Wrong forecasts are made all the time – the weather, elections, traffic, and the list goes on. Their effects can heavily impact your day. Maybe you did not bring a rain jacket, or took the route with the longest traffic jam. Wrong forecasts also occur in the supply chain world, with businesses ending up sitting on too much stock. Inchainge’s business simulations help you understand how to avoid these miscalculations and make better predictions for consumer behavior.
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What is the bullwhip effect?
The bullwhip effect is a well-known phenomenon in modern-day logistics. Many supply chain professionals are reasonably capable of explaining what it is. The bullwhip effect is increasingly severe swings in demand that build up in the upstream supply chain.
However, it is more difficult to explain how the bullwhip effect actually starts. The most commonly heard reason is irrational behavior, i.e. panic among planners. If that’s what you think too, then we have to disappoint you. Irrational behavior is not the cause. In fact, the bullwhip effect also occurs when planners react completely rationally.
The bullwhip effect and inventory-driven supply chain
The bullwhip effect is an inherent result of an inventory-driven supply chain. So, the bad news is that there is really no way to completely eliminate it. However, the good news is that it can be significantly reduced. Though, this requires a serious focus on the true cause of the effect. So what is that cause?
How does the bullwhip effect occur?
The crack of a whip is affected by the force of the arm and hand movement and the length of the whip. Like this, the bullwhip effect in a supply chain is caused by demand uncertainty and transition time. Many companies hold safety stock to help them cope with demand uncertainty. Longer transition times mean more safety stock. Moreover, the further upstream companies are, the greater their demand uncertainty and hence their need for safety stock is. This can be illustrated by a simple example.
Example of the bullwhip effect
If your historical average demand is 100 units per week and your transition time is five weeks, your pipeline is full at around 550 units. There are 500 units to meet the average demand (working stock) and 50 units for exceptions (safety stock). Suddenly, your sales level increases to 150 units. After asking around in the market, you discover that this could be a structural rise. So you now have a shortage of 250 units (5×150-5×100) in your working stock.
To avoid similar surprises in the future, you also decide to increase your safety stock from 50 units to 150. As a result, you place an order with your supplier for 500 units – but your supplier was expecting an order for 100 units. Hence, a potentially structural sales increase of 50 units leads to a (hopefully one-off) volume increase of 400 units. Just imagine what would happen if your supplier were to assume your increase to be a structural one, and the supplier of your supplier, and so on.
How to reduce the bullwhip effect?
The above example demonstrates that the bullwhip effect is not caused by irrational behavior. Instead, it is the consequence of demand uncertainty, transition time and stocking policies. Three phenomena that are present in pretty much every supply chain.
It is therefore not possible to completely eliminate the bullwhip effect, but luckily it can be considerably reduced. After all, the effect is caused by demand uncertainty and transition time. It can also be mitigated by reducing that demand uncertainty and shortening the transition time.
Experience the bullwhip effect yourself
This rather dynamic concept is best understood by experience. The Beer Game (or beer distribution game) was originally invented in the 1960’s by Jay Forrester at MIT, as a result of his work on system dynamics. In the game a multi-tier supply chain is confronted with a sudden change in the end demand.
The more upstream parts of this supply chain experience a huge increase and decrease of demand in time. This is causing problems in costs, capacity and service levels. In the game you learn the background of the system dynamics, and what to do about it on the level of a complete supply chain.
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