Understanding Bullwhip Effect In Supply Chain Management

Many factors, such as organizational structure, information channels, geographical distribution, industry characteristics, etc., affect the effective operation of the supply chain. However, the most significant influence factor is the “bullwhip effect”. The bullwhip effect is about how a small change in consumer market demand in a supply chain can be magnified by the first level to the manufacturer, the first supplier, the secondary supplier, etc. Understanding Bullwhip Effect In Supply Chain Management is important if you want minimize it.

The main reasons for the whip effect can be summarized briefly as the length of time between order and delivery, forecast errors, problems sharing information, long supply times, stack orders, price changes, promotions and product mix changes.

In shape, it’s like a bullwhip waved by a western cowboy, with a flicker of the wrist, and the whip shakes dramatically, drawing a beautiful arc, hence the name – the “bullwhip effect.”

The analogy is as follows-

A 10% change in retail sales suggests that sales will increase further and ensures that the sales forecast is at least 20%. It causes a 40% increase in production and a 70% increase in raw material orders.

Examples of Bullwhip effect

We can see the whip effect in many sectors.

After Hewlett-Packard announced to the market that laserjet printers could experience a shortage of supply, retailers increased their orders in an unceasing way and exceeded sales expectations. The order from the HP printer department to the HP integrated circuit department was also more than required, and the stocks were again exposed to the whip effect

Barilla Company. The company triggered the whip effect by announcing that it would apply price discounts to its customers who place their orders in full truckloads. When customers made enormous orders, the additional cost of producing more was too high, which did not fully cover the shipping price they reduced by taking bulk orders.

Campbell’s Soup : Retailers experienced the same whip effect as they placed pre-loaded orders. But consumer demand for soup remained steady.

Understanding Bullwhip Effect In Supply Chain Management

Bullwhip effects

The bullwhip effect leads to an over-reaction to market changes. When the market demand increases, the capacity of the whole supply chain increases more than the market demand increases, and the excess is overstocked in the form of inventory at different nodes of the supply chain. Once demand slows or there is negative growth, large amounts of money and products will be overstocked in the form of inventory, and the entire supply chain may have poor liquidity, seriously affecting the good functioning of the supply chain and even leading to the closure of business, especially small businesses at the end of the supply chain.

Cisco, for example, burst the dotcom bubble about 2000, leading directly to the write-off of up to $2.4 billion in inventory. In the semiconductor equipment manufacturing industry, the large amount of inventory after the economic bubble around 2000 was not processed until 2002, when companies moved to write off tens of millions of dollars of out-of-date inventory. For many secondary and sub-suppliers, this means no new orders, no new revenues, and no ability to sustain operations. As a result, a large number of suppliers were on the verge of collapse, slashing jobs and even running into bankruptcy.

In terms of the responsiveness of the market, the bullwhip effect indicates that the more at the back end of the supply chain, the slower the response time of the enterprise. As a result, suppliers tend not to be able to support manufacturers when demand increases, while when demand slows, suppliers tend to continue to overproduce, resulting in inventory backlogs. Due to the bullwhip effect, the production capacity of the entire supply chain is over-inflated, accompanied by overproduction. Once the economy is depressed, the entire supply chain is forced to slash staff, shut down and transfer equipment.

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Causes and reasons for the bullwhip effect

The main reason for the whip effect is that we do not know how much production or how much stock we need to keep in order to meet customer orders in the period ahead.

Multiple forecasts

Predicting demand correctly is essential to making the right decisions. On the other hand, changing sales forecasts frequently according to instant changes in demand, which we can call noise, will not work, but will cause additional fluctuations in the supply chain.

Order batch decision

Sellers generally place orders with suppliers in accordance with the cycle or order accumulation to a certain quantity. In order to reduce the frequency of orders, reduce costs and avoid the risk of out-of-stock, sellers tend to increase orders.

Mass production/ordering

In order to achieve the scale effect of production and transportation, manufacturers often mass produce or purchase goods, with a certain inventory backlog in exchange for higher production efficiency and lower costs. When market demand slows or products are upgraded, the costs are often huge, resulting in inventory backlogs, inventory expirations, or both.

Price fluctuations and promotions

Manufacturers often introduce various promotional measures for promotions, the result of which is a large buy-in by the buyer, which leads to a partial backlog. This is particularly significant in the retail industry, making market demand more irregular, artificially increasing the magnitude of demand changes, seriously affecting the normal operation of the entire supply chain. Research shows that price fluctuations and promotions can only advance future demand, and in the end no one can profit from it throughout the supply chain.

Tackle shortages

When the demand for the product is greater than the supply, the supplier will implement rationing, at which point the seller deliberately exaggerates its order demand in order to obtain a larger share of the rationing quantity, resulting in the supplier not being able to obtain accurate and real demand information.

Human psychology

Executive psychology is also thought to have a significant impact on the whip effect. As fluctuations in demand increase, managers who sometimes face very high orders and cannot meet them on time can decide to keep more stock than they need in order to not fall into this situation in the future, and in this way they become a source of bullwhip effect without realizing it.

Another factor that creates the whip effect is the deviation and loss of information that occurs when one item is passed from one item to another item in the supply chain. The desire to react to instantaneous but temporary fluctuations in demand and frequently update demand forecasts cause additional fluctuations in the supply chain.

How to minimize the bullwhip effect?

Understanding the elements that cause the whip effect will also guide the methods that can be used to reduce it. Measures such as correctly updating sales forecasts, frequently making orders with small parties, implementing fixed price policies such as Walmart’s “low price every day” application, not using discounts as much as possible based on order quantity will be effective in reducing the high costs in which fluctuations are generated throughout the supply chain.

In addition, sharing orders, demands, capacity and other information within the supply chain from the end customer to the manufacturer and its suppliers, managing customer stock by the supplier and centralization of supply chain inventory management, shortening supply and order times will also play a big role in rapidly reducing inventory costs in the supply chain.

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Understanding Bullwhip Effect In Supply Chain Management

Basic methods of controlling the bullwhip effect

Demand Forecast

The most important process that needs to be managed in order to control the bullwhip effect is the demand forecast. With demand forecasting, we try to predict how demand may change in the coming periods, taking into account historical data, experience and economic conditions.

In the supply chain, all items make various demand forecasts depending on each other. Each item is based on estimating the demand of the next item and accordingly following a inventory and order policy. Since the continuous correction of forecasts in the chain will reveal the whip effect, the method of receiving requests directly from the last item, i.e. the customer, should be used. In this way, since the data on the final customer demand will be shared among all elements of the supply chain, the items will make demand estimates according to the actual needs of the chain, i.e. depending on the final consumer order.

Ordering/supply mode

Ordering/supply mode from a one-time large batch to a multi-batch small batch change, to encourage the shortening of the order period

According to Walmart, if you buy 26 weeks in advance, the demand forecast error is 40 percent, if you buy 16 weeks in advance, the demand forecast error is 20 percent, and if you buy at the beginning of the sales season, the demand forecast error is 10 percent. Through the application information system, sales information and the flow of goods can be obtained in a timely manner, and real-demand orders can be realized through multi-frequency and small quantity joint delivery methods, thus further reducing the error of demand forecasting.

Reduce the number of stages of supply chain systems

Reduce intermediate circulation and distribution links, shorten the supply chain, thereby reducing upstream demand fluctuations.

Order grading management

Suppliers should classify sellers according to certain criteria, divide different levels for different sellers, and implement hierarchical management of their orders, so that the probability of variation can be reduced by keeping key sellers and important sellers under control;

Information Sharing

When you try to reduce the whip effect by making accurate demand estimates, controlling price fluctuations, or order management, it will actually be seen that the necessary data in all of these applications comes from the next element of the chain. However, the important thing for these methods to be effective and reduce the whip effect is the necessity of “using a single and accurate data source”. This will only be through the sharing of the correct data by all items. In addition to sharing this information, it is of great importance that the system dynamics are fully understood by chain elements. The sharing of POS (point-of-sale) data with all elements as tools for sharing information within the chain will be the sharing of electronic data exchange (EDI), internet-based order processing, sales, inventory and capacity information between chain elements.

Conclusion

Considering that competition is not between companies, but between supply chains, the necessity for items in the same supply chain to collaborate with their customers and suppliers is once again revealed. In supply chains, without considering the structure of the system, the steps each company will take on its own will not be enough to improve the entire supply chain. The additional costs that any item in the supply chain will be loaded due to the specified strategy are actually shared within the entire chain unnoticed. Here, it is very important for the companies that make up the supply chain to ensure that information is exchanged forward and backwards around a strategic plan for the common interests of the chain in order to prevent the whip effect.

Reference:

Lee, Hau L.,Whang S. and Padmanabhan,V. (1997) The Bullwhip Effect in Supply Chains, Sloan Management Review/Spring

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