Bullwhip Effect Current Situation
Many companies are currently dealing with a strong bullwhip effect. In part, this problem is tied to the ongoing impacts of the pandemic, but it’s amplified by the changing nature of demand for consumer goods.
Consider that during the pandemic many companies were over-buying to meet rising consumer demand, but due to container and harbor shortages, a lot of these products were backed up.
These shortages caused companies to order even more as they reasoned this would give them a larger share of the pie. As lead times return to normal, however, all these products are finally flowing in but demand drops for these same products leading to large excess inventory.
At a time when central banks are also increasing interest rates, the bullwhip effect becomes a high priority for many executives. Three years into the pandemic, the bullwhip effect continues to cause problems for companies.
So what can businesses do to mitigate the sting of this supply whip?
First, we’ll explore the impact of this effect, then examine proven tactics to minimize the bullwhip effect. Finally, we’ll talk about how to stop the bullwhip even before it starts by identifying the origins of demand drop.
Bullwhip Effect’s Impact on Supply Chain:
The above Figure 1 shows the typical COVID demand (they are real numbers) that we noticed across our customers from Sep 21 until May 22, and a sudden drop in demand starting June 22. When demand drops for many items at once, the impact is huge but how does it affect the supply chain at scale?
To understand this further, in 2020 Slimstock played two simulation games with participants from the supply chain industry:
- To see the actual impact of the bullwhip effect
- To test a few effective tactics to mitigate the impact
In the first game, we simulated a supply chain of hand sanitizer facing a sudden bump in demand and let the participants take on a role in the supply chain (one person played as a retailer, wholesaler, distributor, or manufacturer).
The game was played with traditional supply chain practices over 20 rounds (equal to 20 weeks). When we say “traditional”, we meant:
- a supply chain with no communication between the different roles, other than the order they place with each other.
- On top of that, the supply chain had long lead times, making it difficult to respond effectively and quickly to a sudden spike in demand.
Participants only knew demand in the week it occurred, and the true demand was only known to the retailer who had no way of sharing information with the other teams.
Below figure-2.1 shows the demand from the customer side over a period of 20 weeks ie 20 rounds. This information was known only to the retailer.
Figure 2.1: Customer demand over 20 weeks
If we look at figure 2.2 below, we notice the order size fluctuation throughout the 20 rounds.
We see the manufacturer preparing early for the crisis, but the distributor and wholesaler do not start pulling any product in anticipation (participants did know a crisis was coming but they did not, however, know exactly when and how severe).
The retailer responded to the crisis as it occurs. As they knew what the actual demand was, they could respond quickly in terms of ordering. They only needed to react as it was happening.
Figure 2.2: Order fluctuation by role throughout the first game
If we look at the figure-2.3 below, which reflects the inventory fluctuation throughout the game for each of the roles, we see that the anticipation of the manufacturer backfired.
As they did not have any information on true demand, they kept producing for too long and kept building up inventory up until week 9, long after the spike in demand was over.
Figure 2.3: Inventory fluctuation by role throughout the first game
In this game, we learned a few things. We found that in general, manufacturers were willing to run the risk and end up with high inventory levels at the end of the crisis.
Wholesale, meanwhile, had a very large risk of backorders. Retailers ran the lowest risk of incurring heavy costs.
The end result was that the wholesaler had built up a significant number of backorders which left them with very high costs.
In real life, this is exactly what happened after the pandemic (when the bullwhip effect hit supply chain), because many retailers have a major power advantage over their wholesalers (and distributors).
They are close to demand, very large, and keep very minimum inventory compared to the rest of the supply chain.
In conclusion, this is what happened overall:
As a community, this gives us something to think about, as we’ll likely see many wholesalers and distributors incurring large costs, and we’ll see many manufacturers produce until long after this crisis will be over.
This could lead to large periods of no production at all and could cause severe effects on employment and stability at the manufacturing level.
One real-life example of this bullwhip in action is PC manufacturer Dell.
In 1994, the company was struggling — massive amounts of PC parts that were ordered in advance were causing profitability headaches.
If purchase forecasts were wrong, the company was stuck with parts it couldn’t sell, and given the speed of hardware evolution, this meant these parts quickly became obsolete.
By 1998, however, Dell had turned its fortunes around. Revenues grew from $2 billion to $16 billion and the company’s return on invested capital with 217 percent.
How did they do it? By creating a tightly-aligned sales model that focused on predictable sales patterns using pre- established customer relationships, along with a “current quarter plus one” strategy that saw Dell limiting inventory and using real-time pricing to reflect evolving component costs and inventory levels.