If you’ve ever experienced a small change at the retailing end of a supply chain that provokes massive turbulence upstream, there’s a good chance you’ve suffered the bullwhip effect. When somebody cracks a bullwhip, a small wrist movement makes a successively larger wave movement along the length of the whip, with the end flying the biggest distance up and down. The analogy between the whip and the supply chain is apt: a 10% change in order volume at the retailing end can successively lead to 20% changes in sales forecasts, 40% changes in manufacturing and 80% changes in orders to materials suppliers. However, the effect can be both modeled with an operational risk scenario analysis and controlled.
Examples of the bullwhip effectExamples of the bullwhip effect can be found in every sector. Proctor and Gamble was caught on the hop when distributors of its Pampers product varied their orders, even though babies continued in general to go through disposable diapers at a steady rate. In the technology sector, Hewlett-Packard warned of possible shortage of supply of its best-selling LaserJet printer, resulting in retailers artificially inflating their orders to compensate. Sales forecasts went up by a correspondingly greater amount, and the orders from the HP printer division to the HP integrated circuit division went up by even more. One of the first documented cases that led to further operational risk scenario analysis was in the supply of pasta in Italy by the Barilla Company. The firm triggered the effect itself by offering price discounts to customers who placed their orders by the truckload. Customers responded with orders that were highly irregular, making additional upstream supply chain costs so high that the transport cost reductions from complete truckloads could not cover them. Campbell’s Soup also experienced the same effect, because retailers placed advance orders. The effect was all the more unexpected in that end-customer demand for soup remained stable, week in and week out.
Causes of demand fluctuationFour major causes of demand fluctuation and the bullwhip effect are given below. Together they can be put into an influence diagram to better understand the phenomenon.
- Localized Updates of Demand Forecast. One part of the supply chain updates its demand forecast, but this is only seen by its immediate neighbor in the chain, and not by the chain as a whole.
- Batching of orders. To accommodate seasonal demand or delivery pricing structures, retailers and distributors order greater quantities at a time. This artificially inflates sales forecasts (that then dip downwards in the next quarter, because stock levels remain high).
- Changes in price. When retailers take the initiative to offer sales promotions to their customers or when vendors offer different price discounts, orders may vary and the bullwhip effect can occur.
- Rationing and gaming. Telling retailers that supply may be limited may lead to retailers (and distributors) ‘gaming’ the system and over-ordering. For example, if supplies will apparently be cut in half, a retailer may try to compensate by ordering twice as much. When half the order has been filled (corresponding to the quantity the retailer wanted anyway), the rest of the order may be canceled, leading to further havoc.