Everything You Need to Know About the Bullwhip Effect

Businesses use the supply chain to order and distribute goods to consumers. Supply chain layers work together to create and distribute products across the globe.

However, disturbances in this chain can disrupt access to goods and other business functions. In the phenomenon known as the bullwhip effect, retailers make larger orders in response to sudden fluctuations in market demand, leading to further disruption.

Read on for more information about the bullwhip effect on the supply chain.

What Is the Bullwhip Effect?

The term “bullwhip effect” refers to overestimations and shortages in the business supply chain. Small fluctuations in demand for retail products can cause progressively larger changes in other supplier levels, such as manufacturers and distributors. A small wrist motion can send the end of a whip flying in a wide arc — similarly, variations in demand can have progressively larger impacts on other areas of the supply chain.

The bullwhip effect can cause extreme changes in supply and demand. When purchasing trends and needs shift at the retail level, manufacturers and distributors must adjust their methods to keep up. The other levels often overcompensate in anticipation of the trends, causing each layer to make progressively larger changes.

For example, a retailer has a monthly sale rate of 40 units. Then one month they suddenly sell 100 units. The retailer interprets this as a new business trend and orders 200 additional products in anticipation of future sales. The manufacturer notices the sudden increase in orders and prepares 400 items. The vendors who supply the materials also notice and overorder as well.

If the original sale was a one-time occurrence rather than a new trend, the supply chain has overprepared. The bullwhip effect often creates a struggle for raw materials — the overestimations can cause supply shortages as people overuse materials, making it challenging to meet actual consumer demands. It can also cause an oversupply of items with no demand to balance it.

What Causes the Bullwhip Effect?

The different links and layers in the supply chain tend to respond similarly. They typically adjust their numbers accordingly if they notice a difference in orders or supply. That means that if one level makes a mistake, it can have a negative impact on all other levels.

Some of the circumstances that can cause the bullwhip effect include:

• Insufficient consumer data: Many factors can disrupt news about supply chain trends, including natural disasters, significant world events, shipping issues and miscommunication. If these factors limit communication, supply chain professionals might not have the most accurate data on hand when making decisions. Working from inaccurate data can cause professionals to make decisions that lead to the bullwhip effect.
• Inaccurate lead time: Lead time is the estimated time it will take for manufacturers to assemble and distribute goods. Lead times that are longer than the current trend window can create an influx of supply when there is no demand. For example, an item might be hugely popular for one month. If vendors don’t fill their shelves with it until two months later, the units are less likely to sell. When manufacturers use inaccurate lead-time estimates, they can miss the window of opportunity and cause the bullwhip effect.
• Automatic orders: If organizations use automated ordering systems or order excessive batches, they might incorrectly estimate consumer demand. Automating orders can result in excess supply with low demand or vice versa.
• Discounts or cost changes: Discounts and price changes can also lead to the bullwhip effect. If a seller places a discount on a product, demand might rise. The reduced cost can disrupt normal buying behaviors, prompting sellers to order too much stock in response. 

The Risks of the Bullwhip Effect

The bullwhip effect can have many negative impacts on the overall supply chain. Here are a few examples:

• Too much stock on hand: Sellers might order too many units when they inaccurately predict trends. That stock often goes to waste if consumers don’t have a genuine interest in the product. The remaining units take up space in warehouses, causing increased holding costs. Your business might be unable to recoup costs if there is an extreme lack of customer demand.
• Low-quality customer service: The bullwhip effect causes fluctuations in supply. A lack of sufficient supply can lead to unfulfilled orders and customer dissatisfaction. The more unhappy customers you have, the more your profits could decrease. 
• Lost revenue: When suppliers see supply fluctuations and overorder, they can cause long-term issues for their business. If they don’t have enough stock to fill their shelves, they’ll experience a loss in revenue as consumers look to other sources.

How to Reduce the Bullwhip Effect

It’s essential to avoid the bullwhip effect whenever possible, so you don’t have to face the negative consequences. Here are some ways you can reduce the chances of the bullwhip effect for your business:

• Improve supply chain communication: In many cases, the bullwhip effect occurs due to miscommunication between supply chain professionals. Reevaluate your communication techniques with your supply chain workers and customers. A deeper understanding of customer needs and supply chain updates can keep the bullwhip effect from taking off. You may also consider investing in high-quality supply chain software to help streamline communication.
• Invest in forecasting tools: Consider investing in forecasting software or other tools to ensure you make the best supply chain choices. You’re more likely to make precise ordering decisions when you have access to the most accurate supply chain information.
• Use consistent ordering techniques: Maintaining consistent buying choices is good practice. Ordering in bulk or using excessive discounts could disrupt the supply chain and stock supplies.
• Optimize inventory management: Proper inventory management is crucial for all business areas, including the supply chain. Keeping track of your orders and stock can help you order accurately from suppliers. Consider using inventory management software to ensure you have optimized your inventory accuracy. These systems streamline many inventory processes and allow for better stock control overall.

Prevent the Bullwhip Effect With Finale Inventory

Proper inventory management is a crucial part of preventing the bullwhip effect. Consistently tracking your inventory allows you to improve business efficiency and accurately communicate your needs with supply chain professionals. In turn, your shelves remain stocked, and your customers stay satisfied.

Finale Inventory offers a wide range of inventory solutions, including our cloud inventory management system. With this option, you can access inventory updates at any time, from anywhere with an internet connection. The system offers precise inventory counts, future sales projections and secure data. You can reduce the opportunity for the bullwhip effect with our high-quality inventory technology.

To get started with Finale Inventory, schedule a free demo today.