If you've never come across the bullwhip effect or the causes of bullwhip effect, consider yourself lucky.
It can lead to issues meeting customer demand, chew through profits, and hurt your supplier relationship management efforts. Much of the problem comes from a lack of understanding of the way supply and demand affect your inventory control and inventory management process.
Keep reading to learn more about the bullwhip effect, some causes, and how you can avoid or limit it. We'll even get into a bullwhip effect example.
What Is Bullwhip Effect?
The bullwhip effect is a phenomenon where demand changes at the end of a supply chain lead to inventory fluctuations along the chain. Generally, slight variations in demand at the customer or retailer level reverberate up the chain causing greater discrepancies.
This in turn causes too many or not enough supplies as needed to be purchased at each level of the chain. These products often end up as dead stock, on backorder, or need to have their prices greatly cut to avoid total loss.
Bullwhip Effect Example
If this all sounds a little confusing, let's break it down with a couple of examples.
Let's say you are a food wholesaler who regularly sells 1,000 cans of tuna to a customer each week. Then, this customer orders double the amount of tuna they normally do. You assume that demand is increasing and purchase 2,000 cans to ensure you don't run out. Seeing your increased purchase, your supplier may also increase the amount of tuna they stock, thus further amplifying the issue.
On the other end of the spectrum, you can run into issues with too little supply. Let's say, in the scenario above, you didn't increase how much tuna you purchase. However, the demand on the customer side continued to increase. Immediately you'd run into an issue meeting demand. You then place a larger order with your bulk fish supplier who also can't meet the demand, leading to a scarcity in cans of tuna.
Though these are greatly simplified examples, you can see how overreacting to demand fluctuations can cause problems throughout the supply chain. Luckily, BlueCart’s wholesale eCommerce platform is an all-in-one DTC and online marketplace that many food wholesalers use to avoid these issues. It comes with many great reporting tools that let you understand your sales trends and meet demand.
Causes of Bullwhip Effect
There are a number of causes of the bullwhip effect in the supply chain. A lack of proper forecasting for customer demand shifts, delivery time, and inventory tracking are often major factors.
Here are the most common causes of the bullwhip effect:
Issues with Lead Time
Lead time is one of the most important aspects of inventory control and directly impacts your ability to meet customer demand. Calculating lead time and planning accordingly ensures you avoid losses and can fulfill orders. However, if there is an issue anywhere along the supply chain, lead time increases for each remaining step. This makes it difficult to meet customer demand and causes greater inventory level fluctuations.
Lack of Communication
One of the most common causes of the bullwhip effect is a lack of communication both internally and along the supply chain. Sharing information regarding shifts in demand, issues with production, and upcoming sales are key in avoiding issues. This is particularly important if you're interested in what is 3pl or dropshipping for eCommerce fulfillment (see order fulfillment meaning). There, your ability to fill orders relies entirely on maintaining a good flow of information.
Incorrect Demand Forecasts
Demand forecasting is complicated and requires setting and analyzing a wide range of Inventory KPI and eCommerce KPIs. Any mistakes along the way can lead to an inaccurate forecast. This in turn leads to an inability to meet demand or too much sitting inventory. There are also many external factors that can cause your forecast to be incorrect. Regularly conducting an inventory audit and reviewing and updating your forecast is key.
Too Many Discounts and Promotions
Another issue that commonly causes the bullwhip effect is running too many promotions or overusing discounts. This is because they disrupt larger demand trends and cause trouble with forecasting. Suppliers become accustomed to fulfilling orders at a high rate and this can quickly become a problem when the sales end and seasonal trends return.
If you regularly run into issues with excess inventory try kitting instead. It allows you to sell underperforming products by bundling them with better products. The markup is higher and you won’t impact the supply chain.
How to Avoid Bullwhip Effect
Since the bullwhip effect can cause so many problems with inventory control, learning how to minimize the bullwhip effect is key. Though there are some causes that can't be helped, you can limit the chance your business is the cause.
Here are five steps you can take to minimize the bullwhip effect:
Proper inventory and order management go a long way to avoiding problems with the bullwhip effect. This is best done using software that can track inventory levels, product flows, and orders in real-time. They give you actionable data and provide detailed insight into your ability to meet demand. Even better, they can help you set par level, calculate optimal reorder points, and avoid wasting money on storing excess inventory.
Limit Your Promotions and Sales
Many businesses think that they should run promotions often to increase demand. This method of sales is dangerous in many ways and can easily cause losses for both the business and every step along the supply chain. This is why supply chain management is important.
Try to utilize sales periods only as necessary to meet customer expectations and customer satisfaction. Instead, focus on upselling and cross selling to increase your average order value and grow your sales in a sustainable way.
Streamline the Supply Chain
When your supply chain becomes congested with too many suppliers and moving parts, it becomes easier to make a mistake. Try to reduce your supply chain and streamline your order processes to ensure limit this risk. It also makes it much easier to maintain relationships and share information quickly.
Improve Order Planning
The unsung hero of inventory management is order planning. Accumulate as much data regarding inventory levels and demand trends to order the optimal amount of each product. You should also factor in any safety stock needed and any upcoming sales or seasonal demand shifts for inventory reduction. Using an ERP accounting system or demand planning software are great ways to optimize your order planning. SKU rationalization can also provide insight about which orders to prioritize.
Optimize Your Minimum Order Quantity (MOQ)
Setting a minimum order quantity is a good way to avoid shipping products at a loss. However, try to avoid complementing your MOQ with bulk discounts as this can attract customers who order more than you can handle. It can cause a lot of strife for your order fulfillment team and cause dramatic shifts in your inventory levels.
Bullwhip Your Inventory Into Shape
The bullwhip effect is an unfortunate effect of poor supply chain management and demand forecasting. By following our tips above and staying on top of trends, you can avoid causing trouble.
How Businesses Can Benefit from the Bullwhip Effect
Generally speaking, the bullwhip effect poses a threat to businesses. However, troubled times give a company the opportunity to change for the better. Let’s see a few examples of how the bullwhip effect can actually help your business.
- Chance to improve inventory management. Supply change issues and surges in supply and demand can help businesses adjust their stock levels accordingly. That way, their inventory can meet any future surges.
- More leverage. Companies further up in the supply chain can benefit from the bullwhip effect. It gives them more leverage and negotiating power during price negotiations. Variability in demand allows wholesalers to adjust bulk purchasing and negotiate better prices.
- Efficiency. Surges in demand caused by the bullwhip effect can help businesses improve their efficiency. By utilizing production capacities and adjusting production depending on fluctuations.
- Improve marketing. As we know, investing in marketing increases demand. So businesses can combat the bullwhip effect by increasing their marketing efforts. This can bring in a ton of additional benefits like improved brand recognition and increased customer loyalty.
- Adaptiveness. The bullwhip effect affects not only a single business but rather the whole market. This means some of your competitors might not be able to compete. If a business can adapt to the changes in the market, it will come out stronger.
Keep in mind that the bullwhip effect has a lot of negative effects on a business. However, hard times build strong businesses. Focus on how to turn the bullwhip effect into your advantage rather than thinking about how to survive.
Frequently Asked Questions About the Bullwhip Effect In Supply Chain
The longer you work in a physical products business, the more likely you are to hear about the bullwhip effect. To fully grasp the bullwhip effect and the causes of bullwhip effect, it helps to learn from common questions people ask. Check out our answers below:
Why is the bullwhip effect bad?
The bullwhip effect is bad because small changes anywhere along the supply chain can lead to massive disparities at any stage. For example, if a retailer experiences two or three times the demand from customers but doesn’t order more product right away, they are delaying backorders, which places more pressure on suppliers later.
Where does the bullwhip effect have its greatest impact?
Though the bullwhip effect can negatively impact any stage of the supply chain, it most often has the greatest impact on raw material suppliers. Raw goods providers supply materials to wholesalers and manufacturers, who are responsible for getting products to distributors, retailers, and consumers.
When demand fluctuates at the consumer level, it reverberates up the supply chain, placing greater pressure on entities involved in the production and dissemination of a good. This may force a supplier to produce a much greater or lesser amount of product, which complicates their workflow and delivery.
Who invented bullwhip effect?
Jay Forrester is credited as the person who invented the term “bullwhip effect.” Forrester was a leading American computer engineer and systems analyst who was well-known for his invention of magnetic core computer memory.
He became an MIT lecturer in 1956 and began presenting his concepts on supply chain management in 1961. Forrester started calling supply chain demand fluctuations the bullwhip effect and has been credited with it ever since.
How to avoid bullwhip effect?
To avoid the bullwhip effect, you have to:
- Stabilize your prices
- Break up order batches
- Stay away from multiple demand forecast updates
- Get rid of gaming in shortage situations
What causes bullwhip effect?
The bullwhip effect is caused by forecasted inefficiencies in the supply chain and distribution channels. This often happens when retailers intensify their expectations of consumer demand. Due to this, there may be a domino effect within the supply chain. It's important to understand the causes of bullwhip effect to prevent this from happening in your business.