What is the Bullwhip Effect? Understanding the meaning, definition, concept, Eliminating, and Causes in Supply Chain Management!

Meaning: The bullwhip effect is a distribution channel phenomenon in which forecasts yield supply chain inefficiencies. It refers to increasing swings in inventory in response to shifts in customer demand as one moves further up the supply chain. The meaning, definition, concept, Eliminating, and Causes, Explains Bullwhip Effect in Supply Chain Management. The concept first appeared in Jay Forrester’s Industrial Dynamics (1961) and thus it is also known as the Forrester effect. The bullwhip effect can be explained as an occurrence detected by the supply chain where orders sent to the manufacturer and supplier create larger variance than the sales to the end customer.

The bullwhip effect was named for the way the amplitude of a whip increases down its length. The further from the originating signal, the greater the distortion of the wave pattern. In a similar manner, forecast accuracy decreases as one moves upstream along the supply chain. These irregular orders in the lower part of the supply chain develop to be more distinct higher up in the supply chain. This variance can interrupt the smoothness of the supply chain process as each link in the supply chain will over or underestimate the product demand resulting in exaggerated fluctuations. Who are the Users of Accounting Information inside the Organization?

The Concept of Bullwhip Effect in Supply Chain Management

The problem of the Bullwhip effect in supply chain management has always been a concern for many years. Due to its non-industry specific nature, it has grabbed the attention of many professionals from diverse industries and business schools. Bullwhip effect as its name suggests is an oscillation in the chain or pipeline. In the supply chain, this effect occurs when there is a constant fluctuation in the demand. In-congruence in the information leads to its distortion thereby creating a bullwhip. The expression “Bullwhip Effect” was termed by executives of P&G, the company that manufactures Pamper brand of diapers.

These executives observed that while the consumer demand for Pamper’s Diapers was fairly constant over time, the orders for diapers placed by retailers to their wholesalers or distributors were quite variable i.e., exhibited significant fluctuations over time. In addition, even larger variations in order quantities were observed in the orders that P&G received from its wholesalers. Also, read it The Motivated Personality born in India They inspire Always.

This increase in the variability of the orders seen by each stage in a supply chain was called the bullwhip effect. This situation of misalignment in the supply chain can be termed as ‘Asymmetric Information’ where different parties having different states of private information about demand conditions, products, and the chain operations. The problem of this asymmetry arises because participating firms generally lack the knowledge required about each other’s plans and intentions to adequately harmonize their services and activities.

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Supply chain members often do not wish to share their private information completely and faithfully with all others due to the profitability of that actual or perceived information. Thereby the whole supply chain suffers from sub-optimal and opportunistic behavior. These decisions occur when the members don’t have sufficient visibility to resolve various trade-offs in decision making because lack of information causes decisions to be made in a narrow scope that cannot ensure that products flow properly to end customers. Moreover, with limited information sharing, members don’t have consistent perceptions of market needs and visibility over performance at the other levels of the supply chain.

As a consequence, decisions are made based on either the best estimation of the available data or an educated guess. Such decisions can be biased and prevent the individual member from attaining the optimal solution of the supply chain. For example, the manufacturer often uses incoming orders with larger variance and not sales data from the retailer as a signal about the future product demand. Asymmetric information also produces problems of the vulnerability of opportunistic behavior. Specifically, adverse selection and moral hazard manifest themselves in the relationship between the supply chain members.

The negative selection of adverse selection, for example, is that the member firms cannot optimize supply chain performance because they don’t possess the required capability to meet the predetermined customer service level. To explain this effect a very simple example of the two-tier supply chain, a retailer and a manufacturer, can be taken into account. The retailer observes customer demand and places orders to the manufacturer. For determination of the order quantity to place with the manufacturer, the retailer will use the observed demand data of customer and a demand forecasting technique. In the 2nd stage, the manufacturer plays his role of forecasting by observing the retailers demand to place the order with his suppliers.

In many supply chains, the manufacturer doesn’t have access to customer’s demand data thereby making him rely on the retailer’s data to forecast. As the bullwhip effect implies (the orders placed by the retailer are significantly more variable than the customer demand observed by the retailer), the manufacturer’s forecasting and inventory control problem will be much more difficult than the retailer’s forecasting and inventory control problem. In addition, the increased variability will force the manufacturer to carry more safety stock or to maintain higher capacity than the retailer in order to meet the same service level as the retailer.

What Contributes to the Bullwhip Effect?

There are many factors said to cause or contribute to the bullwhip effect in supply chains; the following list names a few:

  • Free return policies:
    Customers may intentionally overstate demands due to shortages and then cancel when the supply becomes adequate again, without return forfeit retailers will continue to exaggerate their needs and cancel orders; resulting in excess material.
  • Demand information: Relying on past demand information to estimate current demand information of a product does not take into account any fluctuations that may occur in demand over a period of time.
  • Price variations: Special discounts and other cost changes can upset regular buying patterns; buyers want to take advantage of discounts offered during a short time period, this can cause uneven production and distorted demand information.
  • Order batching: Companies may not immediately place an order with their supplier; often accumulating the demand first. Companies may order weekly or even monthly. This creates variability in the demand as there may, for instance, be a surge in demand at some stage followed by no demand after.
  • Lack of communication between each link: in the supply chain makes it difficult for processes to run smoothly. Managers can perceive a product demand quite differently within different links of the supply chain and therefore order different quantities.
  • Disorganization between each supply chain link: with ordering larger or smaller amounts of a product that is needed due to an over or under reaction to the supply chain beforehand.

Eliminating Bullwhip Effect in Supply Chain Management

Following are a set of efficient countermeasures that were designed to minimize the negative effects of the Bullwhip effect;

  1. Avoid multiple demand forecast updates.
  2. Eliminate gaming in shortage.
  3. Stabilize prices, and.
  4. Break order batches.

However, we have to admit that the above-mentioned measures of reduction of the Bullwhip effect are not exhaustive and cannot fully eliminate the existence of this effect.

Countermeasures of Bullwhip Effect in Supply Chain Management

Actual demand for a product is influenced by several factors such as competition, prices, weather conditions, technological developments, and consumers’ general confidence. These would be considered external and unmanageable factors. There are other uncertainties involved as well that can have an effect on the supply chain such as problems in delivery time due to production machine failures. Techniques to lessen or curtail the bullwhip effect would be to understand and recognize who or what is suggesting the variations in demand. Is it the retailer, manufacturer, the customer, or the distributor? The key element to eliminating this setback is being aware of where the demand changes are beginning. Techniques that can be used or put into place to reduce the bullwhip effect is sharing information along the supply chain, Vendor Managed Inventory (VMI), and managing e-business.

The most obvious way to reduce the bullwhip effect is to improve communication and forecasting along the supply chain. Master Data Management (MDM) is can be looked at to integrate all data in an organization at the highest level, both internally and externally. One of the most notable examples of information sharing is between large manufacturers and retailers. Inventory if properly managed, it can increase profits and efficiency. The implementation of a Vendor-Managed Inventory (VMI) initiative would be a key factor in improving and controlling the bullwhip effect. VMI indicates that the vendor, usually a distributor, maintains the inventories for manufacturer or buyer and in turn will reduce warehouse costs for suppliers. VMI alleviates uncertainty of demand and replenishment decisions can be made according to operating needs, and also has heightened awareness of trends in demand. E-commerce brings about new opportunities to improve the performance of the supply chain. The primary advantages of internet utilization are speed, decreased costs, the potential to shorten the supply chain, and flexibility.

Electronic marketplaces provide for more efficient resource allocation, better information flow, and dissemination on products and services in the supply chain. Electronic data interchange (EDI) can be implemented to help supply chain managers in reducing misleading signals sent from sales and marketing (distribution). Enterprise resource planning (ERP) is one of the most successful tools for managing supply chains. ERP is software that integrates the planning, management, and use of all sources in the entire enterprise. The major objective is to integrate all departments and functional information flow across a company onto a single computer system that can serve all of the enterprise’s needs.

A plan created from an SCM system that allows companies to quickly assess the impact of their actions on the entire supply chain, including customer demand, can only be done with the integration of ERP software. ERP and SCM can help alleviate the bullwhip effect across the supply chain by having a shared understanding of what needs to get done, managing the variations in the organization, communication among all that are involved especially top management, and having single control of replenishment or VMI can overcome inflated demand forecasts. Long lead times should also be reduced where it is reasonably beneficial.

Causes of Bullwhip Effect in Supply Chain Management

There are four main causes behind building up of bullwhip effect in the supply chain.

These causes are:

  1. Demand Forecasting.
  2. Order Batching.
  3. Rationing and Shortage Gaming, and.
  4. Price Fluctuation.

From the above information, it is clear enough that all the factors or elements resulting in bullwhip effect originate from a common ground i.e. information sharing. Case Study of International Marketing Strategy in PepsiCoIt is evident enough that the lack of information and interaction between different stages evolve bullwhip in the system thereby plaguing the whole Supply Chain.

Bullwhip Effect in Supply Chain Management
Image Credit from ilearnlot.com.

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