The Bullwhip Effect in Supply Chains: Curse or Blessing?

THE RESILIENT ENTERPRISE | THE RISKMETHODS BLOG

With supply chains currently under a lot of pressure, the “bullwhip effect” is back in the news. This is when small changes in demand amplify into large fluctuations as they move along the supply chain. But the bullwhip effect might just help soften inflation’s sting.

1. What is the bullwhip effect?

Put simply, the bullwhip effect is when demand signals are amplified as they move through the supply chain. It usually starts with an unexpected change in customer demand, a flick of the wrist at the handle of the whip. This increased demand motivates companies to order more parts from their suppliers. Yet purchasers can sometimes only place batch orders containing a minimum quantity, so for example, ten units when they only need one. The greater volume then increases the supplier’s perceived demand for their product.  

2. Why the bullwhip effect is a problem?

Negative impacts of the bullwhip effect come from the extremes it causes. By magnifying perception, it ultimately can cause shortfalls as well as oversupply. Consequences of shortfalls are lost revenues, excess capacity, and unhappy customers when their products are delayed or unavailable. Too much inventory results in waste, inefficiency, and high costs. Some companies maintain safety stock as a buffer against demand fluctuations, but this ties up capital and is not a cure. 

Because order quantities increase, suppliers struggle to meet demand. So, they in turn place larger orders with their suppliers, in an attempt to get enough parts to achieve higher output targets. At the sub-tier level, the behavior magnifies again. Raw materials suppliers may be hit with big orders from several customers who all seek to secure materials ahead of the competitors. 

3. How the bullwhip effect affects supply chains

At every stage of the supply chain, it is all about meeting demand. Recent events illustrate how demand swings amplify as they move along supply chains. One example of the cause-and-effect cycle comes from the semiconductor shortage: 

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  • Demand for electronic devices rose during the pandemic, fueled by lockdowns and online shopping.  
  • Makers of semiconductors could only produce limited quantities. Shipping woes increased the lead times for their customers. 
  • Producers of electronic devices and cars then placed bigger orders to make up for delays, or to secure buffer stock. 
  • As parts became available, manufacturers increased production to match what they believed was an ongoing demand surge. This puts further pressure on logistics to move the goods quickly. 

Yet now, in the pandemic aftermath, according to commentators including Craig Fuller, CEO at Freight Waves, the bullwhip effect could help mitigate current inflation. How?  

 

Inventories of finished goods and automobiles have risen, yet demand is shrinking. Fewer purchases mean lower prices as companies seek to reduce stocks. As demand drops, bottlenecks in shipping capacity, another driver of higher costs and delays during the pandemic, begin to ease. Once China’s cycle of lockdowns ends, a surge in export backlog may again push up delays and already high prices. 

4. Who invented the bullwhip effect?

Also known as the Forrester effect, the bullwhip effect is credited to computer engineer Jay Forrester from Massachusetts Institute of Technology. Forrester developed a computer simulation in the 1960s to model ever-greater fluctuations of inventory levels along the supply chain (variance amplification).  

 

Some sources attribute creation of the term to consumer products maker Proctor & Gamble, who conducted a study in the 1990s on extreme demand swings for their disposable diapers, Pampers. Other names include whiplash or whipsaw effect. 

5. Can the bullwhip effect be eliminated?

One key cause of the bullwhip effect in supply chains arises from lack of communication between manufacturers and suppliers. An open exchange is key to reducing uncertainty over product availability and delivery times. Companies can then make more accurate demand forecasts and improve production planning. Here is where collaborative supply chain risk management plays a role. It enables enterprises and their partners to jointly manage risk events that could cause delays or shortfall.  

  

6. How The riskmethods SolutionTM can help

Using a robust supply chain risk management program can help enterprises protect themselves from the bullwhip effect’s huge distortions. With the AI-based technology of The riskmethods Solution, you can: 

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  • Understand all risks in your supply chains. By visualizing your supply chain and risk objects on a world map, The riskmethods Solution gives you an overall view of threats. You uncover critical situations, such as supplier clusters, which can cause bottlenecks.
  • Identify risk events early through real-time monitoring. This helps you to secure supply before the competition.
  • Collaborate with suppliers to share information and demand forecasts through riskmethods Supply Risk NetworkTM, so you make better decisions.
  • Perform risk assessments to avoid surprises. Conduct regular or ad hoc supplier surveys for accurate and up-to-date data. Find out their inventory management structure and stock levels.
  • Improve sub-tier visibility so you have a clear picture of capacity and lead times further upstream.

Finally, be prepared for all kinds of risk with holistic supply chain risk management. Stay ahead of the curve to protect your bottom line, and avoid the pain of the bullwhip effect.

Manage your risk exposure and transition to supply chain resilience with our guidebook: 

Supply Chain Crisis Recovery 2022

In early 2022, the Ukraine-Russian war shocked already fragile global supply chains. Based on four pillars, our guidebook offers measures to help you gain visibility into your entire supply network and improve risk awareness.

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