While each component in the supply chain adds distinct value for a company, some can end up causing greater ripples throughout the system.
The bullwhip effect refers to instances where small demand changes at the retail level lead to considerable disruptions further up the supply chain.
The term bullwhip effect was popularized in the early 1990s by Procter & Gamble (P&G), when the company noticed a strange order pattern in their best-selling Pampers diapers. While the product had fairly consistent customer sales, there were progressively larger fluctuations at the distributor, manufacturer, and supplier levels.
Since then, the bullwhip effect has been a common observation in many companies, posing significant impacts on a company’s supply chain.
What is the bullwhip effect?
The bullwhip effect is a phenomenon where small changes in customer demand create increasingly amplified disruptions in the supply chain.
Also referred to as the Forrester effect, the bullwhip effect is named after the physics behind a cracked whip. When someone holding a whip snaps their wrist even slightly, it creates a wave pattern that continues accelerating until the whip's end.
Similarly, a slight demand fluctuation at the retail level can escalate considerably throughout the supply chain.
The bullwhip effect usually moves from the customer-facing end up the supply chain, with greater variances seen from retailer to wholesale distributor to manufacturer to raw material supplier.
Left unchecked, the bullwhip effect results in inaccurate inventory forecasts, overstock or stockouts, and other supply chain disruptions.
5 Possible causes of the bullwhip effect
Although the bullwhip effect typically starts at the retail level, miscommunication at every stage of the supply chain can heighten confusion about actual demand.
As supply chains become more complex and market trends change, it helps to know the early signs of the bullwhip effect. Here are five possible causes of bullwhip effects in your supply chain.
Inaccurate demand forecasts
Demand forecasts are the foundation of a company’s supply chain. Relying on past forecasts and old data, however, can leave a company unable to meet current market demand.
To guard against inaccurate forecasts, it’s best to use real-time inventory management from a best-in-class solution like QuickBooks Enterprise to analyze customer demand. Demand planning and forecasting should be conducted regularly, especially for markets prone to frequent fluctuations.
Lack of communication
Every entity in the supply chain needs to be aligned to meet market demand effectively. Just as products move down the supply chain, from manufacturer to retailer, any relevant information should also be clearly communicated across all teams.
Unfortunately, most entities operate independently, multiple software tools and collected data. This lack of communication leads to misalignment throughout the supply chain.
Unexpected lead times
Not being able to replenish inventory stock quickly hinders a company’s ability to fulfill customer demand. While products with naturally long production cycles and reorder points can be scheduled accordingly, some issues may delay anticipated delivery dates. Unexpected lead times leave a company with less than optimal inventory levels and inefficiencies that make it difficult to meet demand.
Larger order batching
Some companies prefer to purchase their inventory in bulk in case of expected supply chain issues.
While order batching is up to the company, it can create an inaccurate reflection of market demand. Manufacturers and wholesalers see these batched orders as signs of increasing demand, which often leads to overreactions and increases in their own supplier orders.
Frequent product discounts
While product discounts are a way to attract customer sales, they also distort regular buying patterns and prompt spikes in production planning. Offering discounts too often makes it challenging to determine natural trends and accurately forecast demand.
Additionally, manufacturers and distributors further up the supply chain may misinterpret the increased sales as a sign to scale up their operations.
Example of the bullwhip effect in action
To see how demand can fluctuate throughout the supply chain, let’s look at an example of the bullwhip effect in action.
Say a retailer normally sells 200 office chairs each week. In the last week, sales increased to 300 office chairs. Noting this rise in demand, the retailer adjusts its forecasts and orders 350 office chairs from its wholesaler, adding an extra 50 units to ensure it doesn’t run out of stock.
The wholesaler in turn orders 400 office chairs from the manufacturer, a bulk amount that offers the best per unit price. After receiving the significantly larger order, the manufacturer decides to be on the safe side and produce a total of 450 office chairs.
Now, 450 office chairs are being produced for an inventory forecast of only 300 office chairs, which may eventually settle back to its original sales number.
At each step in the above example, demand forecasts are increasingly distorted. Unfortunately, if demand decreases, all supply chain entities will be left with excess inventory. Retailers will be forced to sell at a discount (which may temporarily increase sales again), and reduce or even skip succeeding wholesale orders altogether.
Manufacturers, being far removed from direct customer demand, usually take longer to adjust their operations and can end up with much more unsold inventory.
How your business can avoid the bullwhip effect
Fortunately, there are several ways to avoid the bullwhip effect. As with all major areas of operations, clear communication and access to information are necessary to optimize operations. Once those are in place, the following are some proven ways to avoid the bullwhip effect:
Increase visibility across teams
A big factor in preventing the bullwhip effect is improving visibility across your supply chain. Not only will access to real-time metrics help align various teams, it also paints a clear picture as to why customer demand is changing.
Additional context aids in determining whether any changes should be made upstream in the supply chain, whether due to point-of-sale promotions, seasonal trends, or greater market shifts.
QuickBooks Enterprise offers over 200 built-in reports to create a single source of truth and reduce potential misunderstandings. With functionality like automated reorder points, supply chain management is made more efficient with clear inventory visibility and optimized lead times.
Streamline your supply chain
With the bullwhip effect showing more significant variances at each step of the supply chain, an effective way to reduce its severity is to streamline operations management. Eliminating unnecessary steps, finding faster logistics options, and decreasing lead times are all ways to mitigate bullwhip effects. An automated inventory management system, like QuickBooks Enterprise, will further facilitate the process while reducing the risk of manual error.
By getting products to customers in less time, companies can quickly respond to demand changes and reduce the likelihood of overstocking or losing sales.
Minimize price fluctuations
Many companies resort to discount promotions to increase sales, making it difficult to predict demand accurately. While you don’t have to do away with all promotions, some pricing strategies can better facilitate the sale of older products.
For example, companies can utilize bundling or upselling to increase sales. Another alternative is to simply factor in scheduled sales periods when calculating demand forecasts.
Improve inventory and order management
Two key variables of all supply chains are inventory control and order management. When changing demand forecasts, it’s important to review other supply chain details, such as inventory cycle counts, prescribed safety stock, historic sales, and the like.
Understanding data collected over the long-term helps put current demand into perspective and enables more informed decision-making on the best order quantity.
QuickBooks Enterprise brings all inventory and order information onto a single dashboard. With all the available stock levels, delivery dates, and order statuses at your fingertips, successfully avoiding the bullwhip effect is much easier.
Final thoughts
Awareness of the bullwhip effect in supply chains is necessary to run a successful business. Not detecting distortions early on leaves a company prone to excess stock or inventory shortages, both of which result in a significant loss in revenue.
By sharing information and streamlining order management, your company can safeguard against any adverse impact of the bullwhip effect.
