What is the bullwhip effect?
The bullwhip effect (also known as the Forrester effect) is defined as the demand distortion that travels upstream in the supply chain from the retailer through to the wholesaler and manufacturer due to the variance of orders which may be larger than that of sales.
What causes the bullwhip effect in supply chain?
- Demand forecast updating: Members of the supply chain updating their demand forecasting
- Order batching: Members of the supply chain rounding up or down the quantity of orders
- Price fluctuations: Usually driven by discounting resulting in larger quantities of purchases
- Rationing and gaming: Buyers and sellers delivering over or under their order quantities
An example of the bullwhip effect
Let’s consider a retailer sells on average 10 ice creams per day in the summer season. Following a heatwave the retailer's sales increase to 30 units per day, in order to meet this new demand, the retailer increases their demand forecast and places an increased order on the wholesaler to 40 units per day in order to meet the new customer demand levels and to buffer any potential further increase in demand, this creates the first wave in the exaggerated demand being driven down the supply chain.
The wholesaler noticing this increase in demand from the retailer may then also build an incremental increase into their forecast so generating a larger order on the ice cream manufacturer, rather than ordering 40 units to be manufactured, the wholesaler may order 60 units from the manufacturer, this will further exaggerate the demand down the supply chain and so creates a second wave of demand increase.
The manufacturer also feeling the increase in demand from the wholesalers may also react to the increase by increasing their manufacturing run to 80 units, this creates a third wave in the exaggeration of demand.
The retailer may run out of stock during the heatwave whilst the manufacturer is producing new stock and may take the option of switching to an alternative brand to meet customer demand, this will then create a false demand situation as sales appear to slump to next to nothing so the retailer may then not place further demand for the original ice cream brand even though the manufacturer has increased their production runs. Alternatively, if the weather changes and the end consumers slow down on purchasing ice creams, this could result in an overstock situation across the supply chain as each tier of the supply chain has reacted to the heatwave sales and increased their demand. This is an example of the waves and troughs in the bullwhip effect.
How can the supply chain reduce the bullwhip effect?
The bullwhip effect in the supply chain can be reduced through shared knowledge with suppliers and customers. If members of the supply chain can determine what information is causing the overreactions this can be resolved. Communications and response times can be improved using modern technology.
The bullwhip effect can also be mitigated through these areas:
- Reduced lead times
- Revision of reordering procedures/better forecasting methods
- Limitations of price fluctuations
- Integration of planning and performance measurement
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Define the process
The bullwhip effect can lead to excessive inventory investments throughout the supply chain when the parties involved attempt to protect themselves against demand variations. It can also lead to an accumulation of inventory at the manufacturer's end that will further increase supply chain costs.
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