintermediation

disintermediation
Disintermediation is the process in which intermediaries are removed from the supply chain, so that the middlemen who get cut out, make the market overall more accessible and transparent to the final customers. Therefore, in theory, the supply chain gets more efficient and, all in all, can produce products that customers want.

Reintermediation

reintermediation
Reintermediation consists in the process of introducing again an intermediary that had previously been cut out from the supply chain. Or perhaps by creating a new intermediary that once didn’t exist. Usually, as a market is redefined, old players get cut out, and new players within the supply chain are born as a result.

Scientific Management

scientific-management
Scientific Management Theory was created by Frederick Winslow Taylor in 1911 as a means of encouraging industrial companies to switch to mass production. With a background in mechanical engineering, he applied engineering principles to workplace productivity on the factory floor. Scientific Management Theory seeks to find the most efficient way of performing a job in the workplace.

Poka-Yoke

poka-yoke
Poka-yoke is a Japanese quality control technique developed by former Toyota engineer Shigeo Shingo. Translated as “mistake-proofing”, poka-yoke aims to prevent defects in the manufacturing process that are the result of human error. Poka-yoke is a lean manufacturing technique that ensures that the right conditions exist before a step in the process is executed. This makes it a preventative form of quality control since errors are detected and then rectified before they occur.

Gemba Walk

gemba-walk
A Gemba Walk is a fundamental component of lean management. It describes the personal observation of work to learn more about it. Gemba is a Japanese word that loosely translates as “the real place”, or in business, “the place where value is created”. The Gemba Walk as a concept was created by Taiichi Ohno, the father of the Toyota Production System of lean manufacturing. Ohno wanted to encourage management executives to leave their offices and see where the real work happened. This, he hoped, would build relationships between employees with vastly different skillsets and build trust.

Dual Track Agile

dual-track-agile
Product discovery is a critical part of agile methodologies, as its aim is to ensure that products customers love are built. Product discovery involves learning through a raft of methods, including design thinking, lean start-up, and A/B testing to name a few. Dual Track Agile is an agile methodology containing two separate tracks: the “discovery” track and the “delivery” track.

Scaled Agile

scaled-agile-lean-development
Scaled Agile Lean Development (ScALeD) helps businesses discover a balanced approach to agile transition and scaling questions. The ScALed approach helps businesses successfully respond to change. Inspired by a combination of lean and agile values, ScALed is practitioner-based and can be completed through various agile frameworks and practices.

Kanban Framework

kanban
Kanban is a lean manufacturing framework first developed by Toyota in the late 1940s. The Kanban framework is a means of visualizing work as it moves through identifying potential bottlenecks. It does that through a process called just-in-time (JIT) manufacturing to optimize engineering processes, speed up manufacturing products, and improve the go-to-market strategy.

Toyota Production System

toyota-production-system
The Toyota Production System (TPS) is an early form of lean manufacturing created by auto-manufacturer Toyota. Created by the Toyota Motor Corporation in the 1940s and 50s, the Toyota Production System seeks to manufacture vehicles ordered by customers most quickly and efficiently possible.

Six Sigma

six-sigma
Six Sigma is a data-driven approach and methodology for eliminating errors or defects in a product, service, or process. Six Sigma was developed by Motorola as a management approach based on quality fundamentals in the early 1980s. A decade later, it was popularized by General Electric who estimated that the methodology saved them $12 billion in the first five years of operation.

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

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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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