How Things Work
How the Bullwhip Effect Can Distort Your Supply Chain
28 April 2022 |
The C2FO Team
Small actions can have a massive impact, especially in supply chain management.
Tiny movements can produce unexpectedly outsized effects on the supply chain. That’s the basis of the bullwhip effect, a pattern that may be contributing to shortages throughout several industries.
The effect is a metaphor for how slight changes in consumer demand magnify throughout the supply chain. Just as a flick of a wrist can cause a large, loud crack, a slight uptick in product demand can amplify as it climbs each rung of the chain from store manager, wholesale supplier, to the manufacturer.
What the bullwhip effect looks like in action
Let’s say retailers are noticing an increase in candle sales of 15%. To protect against low stock, managers bump up their monthly candle orders from their suppliers by 25%. To adjust for the increased orders while maintaining backup inventory, suppliers then request 40% more product from the manufacturer.
Reacting to supplier requests, the manufacturer increases candle production by 55% to meet what amounts to a 15% increase in candle demand. The result: too many candles, no place to store them, and lost revenue in both product and storage costs.
The bullwhip effect most recently has been associated with the pandemic, when consumers rushed to buy toilet paper, hand sanitiser and COVID-19 home testing kits. After an initial shortage of these products, the bullwhip effect caused an oversupply. In fact, one testing company was driven to destroy most of its tests after sales plummeted in the spring of 2021, only to have to rebuild this supply when demand rebounded the following winter.
What causes the bullwhip effect
This phenomenon has been an issue for supply chains for decades. Several factors can cause this whiplash through supply chains:
Poor flow of communication, sudden changes in demand
For starters, the bullwhip effect can occur when each link of the chain operates in its own vacuum. Wholesalers and manufacturers might have no idea what the actual sales are at the retail level. And individual buyers or procurement associates don’t always have the appropriate knowledge of how things work in the upper links of the chain.
That’s not always the case, of course. Many large retail enterprises have complex systems that monitor demand signals for specific products (like sales at the store level), and they use that information to adjust how much inventory they keep in their stores and distribution centres, said Kristyn Baker, C2FO’s vice president of procurement and sourcing strategy.
As a result, suppliers often know how much their enterprise buyers are ordering. However, they are subject to sudden changes in demand, i.e. if order sizes increase or decrease suddenly.
Sales and discounts
Low prices trigger consumers at all levels to buy more product than they need at one specific time. When prices return to “normal,” demand drops, and so do orders. Seasonal sales and deep consumer discounts cause inconsistency and variance in ordering and production that doesn’t reflect real customer demand, further exacerbating the bullwhip effect.
Boosting orders to account for lead time issues
Most buyers understand the importance of lead time, especially when ordering an imported item. Still, it’s become much more complicated to predict lead times and know exactly when a product will make it to a store, Baker said. That wonkiness can be traced back to increased consumer demand, shortages of shipping containers and other supply chain issues.
If the product doesn’t arrive right away, many buyers may be tempted to order even more to ensure there’s enough inventory to cover the lag. Remember when consumers bought toilet paper every time they saw it in a store in 2020 because they weren’t sure if it would be there the next time? This similar uncertainty about lead time causes managers to overstock certain products.
How the bullwhip effect hurts businesses
The bullwhip effect can result in unfilled orders, dissatisfied customers and lower revenue, affecting suppliers and enterprise buyers. Another consequence is too much inventory at every level of the chain, which in turn increases storage costs.
And finally, cracking that whip triggers inconsistent periods of production. A stretch of frenzied manufacturing, where extra warehouses, labour and supplies are desperately needed, is then followed by a time when factories and workers are idle, with expensive storage facilities stuffed with product that won’t move. Then a few months later, production is ramped up again, and the roller coaster starts once more.
Tips for minimising the bullwhip effect
The bullwhip effect doesn’t have to be a necessary evil of doing business. There are ways to minimise and manage its impact on your enterprise:
Improve communication up and down the supply chain
One of the best ways to enhance communication is with a supply chain automation solution that gathers inputs from the retail level all the way to the manufacturer level. Knowing the actual numbers, and not just a guesstimate, will help suppliers and manufacturers order and assemble a more realistic amount of product that will meet actual customer demand.
Keep a closer eye on inventory levels
Likewise, knowing exactly how much stock is available will lead to more accurate ordering and protection against excessive production. A good inventory management solution can make this easier. (And if you’re trying to invest in inventory while staying ahead of inflation, optimising your cash conversion cycle can help.)
Place consistent, more frequent orders
Placing orders more frequently will more accurately reflect what the customer is demanding daily. This may seem like a more expensive endeavour in the short run, especially when it comes to transportation costs. Managers would rather not pay for a truck that is only half-filled with product. But there are services that can help keep these costs down. For example, a third-party logistics provider will combine orders for several customers into one truck. This way, you can still order a partially full truck for a low price.
Use electronic data interchange (EDI) technology throughout your chain
EDI technology will streamline the ordering process for you when ordering more frequently might seem like a paperwork or email nightmare. When you place an order within your internal system, an EDI-based service electronically notifies your suppliers for you.
Be cautious with consumer discounts
Offer stable, low prices every day. This approach will keep your customer demand consistent and prevent the boom and bust of product availability. You won’t have to crack that whip as you rush to restock inventory depleted from a big sale. In the long run, this strategy will also promote customer loyalty. If consumers know your product or service is always reasonably priced, they won’t need to look anywhere else for it.
The bottom line
The bullwhip effect can introduce various problems into your supply chains, including supply shortages, annoyed customers, higher costs and other headaches. But with a bit of effort — including more communication throughout your chain — you can prevent the worst of these problems in many cases.