The Bullwhip Effect

What is the Bullwhip Effect?

The bullwhip effect can be defined as “the amplification of demand variability from a downstream side to an upstream site” (as cited in Cachon, Randall, & Schmidt, 2007). It refers to the occurrence discovered in the supply chain where products from manufacturers and suppliers are in greater variance than the sales to the end buyer. This variance can disturb the flow of the supply chain management as each following point in the supply chain will cause over – or underestimations concerning the demand of orders, consequently causing even greater fluctuations (What is the bullwhip effect, 2012). The bullwhip effect is a negative phenomenon of supply chain management that results from demand forecast updating, order batching, price fluctuation, and rationing and shortage gaming and can be prevented and eliminated by implementing measures to monitor demand data, share information, implement a vendor-managed inventory system and improve the interaction between members of the chain.

The bullwhip effect can be demonstrated by the “beer distribution game,” which was developed by Sterman (Moll & Bekker, 2013). The main idea of the game is to simulate the beer distribution supply chain. The participants assume the roles of a retailer, wholesaler, distributor, and manufacturer. Customer demand is shown on cards every week. The retailer sends the requested amount and buys a new line from the wholesaler. In turn, the wholesaler sends the requested amount and buys the new line from the distributor, who then buys products from the manufacturer. Each phase involves managing shipments and dealing with delays in the ways that minimize the overall inventory and stock out expenses (Moll & Bekker, 2013). The beer distribution game demonstrates that orders and inventory tend to oscillate and decline for all the participants. As inventory levels drop, the participants place bigger orders resulting in the production of the amount of beer that is higher than needed. Consequently, orders decline fast, and the oscillation escalates (Moll & Bekker, 2013).

The bullwhip effect is a common phenomenon in various markets, and is present not only in theory and simulations. Among first, the bullwhip effect was recognized by Procter & Gamble Company, which discovered abnormal patterns of diapers distribution. The company noticed that small fluctuations of sales at retail stores can result in high fluctuations of orders from the distributor and even higher from the suppliers. The examples of this phenomenon of increasing variations of demand as the orders move up the supply chain were found in the electronics market, the grocery business, automobile industry and many others (Moll & Bekker, 2013).

When Does the Bullwhip Effect Happen?

In order to understand when does the bullwhip effect occurs, Lee, Padmanabhan, and Whang (1997) specify four main factors that contribute to it: “demand forecast updating, order batching, price fluctuation, and rationing and shortage gaming” (3). Each of these causes can result in the bullwhip effect. Thus, understanding them can help the supply chain managers develop measures to prevent or solve it. Moll and Bekker (2013) refer to these causes the operational ones. In addition, they identify behavioral factors that include inadequate estimations of the order delivery delays for all the companies in the supply chain. These miscalculations result in over or under ordering. Another behavioral factor relates to misuse of stock levels when companies only try to manage their own element of the supply chain.

Demand Forecast Updating

All organizations in a supply chain usually perform forecasting for their products that is usually based on the order history. This factor can be intensified by behavioral issues, for example, different perceptions or mistrust. Every company’s decision-making relies on own observations. For example, if a retailer orders some amount of products, the wholesaler perceives this information as an indicator of future demand changes and adjusts own forecasts, making other companies up the supply chain to do the same. Lee, Padmanabhan, and Whang (1997) believe that demand signal processing is the most important cause of the bullwhip effect.

Order Batching

Companies do not always order products immediately after sending some of their inventory down the supply chain. They usually batch demands before placing an order. Lee, Padmanabhan, and Whang (1997) distinguish between two types of batching: “periodic ordering and push ordering” (4). The process of periodic batching involves making weekly, monthly or other regular orders instead of buying products every time frequently, which can be ineffective in terms of the time and cost needed to process a single order. In addition, order batching is advantageous for companies that deal with slow-moving shipments. Order batching is recognized as a cause of the bullwhip effect since it involves an unpredictable demand. A company that orders at one time during the specified period and places none orders in between creates the variability for supplier, which is significantly higher than the demand variability the company has. Periodic ordering amplifies variability and contributes to the bullwhip effect.

Push ordering involves dealing with regular upswings in demand, which relate to “end-of-quarter or end-of-year order surges” (Lee, Padmanabhan, & Whang, 1997, p. 4). The bullwhip effect occurs when an organization experiences periodic ordering from its clients, which is not distributed evenly throughout the specified period. Moreover, ordering is usually random and tends to overlap, causing high variability during these surges.

Price Fluctuation

According to Lee, Padmanabhan, and Whang (1997), “80 percent of the transactions between manufacturers and distributors were made in a “forward buy” arrangement,” which involves purchasing in advance. Forward buying is a result of price fluctuations, which happen due to discounts, coupons, sales, and other promotions. Such actions can have a serious impact on the supply chain if a customer buys in higher amount of product than he/she needs due to low prices. When product’s cost is back to normal, the customer stops purchasing. Consequently, there occurs a variance between customer’s buying and consumption patterns – the bullwhip effect.

Rationing and Shortage of Gaming

Rationing occurs when demand is higher than supply, and a manufacturer has to divide its inventory among customers proportionally to the requested amount. For example, if demand is two times higher than supply, manufacturers provide all customers with a twice smaller amount of products of their order. This practice may present a problem for manufacturers when customers, anticipating the rationing, order more than they really need. Later, when demand decreases, manufacturers face order cancellations. This process is called “shortage gaming” and has a negative effect on manufacturers’ planning in early stages of production. In addition to exaggerating orders, customers may duplicate them with different sellers and purchase from the first one to deliver, and then cancel other orders (Lee, Padmanabhan, & Whang, 1997).

What Measures Could Be Taken to Prevent and/or Solve This Effect

In order to prevent the bullwhip effect, the companies should first understand what influences demand and inventory management. One of the most effective measures for dealing with the variations in the analysis of demand and supply patterns for both the suppliers and customers. Donovan (2002) suggests the following measures for minimizing the bullwhip effect:

• Monitor actual demand.

• Reduce the time between receiving data on forecasted and actual demand (Donovan, 2002). Chen et al. claim, “smoother demand forecasts provide smaller variation increase” (as cited in Ertek & Eryılmaz, 2008). It is recommended that the retailer use more demand data to prevent the bullwhip effect.

• Analyze demand patterns throughout the entire supply chain.

• Share data on demand patterns through more frequent and effective collaboration. Ertek and Eryılmaz (2008) claim that information sharing helps to mitigate demand variance. In addition, quality of data is a significant factor in solving the bullwhip effect. However, the phenomenon cannot be solved completely by using information sharing practices.

• Discover and remove inventory practices that cause demand surges in the supply chain.

• Reduce the amount of incentives for clients that result in order batching and delays demand (Donovan, 2002). Time delays can be reduced by eliminating one or more elements in the supply chain (Ertek & Eryılmaz, 2008).

• Consider discounts in forecasting as they may result in buying surges.

• Implement measures that prevent the reasons for order cancellations.

• Donovan (2002) stresses on the importance of vendor-managed inventory (VMI). This service is effective in eliminating shortage gaming, order batching, and solving the bullwhip effect as it makes available the demand and inventory data to companies in the supply chain (Ertek & Eryılmaz, 2008). Moreover, VMI can diminish the effect of price variations and hold demand variation on the smaller level than in conventional supply chains.

• Kaipia et al. claim that “reducing “nervousness” can reduce the bullwhip effect” (as cited in Ertek & Eryılmaz, 2008). The measures to eliminate this negative practice include stabilization and simplification of the planning process, development of communication practices among members of the supply chain and employment of VMI services.

• Establish centralize control. Yu et al. discovered that information sharing is more beneficial for companies in the supply chain if they establish “centralized control” rather than “decentralized control” and “coordinated control” (as cited in Ertek & Eryılmaz, 2008). A retailer will gain little useful data in the latter two but obtain performance improvement in the former one. However, it is vital that information sharing throughout the supply chain is of high quality.