Bullwhip Effect – Example, Causes, Analysis and Consequences

The bullwhip effect is a supply chain phenomenon in which there are inefficiencies in forecast and supply chain. The bullwhip effect refers to the fluctuating swings in response to the demands of the customer, which has a cascading impact on the supply chain.

Explanation: In the case of Supply Chain, the end customers have the whip in their hands, and even if there is a little movement in demand, it significantly cascades in the supply chain in increasing fashion. The ripple grows larger and larger as it moves away from the customer, and more prominent movements are seen at the other end of the whip.

Usually, there are 6 to 7 inventory points between the raw material supplier and the end consumer, and all of those points try to protect themselves from stockout situations by keeping as it is extra inventory. This is why a large buffer of inventory is present between the end consumer and the raw materials suppliers.

Business inventory is directly impacted by customer demand. It does not often happen that companies try to satisfy the need of customers by propagating the required amount of resources and raw materials in a timely way.

However, when traveling from the lower end of the whip, that is customer, to the upper end, that is the raw materials suppliers variations are often amplified magnanimously. This is when companies usually cut their inventory is or increase significantly. This effect can be seen as a bullwhip effect.

It is a common problem faced by almost all industries. An uncontrolled bullwhip effect has severe effects on the organization as well as on the supplier or seller or distributor. Let us understand the bullwhip effect more clearly with an example.

Example

Suppose there is a demand for a particular product from a customer. The customer has demanded four units from the retailer. The retailer asks for eight units from the distributor, an extra two units so that he does not run out of stock.

The distributor then places a demand on the manufacturer. He demands a total of 15 units from the manufacturer, hoping that bulk buying will give him a discount. The manufacturer then orders for 25 units from the factory considering the demand from the distributor and the seller and tries to push for those 25 units with added incentives. Thus when the customer has demanded only 4 units, the factory will manufacture 25 units, which can be termed as a bullwhip effect.

Similarly, when the demand of the consumer goes down, this has a cascading effect ahead. If the sale drops down to 1 unit from 4, then automatically the orders placed ahead will have reducing percentages.

Causes

Following are a few of the common reasons:

1. Price fluctuations

Price fluctuations happen mostly during the holiday or festival season when there are huge discounts offered on the products by various sellers and resellers. Special discounts can disturb the regular buying pattern, and customers may buy more than the sellers expected that.

The discounts and special offers given during holidays are to gain momentum for sales, but if it is not accounted for in the sales forecasts, then it can disturb the supply chain and cause a massive bullwhip effect.

2. Order batches

Distortion occurs in the supply chain when order batching is done. This happened when every member received the order from the customer and rounds up or down to suit the production constraints.

For example, if a customer requires shirts of $ 100 and one shirt is $ 13, then the customer should precisely get 7.6 shirts, but there is no such thing as 7.6; that is why it can be rounded up to 8. In such cases, the order demanded is more than the expected order of 7 shirts, and if every order is placed in such a way, it will cause a considerable bullwhip effect to take place in the supply chain.

3. Demand information

Most of the sales department works on the achievements of last year. The current year projections are generally based on the sales of the previous year.

But this may not be true every year because government policies may change in the given year, which will fluctuate the projections and disturb the supply chain. Therefore relying on-demand solely on information will lead to creating a bullwhip effect in the supply chain.

4. Communication gap

Many things are associated with the supply chain, and all of them can’t run smoothly if they do not communicate efficiently. It is expected that all of the supply chain points should interact with each other and understand the demand and stocks at each point.

If there is any discrepancy in the forecast and the availability, they can immediately update the supply chain and make available the required stocks.

5. Return policies

Many companies have the return policy is in which the products without any cost to the company. In such cases, it is seen that suppliers often overestimate the demand and buy vast quantities and later return it to the company, which disrupts the supply chain.

Other bullwhip effect causes include Forecasting errors, variation in the lead time, consolidation of demands, misuse of base-stock policies, transaction motive, Shortage gamings, etc.

These types are classified between behavioral and operational causes.

Minimizing the Bullwhip Effect

Every industry will have a different supply chain and inventory management abilities. This is why every sector will have a different way of reducing the bullwhip effect. However, there are common steps that can be taken.

It can be said that after the implementation of one or more of the steps, there is a reduction of more than 15% in stockout situations. Following are some of the methods to minimize the effect:

1. Understanding the effect

The first step to reducing the bullwhip effect is to acknowledge the presence of the same. Many companies do not recognize the existence of the effect. Idle or excess inventory will come forward after a detailed analysis of the presence of stock from the suppliers to the inventory points.

Reasons for the existence of extra stock can be analyzed, and corrective action can be taken in time to avoid the Bullwhip effect.

2. Improvement in inventory planning

Many factors are taken into consideration before inventory planning, like seasonal demand, new product launches, historical trends, customer expectations, and discontinuation of old products.

The minimum and maximum stock availability are determined based on all of these factors, which are regularly reviewed and adjusted. Lying inventory or excess stock is a dead investment for the company as well as for the seller.

3. Improvement of Raw material planning process

There is a trend seen that purchase managers place the orders in advance to keep a buffer of raw materials and to avoid hurdles and production. The production plan is directly linked to raw material planning, and it is released sufficiently in advance so that there is enough time for purchasing.

There should be excellent communication between the distributor or the seller and the raw material management team with the help of the marketing and sales team so that there is no discrepancy in order placing or in inventory management.

4. Inter-departmental collaboration

Clear and regular communication is expected between the purchasing department, production department, and sales department. Regular updates of orders or unexpected bulk order should be updated immediately and circulated by all the departments.

The differences between all the departments should be kept aside to fulfill the long-term objective, vision, and mission of the company. The available stocks can be known from the purchasing department, the existing production line and expected date of delivery can be understood from the production department, and the Sales department can give the expected orders.

When all of these departments work in sync, then the process of production is continuous, the availability of the stock is optimum at all the delivery points, and the supply chain becomes efficient.

5. Stable pricing and optimization of minimum order quantity

Few products have very high minimum order quantity for customers, which results in huge gaps between the second order from the same customer. Lowering this quantity to an optimum level with regularising and generate regular orders from the customer.

Keeping the price stable throughout the year instead of daily offers and discounts will also create a predictable demand.

Analysis and Consequences

It results from overcompensation of stocks by suppliers, vendors, and others involved in the supply chain. This effect not only disrupts the supply chain of the company but also has some severe consequences for business as a whole. Following are some of them:

1. If the customer demand is less, then there is excess stock with the retailer or distributor. Thus once the existing stock is exhausted, the orders will be placed lesser than last time, and if the seller tries to overcompensate it, the orders will be even lower. This will result in understocking, and there will be frequent situations of stock-outs. For example, a soft drink seller usually places an order of 500 bottles of soft drinks every summer. But since the last two summers, he observed that the bottles are sold lesser and lesser every summer. So this summer, he orders for 300 bottles only. But it so happened that the soft drink company slashed the prices per bottle by a considerable amount. This resulted in excess demand from the customers, and unfortunately, the seller had to face stock out situations.
2. On the other hand, if there is excess order of the product following a stock out, then the tendency is seen that there are excess orders. This again leads to excess inventory, and having an excess stock is not only a dead investment but also a liability in case of perishable products. Continuing with the above example, the seller decides to order a few more soft drink bottles to avoid stock out and overcompensates for it. So considering the demand and the price reduction, he orders 600 bottles. Unfortunately, even though the prices are less and there are offers on the soft drink bottle purchases, customers may have become more health-conscious because of which the seller sees a significant drop in sales. Also, the soft drink bottles come with an expiry date, and since he could not sell the stock, he has to discard it, which is a more significant loss.
3. Due to consecutive problems of the bullwhip effect, the companies may see changes in buying patterns of sellers. Instead of ordering in bulk as is the case with them, they try to break it down the orders. This will cost more since shipping charges will go up, but this will avoid wastage and over or understocking. For example, the soft drink seller would now prefer to order 50 bottles of soft drink every week instead of bulk ordering. Even if the sale drops, the seller has less stock to finish, and unfortunately, yet if he has to discard them, the loss will be less.
4. From the organizational point of view, if the bullwhip effect is not controlled, then it can be seen that due to consistent ordering discrepancies, the seller may have switched to other brands or competition brands, and this would negatively affect the company in the long run. The competition will gain the share due to maintaining the frequency in availability and a minimum bullwhip effect.
5. Similarly, from the customers’ point of view, if he faces the frequent problem of availability, then sooner or later, he will switch to competition brand, and if the brand satisfies all the requirements of the customer, then he will permanently change to another brand. This will result in a huge business loss for the company.