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ASCM Insights

Cracking the Bullwhip Effect

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The COVID-19 pandemic is taking its toll on supply chains across the globe. As a result of changes in demand and consumer buying patterns, the bullwhip effect has rippled up and down our networks. What can industry professionals do to crack the bullwhip effect? First, we must remember that the focus of supply and demand is threefold:Deliver quality services to a business’s final customer.

1. Deliver quality services to a business’s final customer.

2. Acquire appropriate information about a product’s demand.

3. Provide the demanded product to the customer on time and with consistency.

In the past, production planning used forecast demand for products, derived from earlier patterns of customer use. Today, however, supply chains that have embraced digital transformation are changing the ways in which materials, information and financial flows are managed within the integrated business network — customers, retailers, wholesalers, distributors, manufacturers and suppliers. Now, demand is transferred from one set of participants to another.

In addition to global disruptions, such as the one we are experiencing currently, the bullwhip effect occurs when there is lack of information and communication among the participants, causing administration hurdles. Managers order inventory based on historical data to meet expected demand; to prevent going out of stock, suppliers also need some safety stock. This perception of the business of supply leads to demand variability and increases the chance of error in forecast demand, causing the bullwhip effect.

Through this distortion in forecast demand, the profitability and performance of the organization is reduced. Meanwhile, inventory holding costs increase, which may lead to stocking obsolete inventory. Therefore, to crack the bullwhip effect, it is important to understand where the inventory is; what is the actual demand; and, most importantly, that the forecast demand should be properly aligned with each level of the supply chain. With the help digital information flow, businesses can prevent the distortion of demand.

Causes of the bullwhip effect

As previously explained, the bullwhip effect occurs when there is a lack of understanding about demand among supply chain participants. People, therefore, must be trained to analyze the effects of the decisions they make in the ordering system so that they can identify any perceived distortion in the demand. Moreover, information and material delays might contribute to the bullwhip effect. When supply chain participants eliminate time delays, the demand amplification can be significantly reduced.

At each level of the supply chain, participants predict demand with the help of customers’ historic data or buying patterns. But, after orders move from retailer to distributor and distributor to producer, the forecast demands must be modified. The longer the supply chain, the more participants it requires at each stage, which increases the chance of unstable demand among participants. It also increases the chance of obsolete inventory when there is no visibility — or understanding — of actual customer demand.

The grouping of orders depends on the internal strategic policies and criteria of companies. For example, firms are more likely to order regularly, and in greater quantity, from a major supplier to gain economics of scale, to achieve a reduction in transportation costs, and to get discounts on a full truckload. However, larger orders create more variability and opportunities for order-cycle overlap, which increases the likelihood of the bullwhip effect.

To prevent order batching from creating the bullwhip effect, an organization can deploy electronic data interchange (EDI), a method for transferring data among different computer systems or networks and creating links between retailer and supplier. EDI can help reduce the cost of the paperwork by generating an order electronically and informing the supplier, who can stipulate delivery quantities based on how much inventory is sold versus how much is in the distribution center. This practice reduces the distortion of inventory information and leads to customers placing more frequent orders.

Often, when prices are low, retailers stock up products to proactively prevent demand uncertainty before any seasonal activity or price promotion. This technique can lead to the bullwhip effect, as well. However, now that many organizations are implementing vendor-managed inventory (VMI), both the shortage gaming effect and the order batching effect might be completely eliminated. VMI helps the retailer ensure that their end consumer gets the right quantity of stock. Having the right amount of stock isn’t just a financial advantage; it improves service level and increases repurchase intention. With a VMI strategy, the supplier can track customer demand and manage the replenishment of orders and deliveries across many customers by receiving and implementing information related to the points of sale and forecast demand. Likewise, to overcome demand spikes, retailers are prepared to communicate information to their suppliers about promotions or other marketing campaigns to meet the requirement of the on-time delivery of any additional items.

Supply variability, including machine reliability and quality problems, is another potential cause of the bullwhip effect. Outputs from unreliable machines fluctuate, and that fluctuation can trigger the variability of demands for the members of the supply chain that are on the upstream of that machine.

Finally, when demand exceeds supply, a rationing of products can occur. When retailers are afraid that their supply will not be able to meet the desired demand, they start to overestimate their real needs. For example, sometimes customers are allowed to cancel orders when their real demand is fulfilled, which leads retailers to rely on a small amount of information and get confused about the buying pattern of consumers.

The following considerations can also help crack the bullwhip effect:

  • When a company has a suitable control system, it allows its trading partners to meet customer-targeted demand. Because of the system’s controls, the guessing game of predicting upcoming demand might be removed from the supply chains.
  • Accomplishing activities on time is critically important. Decreasing the amount of time spent can reduce the effect of the bullwhip. Each process and operation should be completed in the shortest amount of time possible; removing non-value-added activities goes a long way toward achieving the objective of leanness in an organization. It also means that the organization is providing the product to its customers on time, which is highly valuable for the business and customers alike.
  • Visibility is another effective method; when each stage of the supply chain is clear to the other, including understanding at what level inventories are required, then tasks can be transferred easily. With the help of an appropriate information system to optimize inventory, there should be a limited level with each object in the supply chain, allowing organizations to provide the right product, in the right place, at the right time.
  • Another reason for large order batches is the high cost of transportation. Full truckloads are often much more economical than less-than-full truckloads. One remedy to this problem is the use of a third-party logistics provider (3PL). 3PLs have many customers and can combine orders of different customers, which makes it possible to order less-than-full truckloads for a lower price.
  • Synchronization, such as through the tactic of continuous ordering, is another alternative. This process enables organizations to integrate all functions within a supply chain and enhances the visibility of orders and deliveries, eliminating the bullwhip effect.
  • Bullwhip can also be cracked by an everyday low-price policy (EDLP). With EDLP, companies do not offer discounts but promise a stable low price at all times, which saves customers the effort of searching for the best price and experiencing cost variability. In practice, many companies use EDLP strategy to compete with other firms, decrease price fluctuation, and encourage frequent buyers while increasing the sales volume of retailers.
  • Forecasting cannot be perfect every time; many businesses cope with this fact by keeping buffer stock, a practice that can create the bullwhip effect. To avoid this, supply chain practitioners need to accurately identify the forecasted demand and collaborate their planning and forecasting activities with each supply chain participant, which facilitates better visibility through shared information. This eventually reduces variability in demand uncertainty and production planning, cracking the bullwhip effect and leading to better forecasting and lower safety stock.

While these methods are a powerful antidote to the bullwhip effect, supply chain is rapidly changing; sometimes, these strategies are not enough. Technology-driven solutions can make a big difference to real-time visibility. Let’s take a look at four new technologies that have been created as alternatives to the methods listed above and are viable options for analyzing and eventually eradicating the major sources of the bullwhip effect in supply chains:

1. Cyber physical system (CPS) technology processes and collects information in real time by connecting devices within a network, which magnifies the information base, increases information availability and enables visibility of material flows in the supply chain. With these advantages, the bullwhip effect can be reduced easily because CPS provides quality feedback loops, which eventually reduces the time delay and overall processing time in manufacturing. Furthermore, operational information created under this system should be shared and available, which improves demand forecasting.

2. Cloud computing enables flexibility and scalability of infrastructure and software for the entire supply chain, aiding in the implementation of available information and sharing information in real time across and within the supply chain. All this digitalization leads to time reduction and information consistency, reducing the bullwhip effect.

3. Artificial intelligence is one of the most effective and promising technologies to reduce bullwhip effect. It is renowned for improving demand signals processing and reducing time delay in supply chain by inferring and noticing patterns in data, which ultimately cracks the bullwhip effect.

4. Blockchain facilitates traceability and transparency of data among all trading partners in a network. By providing access to demand data in the supply chain, it is easier for parties to reduce the bullwhip effect and improve their planning accordingly. This technology removes the need of an intermediary and allows distributed information to be shared directly with interested parties, reducing information asymmetry and increasing trust, thereby permitting high data integrity and robustness.

Digital transformation has shifted the structure of organizations in terms of effective and visible management of the supply chain. And, by creating meaningful information systems across each element of supply chain, it increases the smooth flow of material, leading to the satisfaction of real customer demand and maximized profit. That is great news as we continue on the path toward recovery.

About the Author

Sehrish Huma

Sehrish Huma is a supply chain researcher and blog writer who has published scholarly research on logistics management, risk management, operations management and more. She may be contacted at sehrish.huma@gmail.com.

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