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:
- Regional warehouse.
- Module manufacturer.
- Parts manufacturer.
- 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:
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.
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.
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.
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.
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.
- 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.
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