What is the Bullwhip Effect in supply chain?
The Bullwhip Effect is a phenomenon in the supply chain and distribution channels in which forecasts reveal supply chain inefficiencies. This mostly occurs when retailers become highly reactive to consumer demand, and in turn, intensify expectations around it, causing a domino effect along the chain.
The bullwhip effect was named for the way the amplitude of a whip increases down its length. Here, the end customers have the whip handle, and as they create a little movement, whip amplifies traveling up, increasing the buffer between the customer and the manufacturer. On average, there are 6 to 7 inventory points between the end customer and raw material supplier.
Better communication among supply chain partners, better forecasting methods, and a highly demand-driven approach can help reduce inventory waste or over-stocking that result out of the bullwhip effect.
Causes of Bullwhip Effect
Some of the factors contributing to the bullwhip effect are –
- Lack of communication and disorganization– this can happen between each supply chain link when managers deduce product demand differently within different links of the supply chain and order different quantities, smaller or larger amounts than what is required. Such miscommunication leads to disorganization and hinders the smooth working of supply chain processes.
- Order batching– Companies sometimes don’t place orders with the supplier after receiving an order. They wait for the demand to accumulate first. This alters the variability in demand because sometime there could be a surge while other times there could be a dip in demand.
- Variation in pricing- promotional discounts, special offers can disrupt the usual demand for products. Since buyers want to make the most out of this hiked demand in a short period, it could lead to inaccurate demand forecasting and consequently over-production.
Example of Bullwhip Effect
Let’s take a look at an example of the bullwhip effect. As we know, the actual demand for a particular product and its materials begin with the customer demand and requirements. However, there are times when the actual demand for the product gets distorted or disturbed going down the supply chain.
Let’s assume for a while that the actual demand of the customer is 8 units, and the retailer may then order, say 10 units from the distributor – here the extra 2 units are to ensure there is safety stock in place and the retailer is not running out of floor stock.
Coming back to the supplier, he, then orders 20 units from the manufacturer, allowing the retailer to buy in bulk so that there is always enough stock to guarantee the timely delivery of goods to them. Now, the manufacturer makes sure that there is enough quantity to ship to the supplier, so they manufacture 40 units to stay on a safer side.
What happened here is clear. There are 40 units manufactured for something that has a demand of 8; meaning the retailer now has to push himself when it comes to increasing the demand by either dropping the prices or finding more and more customers via marketing or advertising.
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Ways to Minimize the Bullwhip Effect
The nature of the supply chain and inventory management practices differs from each industry. Below are some of the ways in which you can minimize the bullwhip effect in your supply chain and distribution channel.
- Improve inventory planning process- inventory planning involves a careful amalgamation of different functions like analyzing sales history for accurate demand forecasting, seasonal inventory demand planning, new product launches, and stock planning of currently selling items and discontinuation of older products.
- Better communication between managers- since managers of different supply chain links perceive demand differently, it can lead to discrepancies while ordering from suppliers. To avoid such a circumstance, establish a better system of collaboration between managers. Focusing more on common company objectives will direct the flow of information equally.
- Collaboration between customers and suppliers- you can improve supply chain efficiency by encouraging more collaboration between customers and suppliers. When companies know about customer demand, they can work that into their forecasting, and convey insights to suppliers to prevent them from stocking extra inventory.
- Demand-driven supply chain management– it is obvious that forecasts are rarely 100% accurate. When the demand actually arises, it is mostly different from what had been predicted. This makes companies order extra stock from suppliers. Lack of communication and information sharing among managers and suppliers results in an over-reaction towards forecasted demand, subsequently setting off a chain reaction of having excess inventory higher up the supply chain. A demand-driven supply chain system will be more proactive and hold less inventory.
The strategy for an efficient supply chain and distribution channel is open communication and collaboration between customers and suppliers, and information sharing within the management of the company. These small but essential improvements will streamline the supply chain process and prevent risk and loss associated with excess inventory.
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