The bullwhip effect is caused by fluctuations in information supplied to firms further up the supply chain. Distorted information causes firms to forecast demand incorrectly. Thereby, many unnecessary costs are put upon each of the firms along the supply chain.
Most firms are affected by the bullwhip effect. The bullwhip effect used to be considered a normal phenomenon. However, recently, many firms have been trying to focus on how to improve communication along the supply chain.
The bullwhip effect can inflict many unnecessary costs on business firms. Inventory costs from stored inventory, problems with quality caused from rapid production, overtime expenses for increased employee labor, and increased units being shipped create costs far and beyond normal levels of production.
Customers can also lose faith in a firms ability to deliver products. This is because firms are having trouble meeting demand. Likewise, firms often must lengthen lead time for finished goods, which also may discourage customers, which in turn leads to lost sales. In a worst case, incorrect forecasts may entice a company to adjust capacity which could be detrimental to the overall success of the company.
To reduce stocked product, retailers may offer sales promotions to customers. If retailers fail to notify firms upstream in the supply chain, these firms may forecast increased sales as legitimate demand. Thereby producing product that was not wanted by the customer in the first place. Furthermore, sales incentives for salesman may entice salesman to sell products to firms to meet incentives. This may cause large inventories for the firm, or the firm may cancel the orders, which causes demand fluctuations in the supply chain.
In this example is only one of many that may occur for firms. A retailer of a good may indeed offer lower prices so as to reduce the amount of inventory sitting on store shelves. A problem may occur if the retailer fails to notify other firms upstream in the supply chain.
Firms upstream in the supply chain may feel that the increased demand may be legitimate and increase production and inventory levels to produce more. However, in reality, the product hardly moved and required a drop in price to be moved off of retailer’s shelves. Each firm upstream in the supply chain will feel the whip effect.
Each of the firms along the supply chain are producing at a constant rate because demand is easily forecasted; the supply chain is in equilibrium. Each of the firms are forecasting demand accurately.
In this example, demand has increased by 10 units over equilibrium. To meet the demand, the distributor doubles inventory to meet production and to meet any other demand fluctuations. The producer further up the chain also notices the increased demand of the distributor and doubles their demand forecast to 40 units and hold 80 units in inventory to meet demand and hedge against any other demand fluctuations. The supplier (or top of the supply chain) receives the blunt of the whip effect. Costs for individual firms, in this example, increase the further you move up the supply chain,
Improved communication from retailers will assist firms upstream in the supply chain in determining what is actual product demand. Improved communication and reliable information helps firms to develop forecasts that are effective and accurate.
Determining product demand from actual data entered into point of sale (POS) computer systems and electronic data interchange (EDI) systems will result in accurate sales forecasts. In contrast, determining sales forecasts on experience or hunches may be risky.
Ordering products up and down the supply chain in smaller increments reduces the time between orders and allows for timely information to be available to your firm. Receiving information in real-time is a great advantage to a firm when forecasting data is essential to reducing costs.
Some keys to reducing costs to your firm: stabilize prices along the supply chain and be sure your information along the supply chain is timely and accurate. This will enhance decision making and allow your company to be responsive to customer demand.
Reduce the speculative decisions in your firm by using actual sales of product entered into point of sale or EDI computer systems. This will help your firm base their decisions on actual demand and not on demand based upon speculation or demand derived from a zealous salesman reaching a sales quota.
Small orders and reduced batch orders increase information quality and contact with vendors up and down the supply chain.
Every firm should look to reduce costs and help them gain competitive advantage. Reducing costs along the supply chain is a new phenomenon. Perhaps your firm can gain a competitive edge by reducing fluctuations in the information along your supply chain.
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