The Bullwhip Effect Decoded: Implications for OEMs, Dealers, and the Supply Chain Ecosystem

Max Wies 13 Jun 2024 8 mins read

Table of Contents

Bullwhip Effect
Picture this.

Machines grinding to a halt due to low fill-rates. Warehouses groaning under the weight of excess stock—bleeding cash as they wait for demand to pick back up. This is the daunting reality for many OEMs and their dealers, trapped in a cycle that’s anything but lagom.

See, that’s what you’re aiming for when it comes to managing your supply chain. Lagom is the Swedish ideal of ‘just right’. Not too much or too little, but the perfect balance. OEMs should be striving for lagom when managing operations.

But how do OEMs achieve lagom? That’s the perennial question in the parts business. Welcome to the world of the Bullwhip Effect, a notorious supply chain rollercoaster where a tiny ripple in consumer demand triggers a tsunami of overstocking or, conversely, catastrophic stockouts.

Now, imagine a scenario that begins innocuously.

Consumers buy a bit more, retailers order extra, wholesalers see this as a cue to stock up, and manufacturers ramp up production. What starts as a minor change in demand escalates into a logistical nightmare, leaving OEMs wrestling with bloated inventories and skyrocketing costs.

But here’s the twist. When OEMs hit the brakes to correct course, they often overshoot, leading to a global crisis of stockouts. It’s a high-stakes game of inventory Jenga, where one wrong move can topple an entire supply chain.

Buckle up as we delve into the bullwhip effect, a phenomenon that’s as impactful as it is unpredictable, and how it can turn the supply chain world upside down.

What is the bullwhip effect in the supply chain?

The bullwhip effect is a supply chain phenomenon that occurs when small fluctuations in demand lead to large distortions down the supply chain. This increased demand is first observed by the retailer, who then amplifies it, leading to progressively larger fluctuations at the wholesale, distributor, and manufacturer levels.

Imagine a farmer who realizes that their tractor’s fuel injector is faulty. To avoid machine downtime, they turn to their local dealer. With no fuel injectors in stock, the dealer orders two from a regional distributor—just to be safe.

The regional distributor understands the unexpected order as an increase in demand, prompting them to order four from the national supplier.

As the trend continues, the national supplier orders eight injectors from the OEM’s central warehouse. They manufacture 16, double the order they received, to ensure enough stock.

bullwhip effect supply chain

The result?

A complete distortion of demand, overstocking, and high inventory costs. Manufacturers may even use the amplified demand as a basis for future production planning—straining inventory and widening the gap between real end-client demand and production.

This supply chain phenomenon plays a crucial and painful role across various industries. Let’s examine the bullwhip effect in action.

Toilet paper suppliers struggle to handle COVID-19

The toilet paper craze during the COVID-19 pandemic is another prime example of the bullwhip effect. It began when everyday people were scaremongered into panic buying toilet rolls under the guise that there wasn’t enough to go around. This saw sales increase by 700% in Europe alone.

Retailers increased their orders to replenish their shelves and anticipate the increased demand. As this dramatic increase in toilet paper demand reached manufacturers, they responded by increasing supply levels even further.

There was only one crucial issue—this increased demand was short-lived. Demand fell again, and by the following year, sales had dropped by 33%.

By the time manufacturers realized that demand had lowered to a pre-COVID level, it was too late. They’d already manufactured the additional toilet roll and now needed to store it, as wholesale and retail demand had dropped. This meant they found themselves subject to much higher inventory fees than ever before.

Hewlett-Packard’s lack of visibility causes manufacturing issues

HP was also impacted by the bullwhip effect when volatile orders from a major reseller made it difficult to predict demand and manage production.

Executives examined the sales of printer models at the reseller and noticed slight fluctuations in demand, which is to be expected. However, when they then inspected the reseller’s orders, they were much greater than the original demand at the retailer level.

This gap meant that HP was manufacturing many more printers than customers actually wanted. Suppliers received a distorted view of customer demand, overproduced, and overstocked their shelves with inventory. It was only when HP implemented strategies and technology to get better visibility over the supply chain that they were able to more accurately predict demand and, subsequently, avoid the bullwhip effect. 

What causes the bullwhip effect?

As demand fluctuations move upstream from end clients to manufacturers, overproduction occurs and inventory fees skyrocket. But, what is it that sets the bullwhip effect in motion?

Supply chain complexity

A customer-facing supply chain often becomes complex with multiple stakeholders, especially when there is a multi-faceted distribution network with everyone working on different systems. The more complex a supply chain, the more impactful minor fluctuations in demand are as they flow upstream.

For example, in a three-tier supply chain, retailers might note higher demand and place twice as many orders with wholesalers, who place twice as many orders with manufacturers. Putting numbers to this, 10,000 orders from the retailer turn into 20,000 orders from the wholesaler and a total of 40,000 units produced by the manufacturer. With just two additional supply chain steps, this turns into 160,000 units.

Complex supply chains with many entities are prime victims of the bullwhip effect. What sounds like a far-fetched calculation is a stark reality in the vast majority of supply chains of manufacturing companies.

Miscommunication

Parties failing to communicate essential factors across the supply chain, such as production issues, demand shifts, lead times, and transportation delays, can lead to the bullwhip effect. Many entities along the chain might even interpret the same information differently depending on their objectives, processes, and perspectives.

For example, a spike in orders may look like a long-term increase in demand for manufacturers, causing them to use the figure as a basis for future production planning. However, those at the retailer level may recognize the increase as a short-term surge due to a promotion or marketing campaign. When retailers communicate the reasoning behind a fluctuation in demand, manufacturers can amend their production planning without distortions.

That’s why ensuring communication, connection, and visibility is essential. Inventory management solutions, like ClearOps, allow for collaboration between suppliers, manufacturers, and logistic partners when it comes to any changes or disruptions.

Delays and changes in lead times

Lead times cover the period of fulfilling an order after the customer or reseller has placed it. Typically, companies aim for short lead times in order to meet customer demand and maintain customer satisfaction. If a delay does occur, companies will frequently order larger batches to ensure safety stocks in case demand grows even higher. These inflated orders, combined with incorrect forecasting at the manufacturer level, can lead to excessive inventory accumulation.

While it’s possible to calculate average lead times, several factors may influence them. Some issues that can further extend lead times include changes in a manufacturer’s service-level agreement (SLA) or a shortage of raw materials for finished goods production.

bullwhip effect supply chain management

The impact of the bullwhip effect on the supply chain

The bullwhip effect leaves players in the supply chain with more than one problem to solve. It can have major consequences for inventory management, fulfilling end customer demand, and everything in between.

Here are three ways the bullwhip effect affects businesses and why you should avoid it.

Unfulfilled demand means poor customer satisfaction

In severe cases, the bullwhip effect can result in a total mismatch of supply and demand. After manufacturers respond to erratic buying patterns with overproduction, businesses may drastically decrease orders as a correction.

The sudden decrease can then lead to extended underproduction. With limited visibility, manufacturers won’t have accurate insight into buying patterns. As a result, underproduction can result in a stockout and unfulfilled customer demand on a large scale.

As businesses fail to meet demands, customer satisfaction tanks. Customers are less likely to trust your brand to provide them with the products they need and will most likely shift their future buying decisions toward the competition.

Overproduction means increased costs

Overproduction caused by the bullwhip effect not only increases costs directly tied to production but also increases the cost of storage, handling, and insurance for excess inventory.

Plus, that’s the best case scenario. The worst case scenario is that the overproduced product can never be sold—such as if it’s a perishable good or event-specific product. In these cases, the manufacturer is left with products they’ll need to sell at a heavily discounted price, or even destroy altogether.

According to Avery Dennison’s global report, which analyzed 318 international businesses across five different sectors, overproduction eats up about 3.6% of annual profits, resulting in the loss of $163.1 billion of inventory. Keeping overproduction to a minimum is crucial for maximizing profits.

Increased production requires more labor

As demand fluctuates unpredictably, almost every player in the supply chain may have to incur increased labor costs to meet and manage the challenges of exaggerated orders. When a sudden increase in demand appears, companies may need overtime or temporary workers to fulfill orders to avoid lengthening lead times.

For manufacturers, that means a higher need for inventory, production, sourcing, logistics etc. personnel. For distributors, it may mean hiring additional labor for increased logistics, inventory, sales, and planning. Regardless of the specifics, one thing’s for sure—more labor means more labor costs, something manufacturers should aim to avoid if looking to maintain healthy profit margins.

Mitigating the bullwhip effect in supply chain

The bullwhip effect benefits almost no one. Not the end customer, not the retailer, not the manufacturer, and nobody in between. The only entities it benefits are the ones that you’ll be paying to store, protect, and insure your surplus inventory. 

That’s why supply chain visibility is key. Instead of just communicating with stakeholders one link up or down the chain, businesses can get a complete overview of the supply chain sets for accurate demand planning – from production to retailers to the end customer. With the right technology and efficient management, companies can navigate through supply chain complexity and most importantly: outperform the competition with efficient global availability.

That’s where ClearOps comes in. With a centralized platform, ClearOps gives you a complete overview of the supply chain, enabling you to accurately manage inventory and predict future demand from end-to-end to ensure you don’t fall victim to the bullwhip effect.

If you’re ready to bring visibility to your supply chain and the customer satisfaction that goes with it, then book a demo with ClearOps and get started.

FAQs

OEMs and dealers respond to the bullwhip effect by adjusting inventory levels, refining demand forecasting, improving communication, and implementing inventory management solutions.

Other industries like electronics and automotive, along with companies in consumer goods retail, have also faced the bullwhip effect. Mitigation strategies include supply chain visibility improvements and demand-driven production processes.

HP utilized advanced analytics, improved communication channels, and optimized inventory management to gain better supply chain visibility and mitigate the bullwhip effect.

The bullwhip effect varies across supply chains and industries but is more pronounced in complex chains with long lead times or seasonal demand patterns.

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