The bullwhip effect occurs when small changes in demand at the consumer end of the supply chain intensify as they move up the supply chain from the retailer through to the manufacturer. Within supply chains, the bullwhip effect arises from the amplification of fluctuations going up the chain. While downstream firms may face stable consumer demand, upstream echelons, including suppliers, may experience greater variations due to causes such as price fluctuations, batching, predictive modelling and coordination problems.
For product businesses, the bullwhip effect can significantly hinder the ability to maintain optimal inventory levels – often leaving them high and dry with too much stock and not enough demand to get rid of it. The bullwhip effect, which was first identified in the 1960s, has become prevalent in a globalized world where supply chains are complex, large, and international. It generates excessive inventories, delays, and poor customer service, especially for industries with many intermediaries. Companies have adapted to meet this irregular demand by smoothing their production and ensuring sufficient stock levels.
Stick around as we explore the causes, definitions, examples, and strategies to mitigate or prevent the bullwhip effect in supply chain management.
Definition of the Bullwhip Effect
The bullwhip effect is a supply chain phenomenon which occurs when slow-moving consumer demand or small increases in demand produce large swings in production at the opposite end of the supply chain.
This effect usually occurs in the supply chain when a retailer changes product order quantities from their wholesaler based on a small change in real or predicted demand for that product. With limited data about the demand shift, the wholesaler then increases their order from the manufacturer by an even larger amount. The manufacturer, being further removed from the demand alteration, will increase production by an even greater amount. As a result, more goods are produced by manufacturers than can be sold by wholesalers or retailers.
Referring to an augmented variability in demand, the bullwhip effect in supply chain management magnifies inefficiencies as each step up the supply channel progressively estimates demand with greater inaccuracy.
Manifestation in Supply Chains
The supply chain can be seen as a system in which companies adjust purchases, production, and prices. The overall goal is to keep supply aligned with demand, faced with random fluctuations requiring constant adjustments to market conditions. Performing these adjustments typically falls under the broad umbrella of supply chain management (SCM).
In this system, SCM decisions can exacerbate fluctuations going up the chain. Considering a simple FMCG example with a store, a regional warehouse, and a factory supplying the entire country, amplifications can arise from batched orders: while consumers buy products only one at a time, the store, for cost reasons, orders pallets from its supplier. Therefore, the regional warehouse is faced with a demand for pallets but can only order full trucks from the factory. In the end, the factory receives erratic truck orders, even though the consumer demand is steady.
In addition, accidental synchronizations, such as calendar orders, cause resonance effects that accentuate bullwhips. If two warehouses get into the habit of placing their orders on Mondays, because it simplifies their internal planning, the result is an order for two trucks instead of one for the factory that day. In this situation, the lack of data can lead the upstream echelon to misinterpret this situation as a demand surge and to increase its production.
Causes of the Bullwhip Effect
Promotions and Price Fluctuations
Producers are trying to increase their market shares through promotions and discounts in the marketplace. Faced with price variations, companies buy in quantities that do not reflect their immediate needs and create bullwhip effects. They prefer to buy in bigger quantities and stock up for the future to achieve economies of scale.
Although promotions may seem irrational because they create additional costs for producers, they are a way to nudge markets and alter equilibria. Indeed, temporary discounts concentrate the demand and force producers to stock at great expense, but they also represent an opportunity to gain market shares by disrupting the status quo.
Price fluctuations in the supply chain are challenging. Strategies to manage fluctuating prices include examining your price discounts, and promotions to make sure they align with your supply chain goals. Identify the products or services that are most affected by price fluctuations and allocate any increases by segment. Conduct a review of your changing cost to serve and identify areas where you can reduce these costs. This can help you to reduce or offset the impact of price fluctuations on your supply chain.
Batching and Inventory Decisions
Batching is companies trying to take advantage of economies of scale through price breaks, batch shipments or production batches. For inventory replenishment, a warehouse does not immediately place an order with its factory. It prefers to batch, or accumulate, requests to reduce the associated costs and achieve economies of scale on delivery.
Batches lead to trade-offs between economies of scale and the problems they create: while large batches reduce production costs, the induced delays between replenishment and sales lead to a desynchronization with the demand and force companies to build up large stocks. Thus, companies must arbitrate to determine a batch size that does not exhaust the gains from economies of scale. If a warehouse orders two trucks at once while it would be possible to spread the orders within the week, this situation does not result in economies of scale but increases stock levels and the associated costs.
While it is not always possible to split batches in production (constraints on reaction times in industrial chemistry…), shipping provides many levers to do so. First, companies can automate orders to minimize the length between the supply threshold and the replenishment. Second, they can place orders with assortments of different products to reduce the number of replenishments. Third, companies can distribute replenishments evenly to smooth out their stock levels over time.
Order batching also occurs when members within the supply chain place orders in large quantities or at fixed intervals, or round orders up and down. This creates demand fluctuations that aren’t an accurate reflection of actual consumer demand, leading to excess inventory or overstocking.
Predictive Modelling and Forecasting
Supply chain management relies on the proper anticipation of future events. Companies determine their adequate production level through a forecast of the demand using predictive models. These models are said to be convex when forecasts absorb and smooth out shocks as reflected by the historical data. By design, these models, the simplest being moving averages, will tend to react slowly to recent variations. On the other hand, non-convex models adopt a different perspective. Instead of being conservative, these models, like linear trends, can propose responses that are not observed in the past. They are not strictly constrained by what has already been observed and can amplify fluctuations at the risk of ending up with overproduction.
The acceptable level of risk generated by predictive models depends on the industry. Non-convex models are optimal for non-perishable products, like luxury watches, where a large part of the production cost is in the materials used. These companies can take advantage of a sudden increase in demand to make a good profit. If the model overreacts, it will still be possible to reuse the materials on another product without incurring excessive losses. On the other hand, convex models are more suitable for perishable products. For strawberries, the product’s value decreases rapidly and an overproduction can turn into a net loss if the prediction model is poorly chosen.
Inaccurate or erratic demand forecasting can lead to over- or underestimating actual demand. This results in discrepancies between supply and demand, increasing the inconsistency of orders.
Coordination Problems and Market Games
“Games” occurs when a firm does not react to market conditions but to the anticipated reaction of other players. In “games”, companies stop aligning supply with demand and try to shift the equilibrium in their own interest. For example, when they spot successes, firms can try to corner the market by buying an entire stock. This strategy allows them to ensure exclusivity on a product and therefore to gain market share by attracting new consumers. However, this creates uncertainty and irregular demand peaks for suppliers, leading to coordination problems. In response, suppliers may decide to ration their products to reduce order fluctuations. This is likely to be suboptimal and costly for both supply and demand, as it reduces the quantities traded.
Rationing or shortage gaming occurs when an inventory shortage happens upstream in the supply chain, and retailers and distributors place larger orders or ration available inventory to ensure safe stock to meet their client demand. Ration gaming directly correlates to a proliferation in the bullwhip effect, increasing it by 6–19%, and hurting the entire supply chain.
The main solution to minimize gaming strategies is to reduce information asymmetries in order to put all players on an equal footing. To do so, some suppliers force their customers to give them direct access to their stock levels. Thus, they avoid misinterpreting customer demand and use this information to secure their stock levels.
Demand-signal processing occurs when distortion of demand information moves up the supply chain. This can lead to a lack of visibility and uncertainty about actual demand, causing suppliers to overproduce.
Mitigation Strategies
Collaboration and Information Sharing
When members of the supply chain work together to align their goals, incentives, and strategies, it helps to improve decisions and actions for the benefit of the whole. This collaboration also enhances trust and communication between the parties which aids in reducing conflicts and inefficiencies.
Maintaining strong relationships with suppliers will help reduce uncertainty. Effective communication will help to ensure that suppliers have accurate information about demand from each stage in the supply chain, allowing them to adjust production accordingly.
Information sharing is vital to ensure that the information flow is both timely and accurate between businesses throughout the supply chain. When supply chain partners share accurate and timely information about their customer demand, inventory levels, production plans, and potential capacity constraints, it helps them all coordinate their activities. Providing better information to each link in the supply chain improves communication and helps to optimize your supply chain. This can also improve demand forecasting and reduce overordering or underordering through the sharing of information. It also helps to reduce uncertainty and variability.
Smoothing and Lead-Time Reduction
Supply chain smoothing is a technique used to reduce the impact of demand variability on the supply chain. Supply chain parties can help to reduce variability by matching supply with demand and by adopting practices that smooth out demand fluctuations.
Smoothing practices involve using inventory buffers – also called safety stock – to help absorb demand variations such as:
- Reducing price variations
- Implementing vendor-managed inventory
- Offering price consistency through regular low prices
- Using continuous replenishment programs
Smoothing can also reduce costs, limit waste, and improve your customer service satisfaction levels. Reducing lead times can help to minimize the bullwhip effect. This simply means reducing the time between when an order is placed and when it is received. Reduced lead times help to ensure that suppliers have accurate information about demand and can adjust their production accordingly. By identifying areas where you can streamline your processes, you can undertake steps to drastically reduce lead times. Shorter lead times mitigate the impact of price fluctuations on your supply chain that result in the bullwhip effect.
Just-In-Time and Quick-Response Manufacturing
Just-in-time (JIT) inventory management is a lean manufacturing strategy that involves ordering inventory only when it is needed. JIT helps reduce inventory holding costs and to minimise the bullwhip effect. Your JIT inventory management system can be adjusted to mitigate the impact of price fluctuations on your supply chain or adapted to meet demand fluctuations.
Quick-response manufacturing (QRM) is a strategy for cutting lead times in all aspects of manufacturing and business operations. QRM is a tactic employed by Spanish-owned fashion group Inditex, owners of the global fashion chain Zara. With long lead times a significant contributor to the bullwhip effect, Zara has reinvented its supply chain to achieve greater agility.
To achieve quick-response manufacturing Zara uses contract manufacturers in the La Coruña region of northwest Spain, where the company has its headquarters. The proximity of these design centers to Zara’s European market dramatically shortens distribution times. This allows the company to manage any supply chain crisis more efficiently and effectively compared to its competitors with longer lead times.
6. Strategic Use of Bullwhip Effects
Exploiting the Bullwhip Effect
Companies can take advantage of bullwhip effects and do not always wish to mitigate them. For “hit or miss products” (fashion, cultural products, etc.), firms choose to produce more than the level of demand to provide impulses, hoping that a massive diffusion of the product will create a buzz effect. This strategy is used for “winner takes all” products in which uncertainty and variability are intrinsic, and for which the success of a highly profitable product will compensate for the many failures.
Attenuation in the Supply Chain
At the opposite of bullwhip effects, the supply chain can also be a source of attenuation. For the example of bottled water production, although the demand is mainly concentrated in the summer, the manufacturer produces throughout the year to ensure buffer stocks to cope with the seasonal peak. In this case, consumer demand varies more strongly than production. This mechanism is exacerbated at each echelon of the supply chain and variations in demand are flattened as we move up the chain.
Scarcity as a Strategic Tool
By playing on time and inventory constraints in the supply chain, companies can use the strategy of perceived scarcity to enhance their products’ attractiveness. By deliberately underestimating demand and favoring delays, they create stock-outs, and expectations for their product (queues), thus reinforcing the associated image of scarcity.
Real-World Examples
Hewlett-Packard (HP)
Hewlett-Packard (HP) experienced the bullwhip effect when the orders from its resellers were much more volatile than the actual sales of its printers. After HP executives examined the sales of one of its printers at a major reseller, they found that there were, as expected, some fluctuations over time. However, when they examined the orders for the printer from the reseller, they observed even bigger swings. In addition, they discovered that the orders from the printer division to the company’s integrated circuit division had much greater fluctuations. As a result, HP faced challenges in managing its resources and costs efficiently. The flow-on effect to the supply chain meant this bullwhip effect was felt by suppliers as they received even more erratic orders from HP’s printer division.
Final Thoughts
The bullwhip effect is a complex supply chain phenomenon with multiple causes including promotions, batching, predictive modelling, coordination problems, price fluctuations, rationing games, and demand-signal processing. It can disrupt production, inventory, and customer satisfaction, yet companies can mitigate or strategically exploit it through collaboration, information sharing, smoothing, reducing lead times, and adopting JIT or QRM strategies.
