What is Bullwhip Effect ?
The bullwhip effect can be explained as an occurrence detected by the supply chain where orders sent to the manufacturer and supplier create larger variance then the sales to the end customer. These irregular orders in the lower part of the supply chain develop to be more distinct higher up in the supply chain. This variance can interrupt the smoothness of the supply chain process as each link in the supply chain will over or underestimate the product demand resulting in exaggerated fluctuations.
What contributes to the bullwhip effect?
There are many factors said to cause or contribute to the bullwhip effect in supply chains; the following list names a few:
Disorganization between each supply chain link; with ordering larger or smaller amounts of a product than is needed due to an over or under reaction to the supply chain beforehand.
Lack of communication between each link in the supply chain makes it difficult for processes to run smoothly. Managers can perceive a product demand quite differently within different links of the supply chain and therefore order different quantities.
Free return policies; customers may intentionally overstate demands due to shortages and then cancel when the supply becomes adequate again, without return forfeit retailers will continue to exaggerate their needs and cancel orders; resulting in excess material.
Order batching; companies may not immediately place an order with their supplier; often accumulating the demand first. Companies may order weekly or even monthly. This creates variability in the demand as there may for instance be a surge in demand at some stage followed by no demand after.
Price variations – special discounts and other cost changes can upset regular buying patterns; buyers want to take advantage on discounts offered during a short time period, this can cause uneven production and distorted demand information.
Demand information – relying on past demand information to estimate current demand information of a product does not take into account any fluctuations that may occur in demand over a period of time.
Let’s look at an example; the actual demand for a product and its materials start at the customer, however often the actual demand for a product gets distorted going down the supply chain. Let’s say that an actual demand from a customer is 8 units, the retailer may then order 10 units from the distributor; an extra 2 units are to ensure they don’t run out of floor stock. The supplier then orders 20 units from the manufacturer; allowing them to buy in bulk so they have enough stock to guarantee timely shipment of goods to the retailer. The manufacturer then receives the order and then orders from their supplier in bulk; ordering 40 units to ensure economy of scale in production to meet demand. Now 40 units have been produced for a demand of only 8 units; meaning the retailer will have to increase demand by dropping prices or finding more customers by marketing and advertising.
Although the bullwhip effect is a common problem for supply chain management understanding the causes of the bullwhip effect can help managers find strategies to alleviate the effect.
How to Avoid the Bullwhip Effect in Supply Chain Management ?
Demand exists at every level of a supply chain, but the only demand that really matters is the end customer’s demand for the final product. Every tier should be aware of the end customer demand and not just of the orders placed by its upper tier. Businesses at each tier should also be aware of the pipeline (outstanding) inventory.
Technology systems, such as point-of-sales product scanning and vendor-managed inventory, make sharing these information points fairly painless.
Align your supply chain
Reducing the number of suppliers and the number of tiers in your supply chain can facilitate better communication and decrease the oscillation that creates the bullwhip effect. The restaurant industry has reduced the number of Tier 1 suppliers, which facilitates communications because restaurants have only one supplier they need to communicate with.
Another advantage is that the Tier 1 suppliers may supply many restaurant chains, allowing them to reduce the overall variability they experience in demand. Pharmacies have long benefited from the same structure, with specialized wholesalers (Tier 1 suppliers) that stock medicines and medical devices from all the manufacturers.
Implement an everyday-low-price policy
Promotional sales are a major contributor to the bullwhip effect. To avoid it, successful retailers such as Walmart have adopted the everyday-low-price strategy. If you look at your local Walmart’s weekly advertisement, you may notice that many, if not most, of the products in the ad are listed at their normal prices.
This marketing approach is quite useful. Customers may actually think they’re getting a price discount when they’re not, and Walmart can strategically advertise products they have in excess inventory with the hope that consumers will see the low price and come into the store to purchase the product.
However, the Walmart approach may not work for some products and industries. Recently, one major retailer, suffering from lackluster sales, embarked on an everyday-low-price strategy. Instead of participating in the weekly sales and discount coupons that its competitors use, this retailer started to offer its products at a low fixed price and had monthly special pricing on certain items. Unfortunately, this strategy didn’t have the desired effect. But why?
Most consumers refuse to buy many products unless they’re on sale, and this has an effect on how retailers promote and advertise their products. This appears to be the trend in the fashion retailing and cosmetics industries.
Establish long-term contracts with suppliers
Many successful companies have made their supply chain an integral part of their core business processes. Toyota’s treatment of its supply chain is a major contributor to its success. The best way to embrace your suppliers is to establish long-term relationships with them. This long-term relationship makes the supply chain vested in your success and helps align the goals of both companies.
Lean companies view their suppliers as an extension of their company. One way to embrace the supplier is with long-term contracts based on shared goals and shared performance standards. Long-term purchase contracts give the supplier confidence to invest in long-term improvements, knowing that the revenue stream will be available. To be successful, though, this relationship depends on mutual trust between the buyer and the supplier.
Long-term contracts also make suppliers vested in the contracting company’s success. Most suppliers realize that improvements in their products and processes potentially improve the customer company’s position in the market, increasing sales and leading to increased demand for the supplier’s products.
Improve operational efficiency
The supply chain is only as good as its weakest link. Therefore, improving the processes of your supply chain companies improves your operations.
Improving your processes and your supply processes reduces your delivery lead times and helps reduce the pipeline inventory. The reorder point and desired inventory levels are a direct function of your delivery lead time. As you reduce this lead time, you can reduce the total amount of inventory in your process. Reducing this pipeline inventory lessons the bullwhip effect.
Thus, for stable supply chain and development in the business growth, it is important to understand the causes and effects of this effect. Implement the business strategies and identify the errors that pull you down in your business; more importantly, analyze the supply chain process, and take the suitable decisions without precipitation, to tackle the demand variations.