What is the Bullwhip Effect in Supply Chains?

The bullwhip effect refers to a supply chain phenomenon where small changes in demand at the retail end of the supply chain become amplified when moving up the supply chain from the retail end to the manufacturing end. This thus involves progressively larger fluctuations in demand at the wholesale, distributor, manufacturer, and raw material supplier levels.

This effect is named after the physics involved in cracking a whip. When a person who is holding the whip snaps their wrist, the relatively small movement causes the whip’s wave patterns to increasingly amplify in a chain reaction. In some industries, this effect is also known as the “whiplash” or the “whipsaw” effect.

The reason why this phenomenon takes place is that in supply chain management, the customers, manufacturers, suppliers, and salespeople, all have only a partial understanding of demand. Additionally, they all have direct control over only part of the supply chain.

However, all of them influence the entire supply chain with their forecasting inaccuracies - which leads to either over-ordering or under-ordering. This thus means that a change in any link along the supply chain can have a huge impact on the rest of the supply chain.

Understanding the Bullwhip Effect

Now, the bullwhip effect takes place due to changes in demand from retailers up to the manufacturer level. This means that it happens when a retailer changes how much of a product he or she orders from the wholesaler based on a small change in real or predicted demand for that product.

The wholesaler does not have complete insight as to why the change in product quantity took place, which will lead to them increasing their orders from the manufacturer to an even larger extent.

This is followed by the manufacturer, having even lesser insights and information behind this change in order quantity, to change its production by a larger amount so as to be prepared for the upcoming times.

However, what happens between this all is that the retailer uses immediate sales data to anticipate a strong increase in demand for a product, which then passes as a request for an additional product from its distributor. Now, while this is not the bullwhip effect, this process is generally distorted by the bullwhip effect in either of these two ways:

When the original order change by retailers is due to an inaccurate demand forecast. In this case, the size of this error tends to grow as it progresses further up the supply chain to the manufacturer.
When the retailer has the correct information about demand, but it leads to incorrect conclusions about the information, i.e, the reason and details of the retailer’s order change are lost. This leads to incorrect assessments by wholesalers, an error that is amplified further up the supply chain.

The bullwhip effect is very dangerous as it amplifies the inefficiencies in your supply chain at each of its steps, leading to more and more inaccurate estimates of demand. This leads to:

Excessive investment in inventory
Increases in expenses
Negative impact on your company’s cash flow and gross profit
Increase in the cost of goods sold
Decrease in returns on investment
Loss of revenue
A decline in customer service and customer loyalty
Delayed schedules
Failure in retaining top talents
and sometimes even layoffs and bankruptcies

Example of the Bullwhip Effect

For example, a retailer is selling hot cocoa and typically sells 100 cups a day in the winter. However, on a particularly cold day in that area, he sells 120 cups instead. This immediate increase in sales is mistaken for a broader trend when the retailer requests for ingredients for 150 cups from the distributor.

This leads to the distributor expanding its purchase order with the manufacturer in anticipation of increased requests from other retailers as well. In turn, the manufacturer increases its manufacturing run in anticipation of greater product requests in the future.

As is evident, in each of the stages above, the demand forecasts have been increasingly distorted. In fact, the level of distortion is so high that when the retailer sees a return to normal hot cocoa sales when the weather normalizes, he or she will find himself or herself with more inventory than needed. The distributor and manufacturer will have even more excess inventory and in larger quantities.

This will lead to lesser gross profits, an increasing ratio of accounts payable over accounts receivable, and slower sales velocity. Additionally, it will also end up putting pressure on their working capital, which will affect the overall profitability and productivity of their business.

The whole reason behind the bullwhip effect is the lack of information. One of the reasons behind this is that larger logistics operations at the wholesale level take longer to change. This means that the conditions that caused a change in demand at the retail level may have passed by the time the wholesaler starts reacting to it.

Considering that changing the manufacturing output takes even longer, and information from retailers is even more delayed in getting to manufacturers, there is an increased difficulty in reacting correctly to changes in demand.

In fact, even if the retailer being discussed here had assessed his or her demand accurately, the bullwhip effect can still occur. This is because the distributor might not be aware fully of the local conditions and buyer persona trends.

This might lead him or her to assume that the current demand is a reflection of a broad increase in demand for hot cocoa, rather than due to the specific favorable conditions for that retailer.

A manufacturer, who would be even more removed from the situation, would be even less likely to understand and correctly react to the change in demand. This would lead to the manufacturer being stuck with a significant surplus of products.

This can lead to disruptions to the supply chain and even to the business of the manufacturer. Some of these disruptions can be, but are not limited to:

Increased costs associated with storage, transportation, spoilage
Losses of revenue
Delays to shipments

And so on.

In fact, the retailer, as well as the manufacturer, might face similar problems as well.

What Does a Bullwhip Effect Indicate?

A bullwhip effect indicates that a small error in assessing consumer demand has been amplified through a supply chain. It also indicates that there is imperfect communication between all the firms of the supply chain, which has led them in missing vital information.

How Do You Identify a Bullwhip Effect?

It is challenging to identify the bullwhip effect in real-time, partly because it has arisen due to a lack of communication throughout the supply chain. This means that quite frequently, this phenomenon is observed after a certain period of time, mostly when the inefficiencies have already been created.

Causes of the Bullwhip Effect

It is crucial for your company to forecast customer demand based on sufficient information so that you are able to accurately predict what your customers will want while accounting for the complex factors that enable that amount to be delivered correctly and on time. These insights will help you with resource capacity planning as well as safety stock calculations.

What is unavoidable are the varying types of fluctuations and disruptions that you might see at every stage of your supply chain. These will in turn affect the supplier orders. Additionally, changes in customer demand will directly influence all the other factors along the chain, including inventory.

Forecasting demand has always been challenging and considering the complexities of today’s global supply chains, and increasing consumer preference for omnichannel and eCommerce, this challenge has intensified further.

However, the bullwhip effect is one that can occur even in relatively stable markets, where the demand is essentially constant. A few of the most common dependencies that can cause a bullwhip effect are:

Supply Chain Complexity

With each passing day, global supply chains are not only becoming increasingly complex but also more dynamic. Additionally, consumer preferences and demands are constantly changing, orders have become more varied, and there is a wide availability of detailed data.

This has led to not only complex supply chains with a vast number of options but also highly competitive supply chains. Today, supply chains tend to involve more parties and more touchpoints, and therefore have many spots for the bullwhip effect to take place.

Consumer Expectations

Consumers these days have become more specific and used to getting things in the manner that they prefer. In a world where everything is possible, catering to consumers has become vital because only then will you be able to encourage returning customers, and improve your customer retention, while being able to stand apart from the competition.

Often, meeting consumer demands involves more options like in-store pickups and direct-from-vendor shipments. These different requirements have led to an increase in pressure to have products on hand and caused the supply chain to branch off into more avenues. This has led to the possibility that while you are ensuring there is stock for each option, it leads to an overall overstocking.

Batched Orders

You might have participants in your supply chain who choose or prefer to round their orders up or down for simplicity or wait until a certain date or situation to order.

Hence, this does not necessarily mean that you are seeing an accurate reflection of demand.

Changing your operations based on it can thus lead to you disrupting your operating expenses and operating income.

Price Fluctuations

One of the most prominent determinants of demand is price and price fluctuations. Hence, sales, discounts, and other offers affect typical demands.

This might end up leading to inaccurate forecasts as buyers attempt to reconcile these sales with their usual forecasting measures, without taking other such factors into account.

This inaccuracy might end up affecting your as well as their financial statements and financial KPIs’ health.

Ration Gaming

When upstream inventory becomes scarce, ration gaming takes place. This involves your retailers and suppliers ordering larger quantities from you so that they can build up their own stock to ensure they meet their customers’ demands.

In this process, they often end up hurting the entire supply chain. In fact, one of the studies found out that ration gaming increased the bullwhip effect by 6% to 19%.

Long Lead Times

Long lead times lead to a bullwhip effect in the supply chains because if the replenishment product does not reach your seller for a long time, then it will not line up with the demand, and hence not help your seller meet their customers’ needs. This in turn will lead to lesser net profits and reduced customer satisfaction.

How Does the Bullwhip Effect Impact the Supply Chain?

The bullwhip effect will have a significant impact on your supply chain. This includes but is not limited to:

Storage Costs

Considering that inventory management consists of paying for physical storage space, the cost of overstock isn’t cheap. Adding on to these costs is the oftentimes unavoidable inefficiency of storing items that may not be in high demand anymore.

Additionally, there can be a steep cost of transporting and selling the items if you have to discount your products to convince people to purchase them. Considering all these factors, the bullwhip effect makes your shipping and storage cost less predictable. This lack of predictability can negatively affect your company’s operating cash flow ratio.

Increased Labor

The bullwhip effect will require more labor, thus adding up on your labor costs and consequently operating costs. This is because you will need to pay your employees to handle, sort, and sell the additional on-hand items.

Similarly, if your seller/s runs out of stock, then they might require their salespeople to work harder to locate alternatives or arrange for deliveries later. This too would add to labor demands.

Unmet Customer Expectations

The bullwhip effect might lead you to run out of your products which can lead to negative brand awareness and reputation. This in turn affects your customer retention as well as profits.

This is because whether you are trying to meet the demands of consumers or of your other supply chain members, if you are unable to provide products, then you will upset them. Also, being unable to fulfill their demands will make you look less reliable, and might even lead them to look for new brands or partners.

This will affect your business metrics as well as operational metrics. The overall performance and profitability of your company will get negatively impacted as well.

Waste

Depending on your product range, keeping excessive inventory can also lead to costly waste. For example, if you are dealing in consumable goods like food and beverages or pharmaceuticals, then you might end up facing a situation where your products expire before you can sell them.

Another probable situation that might lead to costly waste is where your products need to be withdrawn from sale, or they need to be replaced by newer versions, due to changes in trends and consumer preferences.

These situations can lead to a reduction in the value of your products, an increase in the number of resources required to sell them, or an increase in your loss or costs incurred in throwing away the item.

How to Control the Bullwhip Effect?

One of the ways of ensuring that you have a predictable and profitable supply chain management is by keeping your bullwhip effect to a minimum. While the bullwhip effect does have a range of influences, it has several solutions as well. Some of the tips that will help you control the bullwhip effect in your supply chain are:

Increase Transparency Between Suppliers and Customers

One of the reasons that lead to an increase in the bullwhip effect is that your supply chain members do not have a full picture of why buyers are increasing their demand. To be able to see and understand this context of changes in demand, it is important to improve visibility in your supply chain.

Increased visibility of your supply chain will help you answer crucial questions like - is the increase in orders because of a discount? Seasonal needs? Or due to some other reason? Once your members have gotten their answers as to what is causing changes in demand, they will be able to address the bullwhip before it gets out of hand.

Some of the tools that will help you in increasing transparency between suppliers and customers are:

Electronic Data Interchange (EDI) - Implementation of EDI will provide you with a real-time avenue for exchanging business documents with partners, including customers, suppliers, carriers, and third-party logistics (3PL) providers.

With the use of EDI systems, you will be able to automate your business processes, while also being able to streamline a wide range of tasks like ordering, sending shipping notices, and invoicing.

An EDI system will replace and standardize any of your manual processes like email, physical mail, and fax. Due to this, EDI will end up speeding up your communication, while also increasing visibility, and improving relationships with your partners. This will lead to higher gross profits, and better performing profit and loss statements for your company.

Vendor Managed Inventory (VMI) - The advantage of implementing VMI programs is that it will let suppliers receive real-time sales and forecast data from their downstream partners. This information is combined with pre-determined settings like minimum or maximum shelf presence. Then the data is processed through a machine-learning algorithm to create replenishment recommendations.

With the use of VMI, suppliers no longer need to wait for retailers or distributors to run low or run out before reordering. The insights gathered from VIMs will help suppliers determine the efficient reorder point of inventory, after also considering safety stock. This will ensure that they are able to plan for a new shipment at the right time, such that stockouts as well as overstocking, both are minimized.

Internet of Things (IoT) - In supply chain management, IoT is a booming area. IoT involves sensors that are connected to your system, thereby providing you with real-time information about stock counts and product locations. This will impart greater transparency to your company, and therefore for your partners throughout the supply chain too.

Additionally, this transparency also comes with other predictive benefits such as identifying disruptions and maintenance requirements that could affect your stock or operations quality. This will help you in improving your relevant key performance indicators.

Supplier Enablement Portals - These portals let suppliers and buyers communicate in efficient, standardized ways even without the use of EDI. Additionally, these portals allow easy integration with EDI solutions, as well as web EDI interfaces. This ensures that those who use and do not use those solutions are able to work harmoniously with each other’s systems.

Start Predicting

The key to understanding demand changes better is smart predictions. Smart predictions are made possible by the wide range of intelligent inventory software on the market that will let you collect data on every business element.

The software then turns this data into valuable, actionable insights that will help you avoid or at least control the bullwhip effect in your supply chain.

To interpret the historical trends, and current events, and generate forecasts of future trends, advanced algorithms and calculations are used during predictive analysis.

While these programs can range from simple to complex, and they may be using artificial intelligence (AI) the shared thing between them is that they all rely on high-quality data.

In fact, predictive analytics can also help you improve your demand forecasts by pulling in more information. With predictive tools, you would get efficient help in determining ideal inventory levels and shipping methods, which in turn will help control your business expenses, and increase your profitability.

What you need to keep in mind is that if you combine predictive analytics tools like VMI with IoT devices, EDI, and other data collection tools you will be able to significantly improve your inventory management.

In fact, according to Gartner, over 50% of supply chain organizations will invest in AI and advanced analytics applications by 2024.

Encourage Collaboration Between Partners

In order to avoid feeling the bullwhip effect in your supply chain, it is essential that all its different members work together. This will facilitate sharing of information, which will allow different entities to collaborate and be able to see more of the supply chain than just the level that they control.

In fact, collaboration is especially important in increasingly globalized supply chains, where the products may cross borders, and go through several businesses. Additionally, real-time data as well as end-to-end visibility are key essentials to control the bullwhip effect.

For example, sending purchase orders and having a strategic collaboration will let you and your partners work to improve forecast accuracy, strengthen relationships, and even prevent disruptions before they occur. Additionally, aligning KPIs and other performance metrics will ensure that everyone is on the same page.

Foundation for this approach is the VMI as it puts the necessary information for working together in one place. This then leverages the EDI to have both, push inventory and pull inventory, as well as sharing of order data between partners.

All these efforts will lead to robust collaboration, which is one of the best defenses against the bullwhip effect.

Reduce Lead Times

One of the situations that can exacerbate the bullwhip effect is long lead times. This is because long lead times would lead to the products arriving far after they are needed, and therefore becoming overstock. Thus, one of the best ways to mitigate bullwhip issues is by reducing lead times across the board and placing orders when demand is high.

While the factors that affect the lead times will vary based on the needs of your business, some of the strategies to shorten the lead times include:

Using Trusted, Local Suppliers - This will help in minimizing lead times and therefore decreasing costs as the distance that the product is needed to travel will be reduced. While this option is not always viable, it is always possible to find reliable and speedy partners.
Investing in VMI - By investing in VMI, you will no longer have to wait for incoming orders, but rather be able to use real-time data to jumpstart replenishment. This will help you drastically reduce, or sometimes even in eliminating the time that the shelves stay empty.
Hiring a Logistics Manager - By having a team member who is dedicated to logistics, you will be able to improve the level of oversight and attention given to your inventory management. This will lead to a reduction in your lead times, while also helping with other elements of the bullwhip effect.
Reevaluating your Shipping Methods - If one of the problems that you are facing is long lead times or inconsistent deliveries, then you should check other shipping options.

For example, if one of your partners is shipping overseas via boat but also offers air shipping, then you should check if this option can work for you or not. One of the determinants in such a situation can be whether or not the additional costs are being outweighed by the benefits of a more predictable inventory.

Automating Manufacturing - With the use of automated equipment and software that will help you have more efficient processes, you may be able to offer faster lead times on your manufacturing side.

It is important that your lead times are not only short but also accurate. This hence means that even if you cannot reduce your lead times much, being able to calculate them correctly will help you ensure better order fulfillment and reduce customer disappointment. This in turn will encourage returning customers with higher sales velocity.

Minimize or Address Price Fluctuations

One of the ways you might be disrupting your typical buying patterns and therefore having trouble predicting demand is by frequently running discounts or promotions.

It is thus essential that you evaluate your stance on these promotions and assess whether they are causing more interruptions than benefits.

While you might not have to get rid of them entirely, you might benefit more from minimizing them or by incorporating them more accurately into your predictions and forecasts.

FAQs About the Bullwhip Effect in Supply Chain

Who invented the bullwhip effect?

It is Jay Forrester who is credited with inventing the term “bullwhip effect''.” Forrester was a leading computer engineer and systems analyst who was well-known for his invention of magnetic core computer memory.

In 1956, he became a lecturer at MIT 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.

Why is the bullwhip effect bad?

The bullwhip effect is bad because small changes anywhere along the supply chain can lead to massive disparities at any stage. For instance, if a retailer experiences two or three times the demand from customers but does not order more products right away, then they are delaying backorders which will end up putting more pressure on the suppliers later.

Where does the bullwhip effect have its greatest impact?

While any stage of your supply chain can be impacted negatively through the bullwhip effect, its greatest impact tends to be on raw material suppliers. Raw goods providers supply materials to wholesalers and manufacturers, who are responsible for getting products to consumers, retailers, and distributors.

Thus, when there are fluctuations in demand at the consumer level, it reverberates up the supply chain, placing greater pressure on entities involved in the production and dissemination of goods. This thus may force a supplier to produce either a much lesser or greater amount of product, which complicates their workflow and delivery.

How to avoid the bullwhip effect?

To avoid the bullwhip effect, you have to:

Stabilize your prices
Stay away from multiple demand forecast updates
Break up order batches
Get rid of gaming in shortage situations

Why is safety stock involved in the bullwhip effect and in ways of minimizing it?

Safety stock refers to the reserve inventory that is used by businesses to accommodate immediate changes in customer orders. Safety stock enables businesses to meet unforeseen fluctuations in demand throughout their supply chain.

Thus, if there is a rapid increase in customer demand, then businesses can use the available safety stock to fill orders while managers increase their own orders to suppliers. This gives them time to increase their production without imposing on customer service.

While this additional stock does not solve the problem of the bullwhip effect, it does lessen its symptoms. This is because it is used as a safeguard for costly variables in supply chain management.

How can Deskera Help with the Bullwhip Effect in Supply Chain?

As a manufacturer or retailer, it is crucial that you stay on top of your manufacturing processes and resource management.

You must manage production cycles, resource allocations, safety stock, reorder points, and much more to achieve this.

Deskera MRP is the one tool that lets you do all of the above. With Deskera, you can:

Track raw materials and finished goods inventory
Manage production plans and routings
Maintain bill of materials
Optimize resource allocations
Generate detailed reports
Create custom dashboards

And a lot more.

It is also possible to export information and data on Deskera MRP from other systems. Additionally, Deskera MRP will give you analytics and insights to help you make decisions.

So go ahead and book a demo for Deskera MRP today!

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Key Takeaways

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

The causes of the bullwhip effect are:

Supply chain complexities
Consumer expectations
Batched orders
Price fluctuations
Ration gaming
Long lead times

The bullwhip effect impacts the supply chain on many levels, which in turn becomes costly for your company. While businesses work hard to forecast their demand in order to maintain a manageable and useful inventory, the bullwhip effect can lead businesses to have either a lack or an excess of inventory.

If you have excess inventory, and your consumer demand does not increase, then it can result in wasted resources. On the other hand, not having sufficient inventory can lead to poor customer relations due to unavailable products and unfulfilled orders. Thus, in either case, both of these mistakes can prove to be expensive for your company.

Some of the ways in which you can control the bullwhip effect are:

Increase transparency between suppliers and customers
Start having smart predictions
Encourage collaboration between partners
Reduce lead times
Minimize or address price fluctuations

Thus, considering that Deskera MRP will help you in carrying out all of these measures, it will be an asset for controlling the bullwhip effect in your supply chain.