The Bullwhip Effect and Your Supply Chain
There are a lot of uncertainties when it comes to your supply chain and in order for you to avoid most if not all of them you need to understand how it all works and know that one simple mistake might ruin the balance in the supply chain.
Both in life and in finance balance is crucial because one wrong move can put you and your entire company in debt leading to a slow state of recovery at best.
One of those wrong moves is not knowing what the Bullwhip Effect is and how to avoid it.
Once you figure out how you can avoid getting caught in the Bullet Effect you will be more careful when making your financial moves and also know how to forecast future events much more effectively.
Don’t let this introduction scare you because I’ll be explaining everything you need to know when it comes to dealing with the Bullwhip Effect.
So without further ado, let’s jump straight to it.
WHAT IS THE BULLWHIP EFFECT?
The Bullwhip Effect commonly referred to as the Forrester effect and is called the Forrester effect because it originated from Jay Forrester and he wrote a book in 1961, called “Industrial dynamics” and he was basically trying to explain to account for the unforeseen spikes in demand within a supply chain.
These unforeseen spikes in demand within a supply chain have a reverberating effect throughout the entire supply chain to the extent where every member of the supply chain wraps up their inventory counts to account for the demand that they suddenly came face to face with.
How this works is everyone ramps up their inventory counts and then all of a sudden for example the next month or two the demand is not there anymore and you are left with a lot of products in your inventory and not a lot of sales to back it all up.
This is basically a very simple and straight forward process to understand, but what I see is that a lot of companies today are either unaware or choose to ignore it or even think that it doesn’t that much of an impact, but they are terribly wrong.
FIVE CRUCIAL PARTS OF THE BULLWHIP EFFECT
There are five signs you can look for in order to make sure the bullwhip effect is not going to impact your inventory or at least give you some insight into what to look out for in order to make sure that you are protected against these unforeseen spikes in demand.
Essentially, what the bullwhip effect shows is that every member of the supply chain relies on the other:
- The vendor sells the manufacturer raw materials for the product;
- The manufacturer relies upon the feedback in terms of forecasts from the distributor;
- The distributor relies upon the wholesaler in terms of product orders;
- The wholesaler relies on the retailer in terms of stock.
And this typical order of supply chain can easily be disrupted simply when one day you have this consumer or a series of consumers that come in and they all of a sudden place this huge order and they essentially liquidate the retailers’ inventory completely.
A MORE PRACTICAL EXAMPLE
To put things more into perspective I’m going to give a simple but more practical example of how this all works.
I don’t drink beer but I think that beer is a good example and I will tell you why later.
So let’s say that the consumers are buying beer and a whole group of people comes in a period of about a month and they buy the retailers whole inventory and let’s say that the retailers’ inventory was about 500 cases of beer and at the end of the month it is down to zero.
Typically the retailer sells a certain amount every two months and all of a sudden they sold this two-month volume all in one month and so their anticipation is that they are going to be selling that amount every single month moving forward.
What happens is and of using 500 cases of beer every two months they think that they’re going to need 500 cases every month, and this is where it all begins.
The retailer sends an order over to the wholesaler for 1000 cases because what they want is to replenish their inventory to account for this new demand that they see so the wholesaler gets this order.
What happens next is that the wholesaler wants to place a larger order of 1500 cases of beer to the distributor.
Then the distributor has to buy more from the manufacturer and place an order for 2000 cases.
And finally, the manufacturer thinks he needs to buy more raw materials and they place a larger order for raw materials in order to match this demand.
When all the orders fall into place virtually every subject of the supply chain has doubled their inventory because they expect that the demand now that it has doubled will stay that way, but that usually isn’t the case.
THE MAIN PROBLEM
What happens is this all looks fantastic to everyone, because all of a sudden there is this increased demand and they think it’s going to continue, next month when the consumers come in and their order volume is 250 and it puts all of this out of line because everyone’s inventory is higher than it was before.
How this manifests is when the wholesaler calls the retailer, the retailer will say that they have plenty of inventory, and the distributor calls the wholesaler – the same problem, later the manufacturer calls the distributor- again the same problem, the vendor calls the manufacturer, you guessed it -the same problem.
And this is why it’s called the Bullwhip Effect. It’s this process where a single and sudden change in demand has a reverberating effect across the entire supply chain.
Sounds scary and is even scarier in reality.
In order for this to not happen to your supply chain, you need to understand some key elements when it comes to knowing how the market functions and how to avoid bad investment plans.
What you need to do as a company in order to make sure that you’re aware of these type situations and that it can be a little bit more proactive, and also that there can be some unforeseen events which can quickly create the Bullwhip Effect.
WHAT YOU NEED TO KNOW
One of the things you need to pay attention to is seasonality and what it means that in some consumer markets there are certain times a year where are demand suddenly spiked.
So in terms of beer (I said I was going to get back to beer) every super bowl Sunday beer spikes in demand, the same goes for Thanksgiving and Christmas or any other holiday when you can expect a large family gathering.
Planning ahead when to make a large order and when not will help you not get stuck in the Bullwhip Effect and will assure that you don’t make that mistake just because of a sudden change in demand.
2. Business Cycles
In other markets it’s a concern of business cycles, it’s common for some companies that have some quarters that are busier than other so you need to understand which quarters are going to have a rapid change in demand and which won’t.
For this element, it takes some planning skills and also market research because you aren’t careful one unexpected change in demand can have an impact on all of your quarters.
The Bullwhip Effect is a magnet for business cycles so take care.
If you are able to stop the Bullwhip Effect in one or more of your quarters right at the very start you might manage to stop it from impacting other quarters as well so this is an important element to keep an eye on.
3. New Production Introduction
The third thing you need to understand is new product introductions now one of the things that happen is that we live in a digital market where things can catch on very quickly and products can become suddenly extremely popular.
And a lot of times companies launch a product not understanding just how much a product can become popular because they can’t possibly see it so suddenly that product takes off and there is a sudden mad rush to go out and buy that new product.
But then that demand goes off, and if you look throughout history in terms of consumers introductions with products, for example, the Sony PlayStation, you will see a large spike in demand and people will go to extreme measures just to buy that product.
This sudden spike in demand is the main reason why some companies after releasing a popular product fall into the trap of the Bullwhip Effect because when that new product becomes old news, they are left with a massive inventory and are forced to sell the product at a much lower price, liquidating their income.
4. End of Product Life
Another thing you want to pay attention to is the end of life of a product because of all of sudden a company says that they aren’t going to make this product anymore whether because they think it won’t sell as much as they are used to or just simply want to start producing a different one.
This also causes a mad rush to go out and get what’s left of that product because there are people who are nostalgic and they like the product or they anticipated this would happen but the moment they hear that the company is going to stop making the product they suddenly rush out and they basically buy as many of that product as they possibly can.
The same problem occurs again, the company seeing that the product that they want to stop selling suddenly became popular again wants to make more profit as much as possible and they quickly fall into the Bullwhip Effect.
5. The Unforeseen
The fifth element is the unforeseen circumstances where you just can’t account for this sudden and drastic increase in demand and this is the most common cause of the Bullwhip Effect mainly for newer companies who don’t yet have an idea of how their products are viewed on the market.
What you need to pay attention to is how the consumers are reacting to your product in terms of:
- Quantity – How much of the product you typically sell in a day, week, month or year.
- Expenses – How much do you spend on the finished product when you take into account its way from the manufacturer to the shelves.
- Profit – Is this a product which brings you your main source of income or just one portion of it, and do you want to make the risk of getting more of that product produced in order to increase your profit.
There isn’t a recipe for dealing with the unforeseen circumstances, you will need to either take risks and profit from them or learn from your mistakes.
KNOWING YOUR CONSUMERS
This is easier said than done but if you get to know your consumers need early on and start developing a pattern you will quickly get a grasp of knowing when a sudden change in demand could occur but nothing is certain.
Look at this as like a precautionary measure, if you know the average amount your consumer buys in a month, try not to step away from that number or at least try to gradually add more of the product in your inventory in order to see if that will work.
By adding or removing the product gradually from your stock you can easily pinpoint a round amount of how much of the product your consumers buy and also how much you are expected to have in inventory if a sudden rise in demands does happen.
When you start to pay more attention to how your consumers react to your product you will see what portion of your supply chain you need to be careful the most but more often than not it starts from the retailer which creates a domino effect in terms of increasing orders from the retailer all the way to the manufacturer.
This is very nitpicky and sometimes it seems like too much effort, but Rome wasn’t built in a day and neither was any big company so patience is vital.
THE MAIN CAUSE – GREED
Now I want to talk about something few business advisers will tell you which is that the main cause of the Bullwhip Effect isn’t just a sudden change in demand but also one of humans’ seven deadly sins and that is greed.
Now it’s normal for a company to double their inventory when they see a change in demand but some companies go to the extent where they blindly take that risk right off the bat without thinking of the consequences or simply by not knowing how the supply chain functions.
Don’t try to make a risk if you aren’t sure it will work, this will save you a lot of time and a lot of money and instead of wanting to make more profit than you’re used to trying to maintain the usual state of your supply chain and learn how to protect it from failure.
Sometimes in the world of finance, it isn’t all about making more money but instead about how to keep the status quo.
This sounds terrible for some but helpful for others, depends on your viewpoint on things I guess.
LEARN FROM OTHERS MISTAKES
I would like to remind you that the economy, like history, is bound to repeat its self, but what economy does even better than history is it tracks the rise and fall of great companies in its record of finances so you don’t have that problem of proving whether something has worked before or not.
What I’m trying to say is you literally have living proof throughout the history of big companies and their financial moves and more importantly if those moves that they made have paid off.
Learn from others’ mistakes not from your own ones because it will surely cost you cheaper or nothing at all and you don’t have anything to lose except a little of bit of time while planning your next move.
Once you understand what to do, what to expect and how to turn your plan into reality you will easily avoid the Bullwhip Effect and it’s devastating on your supply chain. And another thing – don’t be greedy.
EXPECT THE UNEXPECTED
Everything can go downhill by just one wrong move and a good way to avoid this is planning which some companies, I don’t know for what reason, either avoid doing or don’t do well.
In order for you to not be in that position where your entire supply chain has a bigger inventory than its sales, you need to plan ahead and foresee the unforeseen even though it is literally impossible.
Sometimes even if you know your consumers very well to the point like it seems you know them personally, you can easily fall in the trap of the Bullwhip Effect just by not planning ahead your short term and long term goals.
So you need to stop and think for a second what are you trying to achieve and whether you want to keep the situation as is or if you want to move forward, but keep in mind that you can’t forecast everything that will come in the way of your goal.
Expect everything, do your researches, plan every single possible outcome and it will eventually pay out, you just need to be consistent and not get demotivated
WHAT TO DO IF YOU GET TRAPPED IN THE BULLWHIP EFFECT
This is a common question from the companies which have experienced the Bullwhip Effect and a large portion of them do eventually go into debt by not knowing how to get out of the mess that they’ve created.
The simplest answer I would suggest for you to try is simply waiting for your inventory to go down to the stage it once was because there is nothing you can do which can have a quick result of solving this problem if you want to keep the same profit as before.
Another thing you can do is sell the product at a much lower price in order to quickly empty out your inventory, and try not to make the same mistake twice because the next one could be deadly to your company.
But if you do find yourself in this situation try not to panic and maybe start thinking of closing down the company and instead try to move forward so you can recover as quickly as possible.
At the end of the day at least you felt the Bullwhip Effect on your own skin and now know how to avoid it in the future.
To summarize, the Bullwhip Effect is a big trap for any supply chain and company who acts before it thinks so try not to fall in that never-ending cycle of having more in stock than in your sales account especially if you have a food supply chain because the food can spoil and go to waste before you even recover from your losses leading to even more debt.
The Bullwhip Effect is like a deadly disease, which can completely abolish your whole supply chain which at first it doesn’t seem to have a huge effect until the backlash happens, and suddenly you realize that you’ve bitten more than you could chew.
Try to utilize everything that I’ve talked about here and also see on what key element you need to pay attention to in your supply chain and I’m sure you won’t have this problem if you know the consequences.
Nevertheless, everyone likes to do business in their own way but the Bullwhip Effect can occur in every supply chain so be careful and watch out.