“Bullwhip effect” in supply chain management is a fascinating phenomenon. Besides this, we hear it often with regard to customer demand. Ever wondered how it got such a crazy name?… Let’s understand!
For a better understanding, Imagine this man using a whip. A small jerk to the whip forms a large wave on the other end.
In short for a small movement on his end there was a bigger impact on the other end.
Businesses observed a similar pattern with customer demand. For every small change in customer demand, there was a bigger change in demand received by the manufacturer. Therefore this effect was named the Bullwhip effect under supply chain management.
What is a bullwhip effect?
“Bullwhip effect” also is known as “whiplash effect” refers to a situation resulting in increased fluctuations of inventory. This situation is caused due to a change in customer demand, as we move further up the supply chain.
In other words, a ‘small wave’ from the side of a customer develops into a ‘larger wave’ by the time it reaches the supplier of that product.
In short, The smaller wave here is symbolic to the customer demand and larger wave is symbolic to the demand which the supplier gets on his side. There is a bigger demand variation between both.
causes of the bullwhip effect in Supply Chain
We know that a supply chain consists of the members which are the suppliers, manufacturers, distributors, wholesalers, and consumers.
Therefore, It is very important to note that all the supply chain members rely on each other and their actions initiate a bullwhip effect. let’s understand a few of them.
All members of the supply chain estimate their own individual demands. In general, each member forecasts his future demand based on orders received from his immediate customer. Therefore, the more members a supply chain has, the less these forecast updates reflect actual end-customer demand. It is always better to collect demand closer to the customer.
Mostly this occurs in an effort to reduce ordering costs. Admittedly, there is a motive to achieve full truckload economies and benefit from sales incentives. In addition to it, many members involve in such rounding up of order quantities. Rounding up at every level leads to distortion of original quantities that are actually in demand.
Price fluctuations occur due to Discounted sales, offers or any other events likewise resulting in an irregular buying pattern. The price fluctuations cause a temporary demand often considered as an expected demand. Subsequently, this leads to a distorted demand information.
Lack of communication
Due to a lack of communication and asymmetric information between each link in the supply chain, it gets difficult for the activities under the supply chain to run efficiently. Without proper discussion within the immediate members, the estimations are made on-demand gradually leading to a bullwhip effect
Cancellation of orders
Sometimes policies like free return policies drive customers to purposely overstate demands with the fear of shortages and then cancel when the supply becomes adequate again, without any policies to control this effect this results in excess material and a bullwhip effect.
Examples of Bullwhip effect from companies
There are many examples of past and present which shows us what the bullwhip effect can do to a company. Let’s see one of them
Nike In 2001, Nike installed a new demand planning software without adequate testing, based on a small spike in demand they overstocked low-selling shoes and thereby left out to stock the popular Air Jordan’s. Later, the demand for Air Jordan’s spiked up leading to a loss of sale. This ended up costing Nike $100 million worth of sales, according to a press release by the company.
Bullwhip effect in supply chain Example
One day a group of customers visited a store and placed a huge order of soft drinks and bought the retailer’s inventory fully!
The shop keeps an Inventory as 600 units of soft drinks for three months, but this time the inventory was down to 0 due to the sudden demand.
Anticipating that he’ll require 600 units every month he approached wholesaler with a demand of 1200 units(for 2 months ), wholesaler did the same mistake and further placed an order of 1800 ( Ordering an additional few units to it ) and so manufacturer received a completely distorted demand on his side.
The manufacturer made arrangements for additional production and circulated the demanded goods to the market. On contrary to the expectations the demand went back to normal. Therefore, everyone became stuck with inventory leading to higher inventory holding costs. This is a classic example of the Bullwhip effect in the supply chain.
Impact of bullwhip effect on supply chain performance
The impact of the Bullwhip effect is different in terms of industries. Commonly observed impacts of Bullwhip effects are as follows.
Investments in the form of Capital like Equipment, building, etc to meet excessive capacity investments will turn out as failure due to the Bullwhip effect.
Industries will suffer a loss or negative return on investment on it. Bullwhip effect also leads to higher Inventory holding costs leading to an increase in per-unit cost of product or loss thereof.
In addition to everything Bullwhip effect also results in wastage of storage space. Due to the overstocked non-selling products in the warehouse.
Loss of time and investment is a major risk due to the Bullwhip effect.
How to reduce the bullwhip effect in supply chain?
The bullwhip effect can be minimized using the following ways:
1. Track demand closer to customer
Demand Should be studied closer to the customer as we move away from customers along the supply chain. The demand information obtained might be faulty.
2. Select the right strategy based on demand
Modify your inventory allocation based on demand certainty. If there is a Stable demand expected go for a push strategy. If Demand is uncertain or doubtful go for a pull strategy. But the application of this method will depend on the nature of products too. Thereby, often one will be somewhere in the middle with a push-pull strategy.
3. Increasing Visibility
Lack of visibility leads to a rise in costs. As we discussed earlier It is very important to note that all the supply chain members rely on each other. Therefore, encourage information sharing among members. Work with suppliers and other members on releasing lead times and improving on-time delivery.
4. Break order batches
Use measures to reduce the cost of placing orders. Place orders more frequently. Ship assortments of products in a shipload to counter high transportation costs or use a third-party logistics company to handle shipping.
5. Reduce price fluctuations
It is more preferable for manufacturers to reduce the frequency and level of wholesale price discounting to keep customers from stockpiling. Unless there is a strong reason for doing it the businesses should not frequently fluctuate the prices.
6. Minimize order cancellations
Suppliers should allocate products based on past sales numbers. Bring a change to return policies so retailers can’t cancel orders as and when he feels so. Doing this will also increase a responsible order placement rather than placing excess orders to cancel them accordingly once they see the real demand.
7. Minimize order cancellations
Even if a company tries to become more demand-driven, it still needs a forecast to plan long lead time items or to cover demand from new customers, new products, or in-house promotions. While it’s a given that a forecast will be inaccurate, there are steps that can improve accuracy. Ensuring that you use the right algorithm to project demand is one way to increase accuracy; taking input from sales and customers is another.
Bullwhip effects are also known as Forrester effect as it is originated from jay Forrester who wrote a very popular book named industry dynamics in 1961! He tried explaining the account for the unforeseen spikes in the demand within the supply chain and why these unforeseen spikes drastically impact the entire supply chain.
Therefore, Bullwhip effect can do great damage to the supply chain and must be bought in control of the efficient functioning of a business.