When it comes to a supply chain, each part of the process stands alone—with little to no sway or control over the other aspects. Businesses can’t really dictate the actions of manufacturers, retailers can’t directly influence their suppliers to always act in line with their needs, and so on. All parties generally seek to respond to changes in demand in order to profit from a smooth flow of goods. However, the bullwhip effect can throw the supply chain off course, with longer-term consequences. Understanding the bullwhip effect can help ecommerce businesses better manage their own supply chains and prevent disruption.
The bullwhip effect takes its name from the action of a bullwhip. That is, a small movement in the hand holding a whip leads to an uncontrolled, flying movement at the end of the whip. Responses to changes in customer demand or the supply of a particular material create similar ripple effects that echo through the supply chain. This leads to a mismatch between supply and demand—causing difficulty when predicting and stocking the right amount of inventory.
If customer demand increases by, say, 5% then retailers may need to increase orders from their suppliers. They may request a 10% increase so that they won't run out of goods when needed and account for any necessary buffer. The suppliers, looking at the requests from a retailer and expecting this effect to be replicated by multiple customers, will then order 15% more from their manufacturer. Then, manufacturers might raise their production by 20%, leading to an overproduction of products. As a result, all levels of the supply chain suffer from excess inventory, downward price pressure, and higher costs.
One famous example involves Hewlett-Packard (HP) printers. HP used to rely on retailer/reseller demand in order to restock components and manufacture printers. As a result, sales and promotions at retailers led to wildly shifting forecasts. At times, HP had a glut of excess printers, while at other times, they were hard to find in retail stores. Shifting demand forecasting internally and increasing transparency helped to mitigate this problem.
In order to plan for the future, companies must forecast upcoming demand—sometimes using a reorder point formula—along all steps of the supply chain. Direct-to-consumer brands must look past trends, seasonal expectations, and other customer behavior to determine the correct level of inventory. After all, if a product is out of stock, customers are likely to go elsewhere to fulfill their needs.
There are several major causes of the bullwhip effect on supply chains:
Demand forecasting is a challenging task for any ecommerce business. All companies strive to have a perfect understanding of their customers' upcoming demands in order to maximize profit, avoid backorders, and minimize excess inventory. However, overreacting to small fluctuations or underreacting to major trends can lead to significant problems. This has been the case even for established products with relatively steady demand. For example, one classic instance of the bullwhip effect involved Procter & Gamble assessing demand for Pampers diapers. Of course, this can be even more challenging for ecommerce vendors selling newer products on the market.
In general, downstream customers need to order products in advance and in bulk in order to receive the best price on manufacturing or shipping. Order batching means that retailers order from their supplier(s) only once a month or quarter rather than consistently throughout the year. As a result, the supplier has inconsistent demand and must also estimate demand when placing orders from its upstream manufacturer.
Businesses offer promotions and discounts to drive sales. Retailers may also offer promotions and discounts to drive customers to try new products, solicit demand at less active times of the year, or clear out poorly selling merchandise. However, the savings generated by promotions and discounts can lead to increased customer demand. If the effect of items on sale is not taken into account, businesses can easily mistake these fluctuations for long-term changes in demand.
When stakeholders within one company or throughout the supply chain do not communicate adequately, decision-makers may not have correct estimates of demand. For example, suppose the people placing orders to upstream providers are unaware that demand changes have been driven by promotions or major marketing campaigns. In that case, they may place orders that lead to the bullwhip effect due to these misperceptions.
Logistics professionals have come up with several formulas to determine the impact of the bullwhip effect. In essence, you want to measure the variability of orders compared to your actual sales. Inventory management software can help you to do this effectively.
Some of the consequences of the bullwhip effect for businesses include:
Surplus inventory can be costly to companies. Ecommerce businesses may need to spend extra money on inventory holding and warehouse costs. If they sell perishable goods, they may face concerns about expiration and be forced to offer unplanned discounts and promotions to move the merchandise.
This effect can ripple throughout the supply chain, with upstream manufacturers and distributors facing higher costs and raising prices as a result of their excess inventory.
Of course, the bullwhip effect can also echo in reverse. Overreacting to a perceived decrease in demand can lead to shortages in the market. Spaces for popular products may display "out of stock" messages for the long term because it is challenging to obtain the materials from upstream suppliers.
Because of all of these problems, many companies are trying to learn the best ways to avoid the bullwhip effect. There are several tactics that ecommerce businesses can use in order to improve their demand forecasts and avoid inventory excesses and shortages.
Ecommerce businesses can benefit from improving their demand forecasting. Advanced inventory management systems, such as those offered by Airhouse, can help companies better understand surges and ebbs in customer demand. Complex algorithms and predictive analytics can help your business have a better understanding of future demand and make orders that align with it too.
Reducing the batching of orders and lengthy lead times can also help prevent supply chain disruption. By using suppliers that are more local, companies can reduce the time needed to produce or obtain new merchandise. Negotiating agreements or finding new shipping options that reduce shipping costs for smaller orders can also help to avoid this problem, which can benefit suppliers as well.
Price promotions and discounts can help to drive business to your ecommerce site. However, a constant stream of discounts and promotions can disrupt buying patterns, lead customers to expect a discount more frequently, and confuse potential future demand. Scheduling sales and promotions in advance and incorporating major discounts into demand forecasting can help to prevent the bullwhip effect.
Electronic data interchange (EDI), supplier integration, and other advanced data technologies can help both suppliers and ecommerce businesses better understand supply needs and future demand. Integrated software solutions can increase transparency and produce more effective results for all parties concerned.
An end-to-end fulfillment partner like Airhouse offers your ecommerce business access to a suite of advanced inventory management and electronic data tools and systems. Our support options for supply chain visibility, demand forecasting, and inventory modeling can help you save on costs and reduce the bullwhip effect. Request a demo of Airhouse's system to try these advanced options for yourself.
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