Breaking down the bullwhip effect in supply chains

Do you have an interest in global supply chains? You may work in the supply chain logistics space or run a wholesale or retail business that relies on supply chains. Whatever the case, it pays to be across all the aspects of supply chains, including the bullwhip effect.

If you haven't heard this term before, don't stress. We'll demystify it in this helpful article, where we're going to be breaking down the bullwhip effect in supply chains. Read on to learn more.

What is the bullwhip effect?

The bullwhip effect refers to a situation where small changes in demand at the retail end of the supply chain become amplified when moving up through the chain from the retail end to the manufacturing end.

If you didn't know, most supply chains start with manufacturing, move to wholesale distribution, and then to retail stores, either online or brick-and-mortar. 

The bullwhip effect happens when a retailer changes the quantity of a good it orders from wholesale distributors based on a small change in real or predicted demand for that particular good.

Due to not having the full information picture on the demand shift, the wholesaler chooses to increase its orders from the manufacturer to a large extent, and the manufacturer, who is even further removed from retail sales, will change its production by a still larger amount to meet the perceived increase in demand. 

The term bullwhip comes from a scientific concept where the movements of a whip become the same amount of amplification from the origin (the hand that is cracking the whip) to the endpoint (the tail end of the whip).

What does the bullwhip effect look like?

The bullwhip effect often occurs when retail business owners become highly reactive to demand without being correct; they then amplify expectations around the demand, which causes this domino effect along the supply chain that looks like a bullwhip if presented graphically. 

Let's give an example - an alcohol retailer may typically retain 100 six-packs of one beer brand in stock in their store.

If it normally sells ten six-packs per day, it will order that replacement amount from the distributor to keep stock levels to meet demand.

But one day, the bottle shop sells 60 six-packs of the beer and assumes customers will start buying more products, incorrectly guessing the demand for the goods.

They react by ordering 100 six-packs, or an equivalent amount of slabs of beer, to meet this higher forecasted demand.

The distributor receiving the order might then also incorrectly assume the demand and respond by ordering double, or 200 units, from the manufacturer to ensure they don't run out of stock and can meet the retailer's demand.

The manufacturer then produces even more slabs of beer to err on the safe side. At the end of this scenario, the perception of increased demand has amplified the supply chain from 100 units at the customer level to 250 units at the manufacturer.

While this example is quite simplified, it still explains the idea of exponentially increasing incorrect demand predictions as actions and reactions at all three levels continue across the supply chain.

Conversely, the bullwhip effect occurs because of the perception of lower demand at the customer level, which can cause shortages when demand is predicted inaccurately, and this ripples back up the supply chain. 

How to identify the bullwhip effect

Businesses - retail, wholesale and manufacturers - can potentially identify the bullwhip effect by using sales and order data to analyse order patterns.

They can also use inventory data and lead time variance across different supply chain stages to figure out where and how demand variation is amplified in the supply chain.

This typically means employing business analysts, which might be out of reach for retailers unless they are big players but should be possible for most wholesale distributors and manufacturing companies. 

Causes of the bullwhip effect

One major reason the bullwhip effect occurs is that companies have to forecast consumer demand based on insufficient or incomplete demand information and then try to figure out how much product consumers will actually want.

At the same time, they need to account for the complex factors that enable that amount to be delivered correctly and on time.

For instance, the global shipping industry can have major disruptions due to pirates, industrial action and shipping container shortages.

At every stage of the supply chain, there are various possible fluctuations and disruptions, which influence all the wholesaler distributor supplier orders.

Its implications on supply chain management

The bullwhip effect has caused disruptions in supply chains throughout history and can be expensive for all the businesses in the supply chain.

 Holding too much inventory can result in waste, especially for perishable goods, while having too little inventory can lead to reduced lead time, poor customer experience due to out-of-stock items, and lost sales.

Some key issues caused by the bullwhip effect can include excessive inventory, increased storage costs, customer disappointment and dissatisfaction, and increased labour costs. 

How to reduce the bullwhip effect

There are several methods that businesses in the supply chain can utilise to reduce the bullwhip effect.

One of these methods is to use forecasting and visibility tools to see what's happening along the supply chain accurately; this method includes using analytics tools, so organisations will need qualified professionals with a Graduate Certificate in Business Analytics or similar who can do this.

Another method is to foster communication and collaboration across the supply chain, where demand is communicated effectively and accurately. Data analysis can assist with this, such as predictive analysis. 

You could also adopt a demand-driven approach to supply chain management, which uses coordinated technology and processes to gain insight into supply chain demand occurrences and react to them in real-time.

Finally, enhanced transparency between all players in the supply chain can reduce the bullwhip effect.

This is achieved by improving the accuracy of information movement across different supply chain providers.

Transparency will provide clear visibility into demand and inventory levels and data, therefore helping to prevent overproduction, excess inventory storage, and low or no stock levels. 

Sorting out your supply chain

This helpful article has broken down the bullwhip effect in supply chains and shared all about this phenomenon, its implications, and how businesses across the supply chain can work together to reduce it resulting in better business outcomes for retailers, wholesalers, and manufacturers.