Bullwhip Effect

What is the bullwhip effect

The bullwhip effect can be described as a series of events that leads to supplier demand variability up the supply chain. Trigger events include the frequency of orders, varying quantities ordered, or the combination of both events by downstream partners in a supply chain. As the orders make their way upstream, the perceived demand is amplified and produces what is known as the bullwhip effect (1).

The bullwhip effect has been perceived as an unavoidable effect of demand variation. Only recently have companies begun to tackle the ripple associated with variances in demand. The key to stemming the effect is realizing who is signaling the change in demand. Is it the manufacturer, distributor, the retailer, or the customer? Knowing where the demand shifts are originating is vital to attacking this problem.

How to manage it

There are a few methods that can be utilized to minimize the bullwhip effect. These methods are:

Portfolio approach

Postponement

Information sharing between supply chain members

1. Portfolio planning

Portfolio planning places an emphasis on diversifying the supply base. Portfolio planningЎЇs goal is to involve one or two suppliers in long-term contracts to cover a majority of the expected demand. The remaining demand is fulfilled by a smaller base of suppliers with short-term contracts who can respond quickly to changes in demand. These short-term contract suppliers receive a premium, because they are bearing the risk in this situation. Yet this short-term contract relationship with these suppliers allows the manufacturer to quickly adjust to shifts in demand.

Advantages

The portfolio approach attacks procurement issues by diversifying the manufacturerЎЇs risk, much like a financial planner would protect a client from wild swings in the stock market. This approach protects against uncertainties that are out of the manufacturerЎЇs control.

For instance, a company that has exclusive long-term contracts with only one or two suppliers may choose the portfolio approach. It mitigates risk by giving these suppliers long-term contracts to handle up to 90 percent of expected demand. The remaining demand should then be covered through short-term contracts ÐŽowith slightly higher unit prices but guaranteed availability, to cover uncertainties in demand variability (2).ÐŽ±

Example

Hewlett Packard has recently adopted this approach in some aspects of its business. During the 90s, Hewlett Packard ÐŽotransitioned from a full-time employee-only labor force to embrace a mix of full-time employees, part-time contractors, consultants and temps. By using a diversified mix of labor resources, HP increased its flexibility to match supply (labor) with demand, and reduced labor costs by 13% (2).ÐŽ±

2. Postponement

Postponement is a concept in which the manufacturer delays completing, as much as possible, the final features of a product. Final assembly is normally done in regional distribution centers because these sites are closer to the customer than the manufacturing facility. For example, a canned corn manufacturer distributes its corn for various grocery store retailers. The distributor waits to see what grocery stores demand before labeling cans of corn under each grocerЎЇs brand name.

Advantages

Postponement is most successful in an environment that cannot forecast product assortments very well, but can aggregate end-user demand and delay the final step or steps in completing a product. Because the manufacturer can accurately judge the overall demand of a product category, the distributor can wait until the moment when the demand for a particular product is realized. The distributor can then differentiate the product quickly and the customer will be served better.

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