Bullwhip effect

The bullwhip effect is a phenomenon experienced by businesses involved in any aspect of producing or selling products. The phenomenon refers to the way small changes in demand by the consumer result in increasingly larger changes up the supply chain, affecting even those suppliers that provide the raw materials needed in production. It addresses a perennial problem that can result in excessive inventory or shortages at various points in the supply chain. The effect has a number of causes, and can usually be overcome by enhanced point of service sales monitoring and inventory management techniques. It is considered by many to be the single most important theory about supply chain management.

Background

The bullwhip effect gets its name from the similarity between the action of the cracking of a literal bullwhip and the way small changes at the consumer level can cause increasing ripples of effect up the supply chain. The small action of a person cracking a whip causes the whip to form waves that increase in effect until they reach the tip. In the same way, the small changes in demand by customers cause increasing waves all the way to the supplier of raw materials at the top of the supply chain.

The concept originated from Massachusetts Institute of Technology (MIT) systems scientist and professor Jay Wright Forrester in his 1961 book Industrial Dynamics. Forrester never used the term bullwhip effect, however. The name was given by logistics experts at Procter and Gamble Corporation (P&G) sometime later. The P&G employees were studying the sales and ordering history for baby diapers and observed the effect at work. They noted that even when consumer demand for diapers changed only slightly, the resulting fluctuations in demand at the distributor level were greater than expected. These differences increased all the way to the level of the orders for the various materials used to make the diapers.

The P&G logistics experts dubbed this phenomenon the bullwhip effect. Although it had been identified in 1961, it was not until 1997 that it was popularized by college professor Hau L. Lee and his colleagues in journal articles. The phenomenon is also known by a number of other names, including the Forrester effect, after the man who first described it. Other names for the phenomenon include the whiplash or whipsaw effect and the demand amplification effect.

Overview

The bullwhip effect is an important concept in supply chain management. Supply chain is the term used for the series of steps and companies between the materials used to make an item and the person or other entity that ultimately buys it. For example, the supply chain for a piece of paper would include the lumbering company that cuts down the trees, the plant that processes the wood into pulp, the plant that turns the pulp into paper, the distributor that sells the paper to the office supply store, and the customer who buys the paper.

The effect occurs when there are greater variations in the supplies ordered along the chain than can be accounted for by the purchases at the customer level. For instance, the customer at the office supply store buys three packs of paper; the entire supply needed to meet customer demand is, therefore, three packs. The office supply store then orders five packs of paper to restock to ensure it has enough for future customers. The distributor serves five office supply stores, so it orders twenty-five packs, so it has enough if all its customers order five packs. The plant that turns the pulp into paper gets this order, but it is not feasible to make just twenty-five packs to fill this order, so the plant processes enough to make five hundred packs. It orders more pulp to meet this order, which requires the company that provides the pulp to request more trees. To meet the minimum order, it has to order enough trees to process five thousand packs of paper.

This is a simplified version of the effect because each step along the supply chain very likely has more customers than just the ones included here. However, the concept remains the same: There can be wild variations in how much of an item is produced or ordered in relation to how much customers want.

Experts identify a number of reasons why this effect occurs. One reason can be fluctuations in demand at the customer level. This can be caused by personal preferences, aversion to risk, changes in the market, and a number of other factors. For example, customers may purchase more paper during back-to-school time and comparatively little the rest of the year. If order projections are based on the peak orders in August and September, too much inventory can result.

Another cause can be the overestimation of how much safety stock, or reserve inventory, the company wants on hand. Companies know it is bad for business when they cannot meet customer demand, and this may prompt them to over order. Order batching, or holding orders until the end of a week or month before sending them up the supply chain, can also contribute to the bullwhip effect. Companies do this for various reasons, including convenience, to take advantage of bulk discounts, and to save on transportation costs. Batching can artificially inflate expectations at the next supply level for how much will be needed and result in excess ordering. Another factor can be a technique called shortage gaming. If a company knows an item is in short supply and it is likely to only get half of what it needs, the company may order twice as much to ensure it gets an adequate supply to meet its customers' demand. The next step in the supply chain produces more merchandise based on the larger order, which is not really needed and results in excesses.

The bullwhip effect can cause a number of consequences. In addition to excessive inventory that needs to be liquidated at low prices, it can result in backlogged orders, unpredictable work schedules for employees in the manufacturing process as orders fluctuate, missed sales because of lack of merchandise, and price increases because of inflated demand. The effect can be minimized by maintaining good inventory control through point of sales systems, using historic trends instead of current demand to guide ordering, and implementing "just in time" production techniques that produce just the amount of merchandise that has been ordered.

An example of the bullwhip effect occurred in the early 2020s amid the COVID-19 pandemic. Panicked consumers bought excessive amounts of toilet paper, with some experts estimating the increase to be six to eight times its normal level. As stores sold out, they ordered more and manufacturers increased their production to meet demand. However, the demand was a temporary fluctuation in consumer behavior, and when consumption returned to its normal level, manufacturers had to adjust their workforce and raw materials ordering.

Bibliography

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