Bullwhip effect
The Bullwhip effect (also know as the "whiplash" effect) refers to a supply chain management issue relating to inventory management and market demand projection. The metaphorical bullwhip represents demand, with the end consumer "holding" the handle. When the consumer market demand increases for a specific product, that increase in demand is felt down throughout the supply chain, in increasing severity from one supplier to the next. There are usually about six or seven inventory points between the supplier of raw materials, to the end consumer.[1] When the expected flow of product is disrupted by a small amount, that disruption tends to be amplified to upstream suppliers. This can happen for a number of reasons, but typically the cause falls into one of these categories:
- Forecast errors (Inaccurate estimation of future demand)[2]
- Order batching (larger, less frequent orders from suppliers can cause these suppliers to estimate demand poorly)[2]
- Communication gap (Especially when combined with order batching, a lack of communication between retailers and suppliers can make a ripple much worse)[1]
- Lead time (failing to account for lead time on orders can result in overstocking or a shortage)[2]
- Sales and price discounts (temporary discounts cause a "boom-and-bust" cycle where consumers buy more for a short time, then buy less for a period of time afterwards)[2]
Example
If a retailer typically sells about two pallets of paper towels each month, their supply chain is well accustomed to that level of demand. However, if for some reason the retailer suddenly sells twice that amount (due to discounts, environmental conditions, panic buying, etc.), problems can occur. The retailer will often keep a small surplus on hand (called a "safety stock"), to ensure that they do not run out. However, holding onto excess inventory is waste of money, so this will typically be a small amount. Some retails keep virtually no surplus on hand. When the demand increases, the retailer's buffer stock is quickly depleted, and they must order more from their regional distributor. They need to buy enough to restock their shelves, replenish their depleted buffer, and get enough of an excess to continue providing for the increased demand. Their distributor is now surprised by an order coming in earlier than expected, for not one or two pallets, but six. The distributor will also have a buffer stock, but again, only a limited amount. They will fulfill this order, but now have their own inventory running lower than expected. They can also predict that based on this new, large order, there will be more large orders coming, not only from this retailer, but probably from others as well. So, the distributor orders an extra twenty pallets from their distributor, and the process of amplification continues.[2][1][3] After several steps through the chain of distributors and warehouses, the manufacturer is suddenly surprised with an order for sixty extra pallets of paper towels, as each supplier and distributor is attempting to increase their buffer and keep up with demand. The manufacturer will be somewhat limited in how much they can increase production, but they will do what they can to meet the demand. To do this, they will need more wood pulp, so they make an unusually large order for wood pulp from their supplier. This results in their supplier making an unusually larger order for wood chips and timber from their suppliers. Now there is suddenly a very significant spike in demand for logging, due mostly to a retailer or two selling many more paper towels than usual.[2][1][3] Eventually the demand will diminish, so much so that demand falls below the norm. This will result in overstocking and excess production. To deal reduce the surplus, the suppliers will probably offer a discount on paper towels, leading the retailers to also put paper towels on sale. Eventually, the demand and supply will stabilize.
As a side note, this bullwhip effect can also have an impact on other related products. Consumers who are unable to find paper towels in stores might buy other paper products instead, such as napkins. Additionally, the increased demand for wood pulp in this scenario may cause a shortage in other other wood-based products, as wood pulp becomes temporarily scarce.
See also
- Just in time inventory management