The Bullwhip Effect

Poor demand planning and forecasting in a supply chain often leads to an imbalance between supply and demand that, in turn, results in either product shortages or over-stocked inventory. An amplified demand forecasting error further downstream in the supply chain, when each supply chain member is blindsided by the lack of accurate demand information.

For example, when the actual customer demand is 1,000 units, with 10% set aside for a safety stock, the supplier furthest upstream of the supply chain ends up absorbing 1,464 units—that is, 364 units more than what is actually needed.

This phenomenon is called the bullwhip effect. The bullwhip effect (or whiplash or whipsaw phenomenon) is generally referred to as an inverse ripple effect of forecasting errors throughout the supply chain that often leads to amplified supply and demand misalignment, where orders (perceived demand) to the upstream supply chain member (e.g., the supplier) tend to exaggerate the true patterns of end-customer demand because each chain member’s view of true demand can be blocked by its immediate downstream supply chain member.

The common symptoms of the bullwhip effect include delayed new product development, constant shortages and backorders, frequent order cancellations and returns, excessive pipeline inventory, erratic production scheduling, and chronic overcapacity problems.

Causes of the Bullwhip Effect

The bullwhip effect can be caused by a number of management failures and mistakes, as

• Information failure— Product proliferation, diversity, and demand uncertainty make it increasingly difficult for manufacturers, suppliers, and retailers to predict and plan for orders and production volume. In particular, during the period of continuous product shortages, overzealous downstream suppliers and retailers tend to over-order and stockpile their shelves with excessive inventory to catch up with previous demand, thus creating “phantom demand,” which in turn triggers over-production in the supply chain. Therefore, a lack of accurate demand information is one of the primary causes of the bullwhip effect.
• Chain complexity—In a typical chain structure, middle men such as distributors are considered sales agents of manufacturers and often represent multiple manufacturers with diverse products. As such, channel intermediaries such as distributors by nature cannot match the quantities and characteristics of products desired by the ultimate end customers to those of products provided by manufacturers. For this reason, the presence of channel intermediaries complicates the supply chain and subsequently increases order cycle time throughout the entire supply chain. Therefore, the chain complexity that further blurs supply chain visibility can add up to forecasting difficulty and the subsequent bullwhip effect.
• Product proliferation—As many mass-merchants or whole sellers are demanding more diversified product lines and tailored services to meet the specific needs of different segments of customers, there has been an explosive proliferation of products offered to customers in terms of color, design, and function. Such product proliferation may significantly increase the chain complexity and demand volatility, which in turn causes the bullwhip effect.
• Sales promotion—Today’s savvy customers tend to shop only when a sales promotion in the form of coupons, rebates, and seasonal discounts is available. This shopping pattern often results in peaks and valleys of customer orders and correlates with frequent price changes. Although a sales promotion is intended to benefit end customers, many downstream distributors also tend to stockpile huge amounts of promotional inventory with an expectation of a future price increase. Therefore, a sales promotion is likely to create phantom demand throughout the supply chain, contributing to over-order, over-production, or temporary product shortages.
• Economies of scale—To exploit cost-saving opportunities resulting from economies of scale, many firms prefer to order on a periodic basis so that they can accumulate orders large enough for volume purchasing or freight consolidation. Such periodic ordering is likely to cause a so-called “hockey stick” phenomenon (order surges at the end of month, quarter, or year), which not only amplifies order variability but also increases order cycle time. For instance, with the widening spread between truckload (TL) and less-than-truckload (LTL) rates in the wake of transportation deregulation, a growing number of firms are prompted to aggregate small orders into larger shipments by delaying shipments until a sufficient amount of volume is created. Such freight consolidation can substantially increase order cycle time, thus exacerbating the bullwhip effect.
• Speculative investment behavior—In years of economic upturns, many firms tend to perceive product shortages as the loss of market share or revenue, thereby triggering a period of over-investment and production. Because speculative investment behavior often impedes a firm’s ability to match supply and demand, it aggravates the bullwhip effect.