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What is the whiplash effect?
The bullwhip effect refers to a scenario in which small changes in demand at the retail end of the supply chain amplify as they move up the supply chain. retail end to manufacturing end.
This occurs when a retailer changes the quantity of a good it orders from wholesalers based on a slight change in the actual or expected demand for that good. Due to the lack of complete information on the development of demand, the wholesaler will increase his orders from the manufacturer even more, and the manufacturer, being even further away, will change his production by an even greater amount.
The term is derived from a scientific concept in which the movements of a whip are equally amplified from the origin (the hand cracking the whip) to the end point (the tail of the whip).
The danger of the bullwhip effect is that it amplifies the inefficiencies of a supply chain, as each step in the supply chain estimates demand increasingly incorrectly. This can lead to excessive inventory investments, lost revenue, reduced customer service, delayed schedules, and even layoffs or bankruptcies.
Key points to remember
- The bullwhip effect refers to the amplification of demand variability as you move up the supply chain from retailers to manufacturers.
- When a retailer incorrectly forecasts demand, this error is often amplified when orders are sent to distributors and manufacturers, ultimately leading to massive discrepancies between product inventory and demand.
- Bullwhip effects can lead to excess inventory, lost revenue and overinvestment in production.
Understanding the bullwhip effect
The bullwhip effect typically spreads from the retail level through the supply chain to the manufacturing level. If a retailer uses immediate sales data to anticipate a large increase in demand for a product, the retailer will transmit an additional product demand to its distributor. The distributor, in turn, will communicate this request to the manufacturer of the product. This alone is one aspect of supply chain operations and does not necessarily reflect a bullwhip effect.
The whiplash effect generally distorts this process in two ways. First, when retailers change the initial order due to an inaccurate demand forecast. The size of this error tends to increase as it progresses through the supply chain to the manufacturer. The second is when a retailer has correct demand information, but this leads to incorrect conclusions about the retailer’s reason and change order details information, resulting in incorrect assessments by wholesalers, which are then amplified further up the chain.
Example of the bullwhip effect
For example, imagine a retailer selling hot chocolate that typically sells 100 cups a day in the winter. On a particularly cold day in this region, this retailer sells 120 cups instead. Mistaking the immediate increase in sales for a larger trend, the retailer asks the distributor for ingredients for 150 cups. The distributor sees the increase and expands its order form with the manufacturer to also anticipate the increased demands from other retailers. The manufacturer is increasing its production in anticipation of greater product demands in the future.
With each step above, demand forecasts have been increasingly skewed. If the retailer sees a return to normal in hot chocolate sales when the weather returns to normal, they will suddenly find themselves with more supplies than they need. The distributor and manufacturer will have even more excess inventory.
Another reason for the lack of information is that larger logistics operations at the wholesale level take longer to change, which means that the conditions that caused demand to change at the retail level can be passed the moment a wholesaler reacts. As the evolution of manufacturing production takes even longer and information from retailers is even later in reaching manufacturers, the difficulty of reacting correctly to changes in demand increases even more.
Even if the retailer had accurately gauged demand, for example, due to the start of a local hot chocolate festival, the whiplash effect can still occur. The retailer, not being fully aware of local conditions, may assume that this is due to a sharp increase in demand for hot chocolate, rather than conditions specific to that retailer. The builder, being further removed from the situation, would be even less likely to understand and react properly to changing demand.
Asset manager and famed “Big Short” investor Michael Burry made headlines in June 2022 when he warned investors of the bullwhip effect for big-box retailers and the like.
Impacts of the bullwhip effect
In the example above, the manufacturer may be stuck with a large surplus of product. This may result in disruptions to that manufacturer’s supply chain and operations, increased costs associated with storage, transportation and spoilage, lost revenue, shipping delays, etc. The distributor and retailer in this example may also experience similar issues.
What does a whiplash effect indicate?
A bullwhip effect indicates that a small error in assessing consumer demand has been amplified through a supply chain. This means that communication between companies in a supply chain is imperfect, causing companies up the supply chain to miss important information.
How do you identify a whiplash effect?
The bullwhip effect can be difficult to identify in real time, in part because it is caused by a lack of communication throughout a supply chain. This is often an afterthought, when inefficiencies have already been created.
How to prevent a whiplash effect?
There are many things companies in a supply chain can do to prevent, or at least reduce the likelihood and severity, of a bullwhip effect. Above all, they can ensure clear and consistent communications between companies up and down the supply chain. This will prevent temporary or localized changes to the offer from being misinterpreted as broader than they are. Businesses can also make sure to take a broader perspective when forecasting demand, to reduce the effect of any temporary or limited changes. Finally, companies can strive to increase the speed at which they are able to respond to changes in demand, which means they can readjust more easily if they assess demand incorrectly. It also reduces the need to overproduce or overorder to have a buffer should demand change.
