Almost anything that is bought in a store is trucked, or shipped in from some other part of the country or flown in from abroad. It is made from parts that come from somewhere else. That’s why, even before the coronavirus outbreak officially hit, and the demand began falling, supply chains for many companies were being squeezed. Now that ‘social distancing’ is being instituted to try and slow the spread of the coronavirus, the disruption to supply chains is likely to get much worse.
A decrease in consumer demand is likely to result in a ‘bullwhip effect’. Retailers, seeing less demand from consumers, order less from wholesalers; wholesalers order less from manufacturers; and manufacturers order less from their suppliers.
But again, as retailers don’t know the demand for products on a daily basis in times like the Covid-19 crisis, they cannot keep many items regularly in stock. If a retailer places an order for a product out of stock or low in stock, if it happens that the supplier is also low in stock, this causes a delay in availability of the item. Or, the supplier places an order higher up the supply chain, which may later end up in a product surplus.
The bullwhip effect, combined with the supply disruptions caused by the outbreak and a major slowdown in consumer spending due to Covid-19 outbreak, will likely have negative consequences for the economy.
With Covid-19 affecting supply chains around the world, more companies are likely to experience this detrimental impact of bullwhip.
In the wake of the Covid-19 health crisis, images of empty store shelves have triggered a few things: even more panic buying, a social media frenzy of hoarder shaming, and even gang activity linked to toilet paper theft in Hong Kong. For many supply chain leaders, this presents the enormous and potentially costly challenge of dealing with the bullwhip effect.
Bullwhip effect refers to a phenomenon wherein small changes in consumer demand for a product at the retail stage can cause larger changes in the demand experienced by other members of the supply chain. It is a result of errors in forecasting demand across the supply chain of goods. It is a concept for explaining inventory fluctuations or inefficient asset allocation as a result of demand changes as one moves farther up the supply chain. As such, upstream manufacturers often experience a decrease in forecast accuracy as the buffer increases between the customer and the manufacturer.
The effects are greater safety stocks, and inefficient production or excessive inventory because each producer needs to fulfil the demand of its customers in the supply chain. This leads to a low utilisation of the distribution channel.
It can affect operational costs and result in a chaos in the economic system. It decreases the profits and efficiency within a supply chain. So, the need is to reduce or do away with such an effect in supply chain management.
Companies lose money as they are not able to accurately predict supply and demand. As a result, all supply chains suffer the effects of uncertainty. Companies which cope best with uncertainty through an effective supply chain are most likely to produce internationally competitive bottom-line performance. Uncertainty may take place in key areas of a supply chain like the supply side, manufacturing process, process controls, and demand side. The supply chain might become a circle of uncertainties but each segment should be cleaned.
The idea of the bullwhip effect was first proposed by the US computer scientist Jay Wright Forrester in Industrial Dynamics, 1961. Identified back in the 1960s, it was woeven into supply chain vernacular in the 1990s.
Understanding Bullwhip Effect
The entire concept that brings out a simple definition of the bullwhip effect is: ‘the final customer places an order (whip) and order fluctuations build up upstream the supply chain.’
When a nudge is given to a whip at the handle, it creates little movements in the parts closest to the handle, but parts farther away would move more in an increasing fashion. Similarly, in the supply chain world, the end customers have the whip handle and they create a little movement in the demand which travels up the supply chain in increasing fashion. As one moves away from the customers, one can see bigger movements. There are generally six to seven inventory points between the end customer and raw material supplier. Everyone tries to protect themselves from stock-out situations and missed customer orders, by keeping extra inventory to hedge against variability in the supply chain. Hence, huge buffers of inventories up to six months can exist between the end customer and raw material supplier. This bullwhip effect ultimately causes the upstream manufacturers to have increased uncertainty, which results in lower forecast accuracies leading to higher inventories.
So, the increase in consumer demand for a product can prompt retailers to order more of it from wholesale sellers, who in turn, might order even more from manufacturers, and so on.
Causes Bullwhip effect starts when a customer places an order. As the customer demand is rarely stable, therefore, business should forecast demand to properly position inventory and other resources. Moreover, most forecasts are based on statistics, so they are rarely accurate. Misled by the statistical forecasts, the companies often carry an inventory buffer, called ‘safety stock’.
Each supply chain varies from end-consumer to raw materials supplier and this effects safety stock. In periods of rising demand, down-stream participants increase orders. In periods of falling demand, orders fall or stop, thereby not reducing inventory. The effect is that variations are amplified as one moves upstream in the supply chain further from the customer.
The causes of Bullwhip effect can further be divided into behavioural and operational.
Behavioural causes include—misuse of base-stock policies, mis-perceptions of feedback and time delays, panic ordering reactions after unmet demand and perceived risk of other players’ bounded rationality. people with increased need for safety and security seem to perform worse than risk-takers in a simulated supply chain environment. People with high self-efficacy have less trouble handling the bullwhip-effect in the supply chain.
Operational causes like forecast errors, lead time, quantity discounts, trade promotion and forward buying and anticipation of shortages, etc., contribute to buffer stock and loss.
Counter Measures To identify and control the bullwhip effect, it is necessary to understand the main factors that contribute towards increase in variability in the supply chain.
Below are some methods to minimise the bullwhip effect.
- Accepting and Understanding Recognising and understanding the effect is the starting point to find solutions. Generally, companies do not acknowledge that high buffer inventories exist throughout their supply chain. Managers of supply chain can analyse the reasons for excess inventories and take corrective action and set norms.
- Improving Inventory Planning Process Stock range of each inventory point should be reviewed and adjusted from time to time. The whole inventory needs to be balanced based on regional demands. Regular reporting and early warning system need to be implemented to identify deviations from the set inventory norms.
- Lowering Minimum Order Quantity and Keeping Stable Pricing Lowering the minimum order quantity to an optimal level will help provide create smoother order patterns. There should be stable pricing for the whole year instead of frequent promotional offers and offering of discounts to ensure a stable and predictable demand.
- Improving Raw Material Planning Raw material planning is to be directly linked to plans of production. Ordering in advance and maintaining high buffers of material would address disruption in production. Production plan has to be reduced much in advance to provide the necessary information for general purchasing.
- Collaboration between Departments and Managers There should be improved collaboration among purchasing managers, production managers, sales managers and others based on common company objectives in performance evaluation. There can be improved information sharing and decision-making through regular inter-departmental meetings that can resolve inter-conflicting targets of the various departments.
Bullwhip effect happens due to errors in forecasting demand across the supply chain of a product. It is high time to shift from a forecast-driven ordering system to one that enables high levels of visibility and information-sharing.