Use of must be coordinated with all participants in the activities that follow in the chain.

A simplified example of the bullwhip effect

The bullwhip effect often occurs when retailers become highly reactive to demand, and in turn, amplify expectations around it, which causes a domino effect along the supply chain. Suppose, for example, a retailer typically keeps 100 six-packs of one soda brand in stock. If it normally sells 20 six-packs a day, it would order that replacement amount from the distributor. But one day, the retailer sells 70 six-packs and assumes customers will start buying more product, and responds by ordering 100 six-packs to meet this higher forecasted demand.

The distributor may then respond by ordering double, or 200 six-packs, from the manufacturer to ensure they do not run out. The manufacturer then produces 250 six-packs to be on the safe side. In the end, the increased demand has been amplified up the supply chain from to 100 six-packs at the customer level to 250 at the manufacturer.

This example is highly simplified but conveys the sense of exponentially increasing misalignment as actions and reactions continue up and down the chain. The bullwhip effect also occurs as a result of lowered demand at the customer level (which causes shortages when inaccurate) and can be caused at other places along the chain.

Causes of the bullwhip effect

Companies must forecast customer demand based on insufficient information, and try to predict how much product customers will actually want while accounting for the complex factors that enable that amount to be delivered correctly and on time. At every stage of the supply chain there are possible fluctuations and disruptions, which in turn influence the myriad supplier orders. Changes in customer demand directly influence all the other factors along the chain, including inventory. However, the bullwhip effect can occur even in relatively stable markets where the demand is essentially constant.

Forecasting demand has always been a difficult endeavor, and the increasing complexity of today's global supply chains intensifies that difficulty, as does increasing consumer preference for omnichannel and e-commerce.  A few of the most common dependencies that can cause a bullwhip effect are:

• Lead-time issues such as manufacturing delays
• Less-than-optimal decisions made by supply chain stakeholders at any point along the chain, for example, customer service or shipping
• A lack of communication and alignment between each link or stakeholder organization in the supply chain
• Over- or under-reacting to demand expectations, such as ordering too many units or not enough
• Customer companies, often retailers, waiting until orders build up before placing orders with their suppliers, a practice called order batching
• Discounts, cost changes and other price variations that disrupt regular buying patterns
• Inaccurate forecasts from over-reliance on historical demand to predict future demand

Impact on supply chain management

The bullwhip effect can be costly to all the organizations in the supply chain. Excess inventory can result in waste, while insufficient inventory can lead to reduced lead time, poor customer experience and lost business.

Most businesses use safety stock (reserve inventory) as a buffer against demand fluctuations. However, safety stock is not a solution to the bullwhip effect, but it provides enough product to fill orders until more arrives from suppliers.

Some solutions to the bullwhip effect

Better information is necessary to reduce the bullwhip effect. This means better communication among supply chain partners and better forecasting methods. Some commonly recommended actions include the following:

Foster supply chain communication and collaboration.

Better alignment around supply chain issues both within the company and among customers, suppliers, distributors, manufacturing and the rest of the partners is needed. In particular, when suppliers work to understand customer needs, they can work to help reduce excessive inventory. Supplier and project portals, Electronic Data Interchange (EDI) transactions and other capabilities of supply chain management software can help.

Use better forecasting and visibility tools.

A wide range of software helps enable more accurate demand forecasts and visibility into what is happening along the supply chain. These include demand sensing software, forecasting software, inventory optimization software and tools that use analytics (especially predictive analytics), artificial intelligence (AI) and Internet of Things (IoT) connectivity.

Explore a demand-driven approach to supply chain management.

A demand-driven approach relies on a system of coordinated technologies and processes to gain insight into supply chain occurrences and react to them quickly. It uses many of the approaches mentioned above, especially collaboration and communication and new technologies to enable supply chain visibility, for a coordinated holistic approach. Each company will need to decide on the right push-pull approach to its strategy, where a push approach is used for stable products and a pull approach is used for those with more erratic demand.

Lessons on the bullwhip effect using the beer game

Developed at the MIT Sloan School of Management in the 1960s, the beer game, also called the beer distribution game, is a role-play simulation game in which players experience firsthand the complexity of supply chain management. It simulates the beer supply chain using retailer, wholesaler, distributor and brewer. The goal is keeping operating costs as low as possible and teams are penalized for having too much inventory.

Players can only communicate by relaying orders through the normal channels, mimicking a real-life supply chain, and they must deal with inventories and backlogs, and their impact on the bottom line. Among its lessons, it illustrates the complexity of the system as a whole, the difficulty of making correct choices with limited information, and quickly brings to life the bullwhip effect in action.