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.
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.
Stick around as we explore the causes and definition of the bullwhip effect in supply chain management, plus look at a few expert tips for reducing its impact and preventing it from happening entirely.
What is 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.
Bullwhip effect diagram
This bullwhip effect diagram demonstrates how small changes in consumer demand result in big shifts in production further up the supply chain:
Bullwhip effect in the supply chain
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.
Factors that contribute to the bullwhip effect in supply chains include:
- Inaccurate or erratic demand forecasting: If individual businesses along the supply chain use their own sales data to forecast future demand, it is easy to under or overestimate the actual demand. This results in the ordering of too much or too little inventory which can create discrepancies between supply and demand, increasing the inconsistency of orders.
- Order batching: Members within the supply chain may choose to 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.
- Price fluctuations from sales and discounting: Any business in a supply chain that offers discounts, deals, or bulk pricing can affect typical demand and induce customers to change buying patterns or purchase more than they need. This can lead to artificial demand peaks and troughs and result in inaccurate forecasts as buyers attempt to reconcile these sales with their usual forecast tactics.
- Rationing or shortage gaming. When an inventory shortage occurs upstream in the supply chain, retailers and distributors may place larger orders or ration their 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.
Supply chain managers and business owners should be aware of how the bullwhip effect can happen, and what they can do to prevent it.
Causes of the bullwhip effect
The bullwhip effect largely occurs when a retailer or ecommerce business incorrectly forecasts demand. This forecast error tends to amplify as orders move up the supply chain to distributors, wholesalers, and manufacturers.
Eventually, this gives rise to massive discrepancies between the inventory being produced and the actual demand for that inventory.
Four common causes of the bullwhip effect in supply chains:
- Demand-signal processing – this refers to the distortion of demand information as it moves up the supply chain. Demand-signal processing can lead to a lack of visibility and uncertainty about actual demand, which may cause suppliers to react by way of overproduction.
- Rationing games – these occur when suppliers allocate limited inventory to customers based on their perceived importance. This can lead to a lack of transparency and trust between suppliers and customers, which can cause manufacturers to overproduce.
- Order batching – the practice of ordering large quantities of inventory at once instead of ordering smaller quantities more frequently. This can lead to an increase in inventory holding costs and a decrease in flexibility, which can cause suppliers to produce too many items in anticipation of future demand.
- Price variations – these occur when suppliers change prices frequently or offer discounts or promotions. This leads to uncertainty about actual demand and may also cause suppliers to overproduce in anticipation of future sales.
Luckily for supply chain managers, there are steps you can take to mitigate or prevent the bullwhip effect. We’ll cover those next,
How to reduce the bullwhip effect
With the right planning and resources, it’s possible to reduce the bullwhip effect in your supply chain. Here are some mitigation strategies you can try.
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 optimise 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.
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.
Address price fluctuations
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.
Reduce lead times
Reducing lead times can help to minimise 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.
How to avoid the bullwhip effect
While it’s possible to implement strategies to mitigate the risk of the bullwhip effect disrupting your supply change, how to avoid the bullwhip effect altogether is a bigger challenge. Below are three strategies to help you avoid the bullwhip effect.
1. Improve forecasting
Accurate demand forecasting helps you avoid the bullwhip effect by revealing how future customer demand will present. Demand identification, forecasting, and inventory optimisation are best achieved using predictive analytic software solutions that improve forecast accuracy.
Inventory optimisation software uses data-driven insights to improve demand forecast accuracy and limit uncertainty.
Retailers can use data analytics tools to evaluate sales trends and predict future demand more precisely. Manufacturers can utilise the data to deliver demand-driven responses to ensure product availability that meets customer expectations helping them best avoid the impacts of a bullwhip effect.
2. Implement a just-in-time approach
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.
This involves identifying areas where you can improve your inventory management processes and reduce the risk of stockouts.
3. Quick-response manufacturing
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 centres 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.
Bullwhip effect examples
Many businesses have been adversely affected by the bullwhip effect; even large, multi-national corporations are not immune.
Bullwhip effect and Hewlett-Packard
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.
Bullwhip effect and Procter & Gamble
Procter & Gamble (P&G), a global giant in the FMCG category experienced the bullwhip effect in 1992. In anticipation of a baby boom, the company had increased its production of Pampers disposable nappies, but the expected boom never happened.
P&G’s expected explosion in childbirth was based on the demographic trend of the baby boomer generation, forecast to have reached peak child-bearing years and expected to have more children than the preceding generation.
In addition, economic and social changes saw a rise in female education and employment, improved healthcare, family planning, and a growing demand for convenience products.
The company had invested heavily in R&D, marketing, and distribution to capture potential market growth. However, greater competition and a drop in the actual birth rate resulted in a USD 30 million loss in sales. Retailers were left with an excess of unsold inventory, which P&G was forced to buy back.
Bullwhip effect and COVID-19
Finally, one of the more recent notable bullwhip effect examples was those caused by the COVID-19 pandemic. The fear-driven panic buying of toilet paper products during the pandemic resulted in shortages and stockouts of a product that previously had unwavering stable demand and is manufactured domestically in most markets.
Not a single industry was left unaffected by the pandemic. Supply chains scrambled to meet the unprecedented demand for products such as sanitisers, disinfectants, masks, and cleaning products while facing staffing and raw material shortages.
Conversely, industries such as hospitality, tourism, and service-based businesses experienced a complete decline in demand, resulting in excess inventory. Many were left with either the carrying costs of the unsold inventory or inventory waste of products that were perishable or with limited shelf life.
When information is distorted at any point in a supply chain, it can lead to a host of inefficiencies such as excess inventory, poor forecasting, capacity issues, low customer satisfaction, and high correction costs – causing a bullwhip effect that is detrimental to the business.