The bullwhip effect describes how small fluctuations in demand at the retail level can cause more significant volatility. We explore this phenomenon in your supply chain.
The bullwhip effect is a supply chain phenomenon that describes how small fluctuations in demand from the retailer can cause progressively larger fluctuations in demand at the wholesale, distributor, manufacturer, and raw material supplier levels.
According to Supply & Demand Chain Executive, a business technology magazine for supply chain executives, “The demand shocks created by COVID-19 have caused extreme bullwhip effects, resulting in an unpredictable and unstable manufacturing environment where suppliers struggle to intelligently predict demand as a result of panicked buyer behavior.”
No matter what industry you’re in, the bullwhip effect will occur at one stage or another, because consumer demand will always be unpredictable, so it’s essential to plan and forecast accurately to avoid stock-outs or excess stock.
In this article, we explore:
What is the bullwhip effect?
Bluecart, the leader in hospitality technology, says, “Jay Forrester is credited as the person who invented the term “bullwhip effect.” Forrester was a leading American computer engineer and systems analyst who was well-known for his invention of magnetic core computer memory. He became an MIT lecturer in 1-6 and began presenting his concepts on supply chain management in 1961. Forrester started calling supply chain demand fluctuations the bullwhip effect and has been credited with it ever since.”
The bullwhip effect occurs when demand changes at the retail level lead to larger inventory fluctuations at the wholesale, manufacturer, distributor, and supplier levels.
A prime and often used example is the car manufacturer, Volvo, when they found themselves with surplus green cars in their inventory. They ran a special offer to get them off the dealers’ floors, and the green cars started selling. Unaware of the sales promotion, manufacturing saw an increase in sales and ramped up production for more green cars. As a result, Volvo was left with a large inventory of unsold green vehicles at the end of the year.
These supply chain fluctuations start small at the retail level and amplify further up the supply chain. When cracking a bullwhip, the whip’s handle moves 60 degrees, yet the tip of the whip moves at 360-degrees, so the term bullwhip effect is appropriate. The impact at the retail level is low and escalates further up the supply chain, with the manufacturer suffering the most. The bullwhip effect refers to the fluctuating swings in response to the customer’s demands, which has a cascading impact on the supply chain.
What are the causes of the bullwhip effect?
Each area of the supply chain has its forecasts adjusted accordingly to cover the increase in demand from customers. Retailers and distributors adjust their forecasts to plan for contingencies and to take advantage of bulk buying prices. Manufacturers don’t have the insight available to see customer sales information at the retail level to make informed production forecasting decisions.
There are some typical causes of the bullwhip effect in the supply chain. These include, but are not limited to:
- Price fluctuations: Price fluctuations can occur in the holiday and festival periods when the retailer offers discounts or promotions. These discounts influence the buyer’s journey and patterns, and an increase in demand may occur.
- Order batches: The retailer places orders with their supplier once per month, which causes inconsistent demand for suppliers over time. A tip here is to place frequent, smaller orders rather than placing a large order at once, so distortion in the supply chain doesn’t occur.
- Incorrect demand forecasting: Demand forecasting is a complicated process, so having full visibility of your inventory and setting and refining your inventory KPIs can avoid errors and inaccurate demand forecasts over time.
- Free return policies: Many companies have a free return policy in place. This causes suppliers to overstate demand due to shortages, order more items, and later return them to the manufacturer “free-of-charge.” This is a continuous cycle that disrupts the supply chain.
- Extended lead times: Lead time is the period of time from when an order is placed and when it is received. If lead time is not taken into account, excess stock may occur, resulting in supplier demand changes.
- Poor communication between role players in the supply chain: Many role players (manufacturers, suppliers, retailers, customers) are associated with the supply chain. The supply chain can’t function properly if there is poor or no communication across the supply chain. Proper communication between stakeholders and suppliers means increased productivity, meeting customer demand and expectations and accurate forecasting across the supply chain.
The impact of the bullwhip effect on the supply chain
The bullwhip effect impacts the supply chain on many levels as the businesses impacted incur more costs.
Ohio University believes, “Depending on the product, an excess of inventory could prove costly to the company, and if consumer demand does not increase it could result in wasted resources. On the other hand, not having sufficient inventory can lead to poor customer relations due to unfulfilled orders and unavailable products. Overall these mistakes could be expensive for businesses.”
Let’s examine how certain industries have been affected by the impact of the bullwhip effect.
Automotive and car parts: We are facing an issue with our worldwide lack of supplies and semiconductors. There’s a high demand for vehicles, but only a few can be produced.
“These supply chain issues may not be shutting down production lines but they are likely to hit the bottom line of many manufacturers with significant price increases. That is leading to a serious rethinking of many current supply chains. OEMs are already making more use of control towers, asset tracking and other data, as well as digital tools to improve visibility of the supply chain. However, manufacturers are also looking at changes in sourcing, including having additional supply options, or new alternatives altogether,” says Automotive Logistics, a news, insights, and supplier directory.
Retail: Let’s think about toilet paper. The household staple disappeared from the shelves at the beginning of the COVID-19 pandemic in 2020 causing shortages across a range of household goods.
The Wall Street Journal states, “The household staple was a “canary in the coal mine” of sorts in the early days of the pandemic, disappearing from stores and serving as a harbinger of shortages across a range of goods. As a rush on store shelves took hold, toilet paper makers converted supply-chain capacity from away-from-home product lines (used in schools, hotels, workplaces, restaurants and so on) to home-use products to meet heightened demand, only to find purchasing of products tailored for home use waning as the industrial-use market recovered.”
Pharmaceutical: Currently, the UK is experiencing a shortage of manufacturing ingredients for the COVID-19 vaccine due to the rise in demand for the AstraZeneca vaccination. Suppliers are struggling to keep up with demand and experience stock-outs.
The Conversation believes, “The most important things now are to focus on sticking to the plan, ensuring vaccine delivery occurs rapidly when the frequency of supply can be assured again and , most importantly , shifting to a more agile supply chain mindset. That means governments and pharmaceutical companies need to work together in order to meet demand and supply as it changes, putting measures in place to assure a steady supply of vaccines in order to alleviate any concerns.”
Shipping: Shippers are ordering more shipping vessels to protect against delayed orders and extended lead times to avoid stock-outs.
The Handy Shipping Guide believes, “This is a truly breath-taking development. We’ve seen a combination of high demand, under capacity and supply chain disruption (in part down to Covid and port congestion) driving rates ever higher this year, but nobody could have anticipated a hike of this magnitude. The industry is in overdrive. Reports suggest that more than 300 vessels have already been ordered this year to try and redress the balance. However, these obviously won’t come on line for some time, so it’s difficult to see, unless something radical transpires, any relief on the immediate horizon for the shipper community.”
Strategies to mitigate the bullwhip effect
There is no secret recipe to keep the bullwhip effect in check, but there are some strategies your business can follow to mitigate the effects of the bullwhip. It’s essential to have the right tools in place to give you overall visibility of your inventory and keep the bullwhip effect from further disrupting the supply chain.
One of the many solutions for manufacturers to consider is implementing a vendor-managed inventory system in the supply chain. Manufacturers will have full visibility and control, and with the advent of IoT, it is even easier to automate and track inventory levels in-store using Radio Frequency Identification (RFID) technology. Tagging items with RFID tags allows users to automatically and uniquely identify and track inventory and assets. Manufacturers will be able to assume the responsibility for maintaining inventory by having access to up-to-date information and can plan their purchase of raw materials and production schedules accordingly. By being closer to the source of the demand, manufacturers also ensure better communication throughout the supply chain.
10 Tips to mitigate the impact of the bullwhip effect in your supply chain:
- Accept and understand the bullwhip effect.
- Improve the inventory planning and policies process.
- Communicate better between teams and managers.
- Optimize the minimum order quantity (MOQ) and your inventory.
- Manage orders and returns, and adjust supplier and inventory policies.
- Build controls and consistency in the sales process.
- Audit, know and strengthen the relationships with your suppliers better.
- Onboard new suppliers as quickly as possible.
- Share and discuss the information about the actual demand and make sure all role-players understand it.
- Align your procurement and logistics teams.
With the technology solutions available today and the right communication strategies in place, there is no valid reason why your business should suffer the effects of the bullwhip phenomenon.
Having the ability to measure your supplier’s performance and having a forecast that can automatically adjust to high or low demands is essential! Netstock ensures full inventory visibility to help you make better decisions for your inventory.