What is the Bullwhip Effect?
The order that the manufacturer receives is often much larger than what the actual customers demand is at the point of sale. This irregularity or variance in the size of the orders placed increases as we move up the supply chain, i.e. from the customer to the retailer to the distributor, and then the manufacturer.
So eventually, 40 units were produced against a demand of 9 units, and now the inventory will be pushed to the customer through offers & discounts and more investment will be made for the products marketing and advertising efforts.
What causes this Bullwhip Effect?
Demand forecast updating: Every company in a supply chain follows product forecasting which is usually based on the past order history. This helps in production scheduling, material requirement planning, inventory control and capacity planning. But in this case, the fluctuations are not accounted for.Also, the lead time of the orders varies or fluctuate drastically in some cases, which might force the buyer to place bigger sized orders.
Order Batching Practice: Larger order sizes often offer discounts and lower cost advantages to the buyer, or at times suppliers dont entertain smaller order sizes. Hence, companies tend to accumulate the demand to reach a respectable order size and develop the practice to order monthly or weekly, which creates demand variability as the average demand is not stable across the time-period.
Pricing Fluctuations & Trade promotions:Specific period discounts, or cost fluctuations, can lead the buyers to order in bulk to avail the discounts which cause demand variability in the supply chain.
Rationing and short gaming: When product demand exceeds supply, a manufacturer often rations its product to customers. For example, the manufacturer then allocates its products in proportion to the amount ordered by the different retailers. Retailers often anticipate on potential shortages by exaggerating their real needs when they order. If demand drops later, this will lead to small orders and cancellations.
The only way to counter bullwhip effect is to have the accurate, real-time demand information. To achieve that, we need to shift from a forecast-driven ordering system to measures that allow information sharing with the supply chain partners and hence complete visibility of the actual customer demand.
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References:J.W. Forrester. Industrial dynamics. MIT Press, Cambridge, MA, 1961.H.L. Lee, V. Padmanabhan, and S. Whang. The bullwhip effect in supply chains. Sloan Management Review, 38(3), 1997Salmon (1993).P. Sellers, The Dumbest Marketing Ploy,Fortune, volume 126,5 October 1992, pp. 8893.Yossi Sheffi, Chinas slowdown: The first stage of the bullwhip effect, Harvard Business Review, 9 September, 2015.