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Managing Your Inventory: The Bullwhip Effect

11/11/20
Grainger Editorial Staff

Accurate demand forecasting and sales projections are critical to effective supply chain management. But in periods of sudden demand, there is an increased risk of inaccurate forecasts due to incomplete information. Inaccuracies can quickly amplify issues further down the supply chain. These ripple effects can eventually disrupt the entire supply chain, leading to what is now known as the bullwhip effect.

What Is the Bullwhip Effect?

According to the Chartered Institute of Procurement and Supply (CIPS), the bullwhip effect describes a supply chain phenomenon where small demand fluctuations from the retailer lead to larger fluctuations at the supplier, manufacturer and wholesale levels. Also known as the whiplash or Forrester effect, the bullwhip effect often occurs when orders sent to manufacturers and suppliers create larger variances or “waves” than sales to end customers. These variances can negatively impact operations, causing each link of the supply chain to over or underestimate product demand, leading to exaggerated demand fluctuations.

For many industries, consumer demand is rarely completely stable, so businesses make demand forecasts and projections to maintain appropriate inventory levels. However, because projections are based on historical data, they are not always accurate. To help plan for uncertainty, companies often try to buffer their inventory with ‘safety stock.’ When demand surges, suppliers may respond by reactively increasing their safety stock. But carrying too much safety stock can snowball, causing the bullwhip effect, as the initial demand continues to inflate as it moves down the supply chain.

Causes of the Bullwhip Effect

The bullwhip effect can occur due to a breakdown in supply chain communication. Supply Chain Academy notes this communication breakdown results in excessive inventory throughout the supply chain when the suppliers and manufacturers try to protect themselves against demand changes. Understanding the bullwhip effect can help business owners and managers avoid costly supply chain disruptions.

The Chartered Institute of Procurement and Supply (CIPS), notes several factors often contribute to the bullwhip effect including:

  • Lack of communication: Breakdowns in communication between supply chain participants or poor decision making by stakeholders along the chain
  • Price fluctuations: Discounts, promotions, and other price changes may lead to irregular buying patterns
  • Demand information: Inaccurate forecasting and demand projections due to a dependence on historical data
  • Order batching: Supply chain members rounding up or down order quantities
  • Rationing or gaming: Buyers and sellers overestimating or under-delivering their expected order quantities

How to Reduce the Bullwhip Effect

The Association for Supply Chain Management (ASCM) states it’s crucial to understand where inventory is, determine accurate demand levels, and, most importantly, properly align inventory within each part of the supply chain.

In the past, supply chain planning relied on historical customer data to help forecast demand for products. However, supply chain managers have recently started embracing digital technology to create a more integrated business network between customers, retailers, distributors, manufacturers and suppliers. Sharing more real-time data increases visibility and works to prevent distorted demand metrics by efficiently managing materials, information and finances through the supply chain.

According to CIPS, a combination of preventive measures and strategies can help steady your supply chain and limit the bullwhip effect from becoming destructive.

Some steps to help minimize the bullwhip effect in your supply chain include

Communicating Clearly Along Your Supply Chain

Effective communication information sharing between internal departments helps avoid order delays, cancellations and returns. Regularly communicating with your customers is important to make sure you maintain both current and accurate forecasts.

Reducing Your Supply Chain

Minimizing the number of suppliers and levels in your supply chain can help reduce the bullwhip effect. Reducing your supply chain network size helps make communication easier and reduces the likelihood of greater supply chain disruptions.

Maintaining Consistent Pricing

Sales and bulk discounts can help attract customers, but it also unnecessarily increases inventory levels and, in turn, amplifies the bullwhip effect. Maintaining a steady price point during market fluctuations and encouraging orders according to customer need instead of bulk discounts can reduce the bullwhip effect.

Consistently Monitoring Min-Max Inventory Levels

Make sure stock levels are appropriate and adjust them as necessary. Using regular reporting and early warning systems can help track certain factors and lead to more efficient inventory planning by maintaining stock levels in each area based on the specific demand.

Implementing Vendor-Managed Inventory (VMI) Solutions

Keeping the right amount of inventory stocked helps improve customer service and ensures you can find the right product, in the right place, at the right time. Vendor-managed inventory (VMI) outsources inventory stocking to a specialized service provider to ensure the appropriate inventory levels are maintained. By implementing a VMI strategy, companies can better forecast and monitor customer demand through a combination of point of sale information and real-time inventory usage.

Limiting Order Sizes

Limiting order sizes and ordering more frequently enables you to respond to the market demand with more flexibility and helps to minimize the reverse bullwhip effect. It’s important to ensure production planning accounts for enough time to reorder materials. Failing to consider lead times can lead to overstocking.

Reducing Lead Times and Cutting Down on Delays

Supply Chain Academy reports cutting the order-to-delivery time in half can reduce the bullwhip effect by as much as 80%. This is because the faster materials move through your supply chain to become finished products, the less chance there is for inventory to pile up. Shipping multiple types of items per truckload or using third-party logistics can help lower shipping costs with smaller orders. Keeping extra critical parts on hand is another important step to reduce order times and avoid costly downtime or delays.

Improving Data Sharing to Increase Supply Chain Visibility

Consider using an electronic data exchange to help prevent order batching from creating a bullwhip effect in your supply chain. An electronic data interchange (EDI) transfers critical data among different computer systems and networks to create better transparency between retailers and suppliers. An EDI can help reduce the costs by automatically generating an electronic order, then informing the supplier, who can set delivery quantities based on how much inventory is sold compared to how much is currently in the distribution center. This practice helps to reduce the inventory data distortions and encourages customers to place more frequent orders.

Effective supply chain management depends on visibility, open communication, and quick access to information and insights. Although most supply chains will experience the bullwhip phenomenon to some degree, the strategies outlined here can help reduce the risk of carrying excess inventory and limit unnecessary inventory shortages.

Learn more about Grainger's KeepStock Inventory Management Solutions.

The information contained in this article is intended for general information purposes only and is based on information available as of the initial date of publication. No representation is made that the information or references are complete or remain current. This article is not a substitute for review of current applicable government regulations, industry standards, or other standards specific to your business and/or activities and should not be construed as legal advice or opinion. Readers with specific questions should refer to the applicable standards or consult with an attorney.

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