If you've never come across the bullwhip effect, consider yourself lucky.
It can lead to issues meeting customer demand, chew through profits, and hurt your relationship with your suppliers. 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.
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 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. Try to utilize sales periods only as necessary to meet customer expectations. 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 demand planning software is a great way to optimize your order planning.
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.