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:
Customer.
Store.
Regional warehouse.
Assembly.
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:
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 inventorymanagement 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 inventorymanagement software and resisting the temptation to offer bulk discounts. An awareness that the effect exists is also crucial.
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.
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.
Distribution represents the set of tactics, deals, and strategies that enable a company to make a product and service easily reachable and reached by its potential customers. It also serves as the bridge between product and marketing to create a controlled journey of how potential customers perceive a product before buying it.
A distribution channel is the set of steps it takes for a product to get in the hands of the key customer or consumer. Distribution channels can be direct or indirect. Distribution can also be physical or digital, depending on the kind of business and industry.
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.
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.
By definition, a horizontal market is a wider market, serving various customer types, needs and bringing to market various product lines. Or a product that indeed can serve various buyers across different verticals. Take the case of Google, as a search engine that can serve various verticals and industries (education, publishing, e-commerce, travel, and much more).
A vertical or vertical market usually refers to a business that services a specific niche or group of people in a market. In short, a vertical market is smaller by definition, and it serves a group of customers/products that can be identified as part of the same group. A search engine like Google is a horizontal player, while a travel engine like Airbnb is a vertical player.
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.
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.
A market type is a way a given group of consumers and producers interact, based on the context determined by the readiness of consumers to understand the product, the complexity of the product; how big is the existing market and how much it can potentially expand in the future.
Psychosizing is a form of market analysis where the size of the market is guessed based on the targeted segments’ psychographics. In that respect, according to psychosizing analysis, we have five types of markets: microniches, niches, markets, vertical markets, and horizontal markets. Each will be shaped by the characteristics of the underlying main customer type.
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.
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 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.
As startups gain control of new markets. They expand in adjacent areas in disparate and different industries by coupling the new activities to benefits customers. Thus, even though the adjunct activities might see far from the core businessmodel, they are tied to the way customers experience the whole businessmodel.
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.
Dropshipping is a retail business model where the dropshipper externalizes the manufacturing and logistics and focuses only on distribution and customer acquisition. Therefore, the dropshipper collects final customers’ sales orders, sending them over to third-party suppliers, who ship directly to those customers. In this way, through dropshipping, it is possible to run a business without operational costs and logistics management.
Consumer-to-manufacturer (C2M) is a model connecting manufacturers with consumers. The model removes logistics, inventory, sales, distribution, and other intermediaries enabling consumers to buy higher quality products at lower prices. C2M is useful in any scenario where the manufacturer can react to proven, consolidated, consumer-driven niche demand.
Transloading is the process of moving freight from one form of transportation to another as a shipment moves down the supply chain. Transloading facilities are staged areas where freight is swapped from one mode of transportation to another. This may be indoors or outdoors, depending on the transportation modes involved. Deconsolidation and reconsolidation are two key concepts in transloading, where larger freight units are broken down into smaller pieces and vice versa. These processes attract fees that a company pays to maintain the smooth operation of its supply chain and avoid per diem fees.
Break bulk is a form of shipping where cargo is bundled into bales, boxes, drums, or crates that must be loaded individually. Common break bulk items include wool, steel, cement, construction equipment, vehicles, and any other item that is oversized. While container shipping became more popular in the 1960s, break bulk shipping remains and offers several benefits. It tends to be more affordable since bulky items do not need to be disassembled. What’s more, break bulk carriers can call in at more ports than container ships.
Cross-docking is a procedure where goods are transferred from inbound to outbound transport without a company handling or storing those goods. Cross-docking methods include continuous, consolidation, and de-consolidation. There are also two types of cross-docking according to whether the customer is known or unknown before goods are distributed. Cross-docking has obvious benefits for virtually any industry, but it is especially useful in food and beverage, retail and eCommerce, and chemicals.
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 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.
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 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.
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.
Jidoka was first used in 1896 by Sakichi Toyoda, who invented a textile loom that would stop automatically when it encountered a defective thread. Jidoka is a Japanese term used in lean manufacturing. The term describes a scenario where machines cease operating without human intervention when a problem or defect is discovered.
The andon system alerts managerial, maintenance, or other staff of a production process problem. The alert itself can be activated manually with a button or pull cord, but it can also be activated automatically by production equipment. Most Andon boards utilize three colored lights similar to a traffic signal: green (no errors), yellow or amber (problem identified, or quality check needed), and red (production stopped due to unidentified issue).
Gennaro is the creator of FourWeekMBA, which reached about four million business people, comprising C-level executives, investors, analysts, product managers, and aspiring digital entrepreneurs in 2022 alone | He is also Director of Sales for a high-tech scaleup in the AI Industry | In 2012, Gennaro earned an International MBA with emphasis on Corporate Finance and Business Strategy.
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.
Gennaro is the creator of FourWeekMBA, which reached about four million business people, comprising C-level executives, investors, analysts, product managers, and aspiring digital entrepreneurs in 2022 alone | He is also Director of Sales for a high-tech scaleup in the AI Industry | In 2012, Gennaro earned an International MBA with emphasis on Corporate Finance and Business Strategy.
