Bullwhip Effect

The bullwhip effect occurs when inaccurate or distorted information is passed on through the links in the supply chain. As the bad information gets passed from one party to the next, the distortions worsen and cause poor ordering decisions by upstream parties in the supply chain that have little apparent link to the final end-item product demand. As information gets farther from the end customer, the worse the quality of information gets as the supply chain member base their guesses on the bad guesses of their partners. The results are wasteful inventory investments, poor customer service, inefficient distribution, misused manufacturing capacity, and lost revenues for all parties in the supply chain.

For example, Open Range Jeans (a fictitious company) are sold in a popular retail store chain. The retail chain decides to promote Open Range Jeans and reduce the price to boost customer traffic in its stores, but the chain does not tell the Open Range manufacturer of this promotion plan. The manufacturer sees an increase in retail orders, forecasts a long-term growth in demand for its jeans, and places orders with its suppliers for more fabric, zippers, and dye.

Suppliers of fabric, zippers and dye see the increase in orders from the jeans manufacturer and boost their orders for raw cotton, chemicals, etc. Meanwhile, the retail chain has ended its Open Range promotion, and sales of the jeans plummet below normal levels because customers have stocked up to take advantage of the promotion prices. Just as end-customer demand falls, new jeans are being manufactured, and raw materials are being sent to the jeans factory. When the falling end-customer demand is finally realized, manufacturers rush to slash production, cancel orders, and discount inventories.

Not wanting to get burned twice, manufacturers wait until finished goods jean inventories are drawn down to minimal levels. When seasonal demand increases jeans purchases, the retail stores order more Open Range jeans, but the manufacturers cannot respond quickly enough. A stockout occurs at the retail store level just as customers are purchasing jeans during the back-to-school sales season. Retail customers respond to the stockout by purchasing the jeans of a major competitor, causing long-term damage to Open Range’s market share.

Causes of the bullwhip effect

The bullwhip effect is caused by demand forecast updating, order batching, price fluctuation, and rationing and gaming.

• Demand forecast updating is done individually by all member of a supply chain. Each member updates its own demand forecast based on orders received from its “downstream” customer. The more member in the chain, the less these forecast updates reflect actual end-customer demand.
• Order batching occurs when each member takes order quantities it receives from its downstream customer and rounds up or down to suit production constraints such as equipment setup times or truckload quantities. The more member who conduct such rounding of order quantities, the more distortion occurs of the original quantities that were demanded.
• Price fluctuations due to inflationary factors, quantity discounts, or sales tend to encourage customers to buy larger quantities than they require. This behavior tends to add variability to quantities ordered and uncertainty to forecasts.
• Rationing and gaming is when a seller attempts to limit order quantities by delivering only a percentage of the order placed by the buyer. The buyer, knowing that the seller is delivering only a fraction of the order placed, attempts to “game” the system by making an upward adjustment to the order quantity. Rationing and gaming create distortions in the ordering information that is being received by the supply chain.

Countering the bullwhip effect

To improve the responsiveness, accuracy, and efficiency of the supply chain, a number of actions must be taken to combat the bullwhip effect:

• Make real-time end-item demand information available to all member of the supply chain. Information technologies such as electronic data interchange (EDI), bar codes, and scanning equipment can assist in providing all supply chain member with accurate and current demand information.
• Eliminate order batching by driving down the costs of placing orders, by reducing setup costs to make an ordered item, and by locating supply chain member closer to one another to ease transportation restrictions.
• Stabilize prices by replacing sales and discounts with consistent “every-day low prices” at the consumer stage and uniform wholesale pricing at upstream stages. Such actions remove price as a variable in determining order quantities.
• Discourage gaming in rationing situations by using past sales records to determine the quantities that will be delivered to customers.

Other Factors

In addition to managing the bullwhip effect, supply chain managers must also contend with a variety of factors that pose on-going challenges:

• Increased demands from customers for better performance on cost, quality, delivery, and flexibility. Customers are better informed and have a broader array of options for how they conduct business. This puts added pressure on supply chain managers to continually improve performance.
• Globalization imposes challenges such as greater geographic dispersion among supply chain members. Greater distances create longer lead times and higher transportation costs. Cultural differences, time zones, and exchange rates make communication and decision-making more difficult. Boeing and Airbus have discovered the downside of sourcing from global suppliers. Much smaller suppliers of kitchen galleys, lavatories, and passenger seats have been unable to fulfill orders from Boeing and Airbus, leaving the latter unable to deliver planes to its airline customers.
• Government regulations, tariffs, and environmental rules provide challenges as well. For example, many countries require that products have a minimum percentage of local content. Being environmentally responsible by minimizing waste, properly disposing of dangerous chemicals, and using recyclable materials is rapidly becoming a requirement for doing business.