Define the Bullwhip Effect

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Define the Bullwhip Effect
The bullwhip effect is caused by unforeseen variables in demands on the supply chain. (chain image by Pefkos from Fotolia.com)

The bullwhip effect refers to an economic condition relating to materials or product supply and demand. Observed across most industries, the bullwhip phenomenon creates large swings in demand on the supply chain resulting from relatively small, but unplanned, variations in consumer demand that escalate with each link in the chain.

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Definition

A series of events leads to variability in supplier demand up each level of the supply chain. The bullwhip effect occurs when consumers purchase more than required for their immediate need.

Cause and Effect

Events triggering the bullwhip effect include increases or decreases in order frequency or quantities, order batching to reduce shipping costs, price reductions or sales quotas, return policies or any combination of these. Triggers begin at any point in the supply chain: consumer, retailer, distributor, manufacturers, raw materials suppliers and so on. As orders progress up the chain, each level perceives a greater demand that it seeks to rectify from its own perspective.

Once the amplified need reaches the top of the chain, an oscillation occurs, swinging the supply and demand variable in the opposite direction, that is, triggering an oversupply that drives down demand, creating unavoidable market and profit variables. The net result is excess inventory, storage and procurement costs, lost profits and substandard service at each level.

Supply and Demand

Demand variability is only one side of the issue. Variations due to weather and natural disasters, industrial accidents and fires, worker strikes, changes in customs and duty fees or other politically initiated unknowns all change available supply. Shortage of just one material causes a ripple in the opposite direction, driving up demand as each link increases orders to hedge against shortages.

Counter Measures

Mitigating the bullwhip effect begins with determining what link signals the demand change: the customer, retailer, distributor or manufacturer. Counter measures seek to break the effect at various points within the chain. For instance, utilising third-party logistics (where trucking companies batch orders for several customers at once) or scheduled rather than random deliveries, counter order batching. Other measures include quantity limits, special purchase contracts and everyday low pricing policies (EDLP).

Portfolio Planning

Diversifying the supply base or involving suppliers in long-term contracts mixed with rapid-response short-term suppliers protects against market uncertainties. Long-term suppliers receive steady income, while short-term suppliers receive a premium associated with the higher risk. For instance, rather than maintain a full-time labour force, a manufacturer could mix some full-time with part-time, contract and temporary labour to manage demand.

Postponement

Delaying the final features of a product, such as packaging, allows the manufacturer to assess demand nearer to delivery time. An example would be a canned food supplier waiting to label store brands based on final orders.

Information Sharing

Regular supply chain members may actively share information allowing for better demand variables. This requires sharing point-of-sale data up the supply chain and involves a level of trust between members of the supply chain group.

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