Bullwhip effect, its causes and ways to overcome

The definition of supply chain is: the flow of information, services and materials from raw materials
suppliers through factories and storage locations such as warehouses, to the end customer.

That covers a lot of ground, and given the time span from raw material to the end customer, there are an
almost infinite number of ways that the supply chain can derail.

One of the most common issues supply chain managers face is known as the “bullwhip effect” in which
small fluctuations in demand at the downstream end of the supply chain may cause out sized variations
at upstream suppliers. The effect is a bloated and ineffective supply chain with too much inventory.
What contributes to the bullwhip effect?
There are many factors said to cause or contribute to the bullwhip effect in supply chains; the following
list names a few:
1. Disorganization between each supply chain link; with ordering larger or smaller amounts of a
product than is needed due to an over or under reaction to the supply chain beforehand.
2. Lack of communication between each link in the supply chain makes it difficult for processes to
run smoothly. Managers can perceive a product demand quite differently within different links of
the supply chain and therefore order different quantities.
3. Free return policies; customers may intentionally overstate demands due to shortages and then
cancel when the supply becomes adequate again, without return forfeit retailers will continue to
exaggerate their needs and cancel orders; resulting in excess material.
4. Order batching; companies may not immediately place an order with their supplier; often
accumulating the demand first. Companies may order weekly or even monthly. This creates
variability in the demand as there may for instance be a surge in demand at some stage followed
by no demand after.
5. Price variations – special discounts and other cost changes can upset regular buying patterns;
buyers want to take advantage on discounts offered during a short time period, this can cause
uneven production and distorted demand information.
6. Demand information – relying on past demand information to estimate current demand
information of a product does not take into account any fluctuations that may occur in demand
over a period of time.

Example of the bullwhip effect

Let’s look at an example; the actual demand for a product and its materials start at the customer, however
often the actual demand for a product gets distorted going down
the supply chain. Let’s say that an actual demand from a customer
is 8 units, the retailer may then order 10 units from the distributor;
an extra 2 units are to ensure they don’t run out of floor stock.

The supplier then orders 20 units from the manufacturer; allowing

them to buy in bulk so they have enough stock to guarantee timely
shipment of goods to the retailer. The manufacturer then receives
the order and then orders from their supplier in bulk; ordering 40
units to ensure economy of scale in production to meet demand.
Now 40 units have been produced for a demand of only 8 units;
meaning the retailer will have to increase demand by dropping prices or finding more customers by
marketing and advertising.

An effective supply chain manager will want to use strategies to reduce the bullwhip effect to improve
the overall efficiency of the supply chain. Some proven strategies are:

1. Collaborate with customers and suppliers

Another strategy to improve supply chain effectivity is through better collaboration with customers
and suppliers. When companies work with customers to understand their plans and forecasts, they
can build promotions and seasonality into the forecast and then provide more insight to their
suppliers to help prevent the buildup of unnecessary inventory due to the bullwhip effect.
Supply chain management software often has capabilities to aid in collaboration. Supplier portals,
EDI transactions, event alerts and project portals are some of the most common ways to increase
visibility and collaboration.
2. Improve forecast accuracy
Even if a company tries to become more demand driven, it still need 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.

3. Enable fast decisions with visibility and insight

The most important benefit of supply chain management applications is the visibility and insight
they provide. Without the right degree of insight, a supply chain manager must rely on guesswork
or rules of thumb to make decisions. The result will nearly always be sub-optimization of the supply
chain that results in higher costs, excess inventory, and slow deliveries.
4. Adopt a demand driven supply chain management approach
Demand driven supply chain management is one of the most effective ways to reduce the bullwhip
effect. It is a known fact that most forecasts are inaccurate, so when actual demand materializes
it is almost certain to differ from forecast quantities. This causes companies to place emergency
orders on suppliers. Without effective communication, those suppliers’ supply chain management
systems will overreact, setting off a chain reaction of excess inventory that increases cost and slows
velocity. In contrast, a demand driven supply network will have less overall inventory and be more
responsive.

The keys to effective supply chain management are visibility, open communication, and fast access to
information and insight. With these five attributes, your supply chain will be more effective, and you will
have minimized the risk of excess inventory as well as inventory shortages. Without them, you will feel
the sting of the bullwhip effect.