It is a widespread misconception that the bullwhip effect is caused by irrational behaviour. In fact, it also occurs when planners react completely rationally. To prevent the bullwhip effect, you first need to understand what causes it.
It is such a shame that the bullwhip effect is blamed on irrational behaviour. Moreover, it is not particularly effective to merely state what the bullwhip effect is. After all, to prevent the bullwhip effect, you first need to understand what causes it.
How does it start?
The bullwhip effect is a well-known phenomenon in modern-day logistics. Many supply chain professionals are reasonably capable of explaining what it is: increasingly severe swings in demand that build up in the upstream supply chain. But it is more difficult to explain how it actually starts. The most commonly heard reason is irrational behaviour, i.e. panic among planners. If that’s what you think too, then I’m sorry to have to disappoint you. Irrational behaviour is not the cause. In fact, the bullwhip effect also occurs when planners react completely rationally.
Inventory-driven supply chain
The bullwhip effect is an inherent result of an inventory-driven supply chain – so the bad news is that there is really no way to completely eliminate it. However, the good news is that it can be significantly reduced, although this requires a serious focus on the true cause of the effect. So what is that cause?
Demand uncertainty and lead time
Just as the crack of a whip is affected by the force of the arm and hand movement and the length of the whip, the bullwhip effect in a supply chain is caused by demand uncertainty and lead time. Many companies hold safety stock to help them cope with demand uncertainty; longer lead times mean more safety stock. Moreover, the further upstream companies are, the greater their demand uncertainty and hence their need for safety stock is. This can be illustrated by a simple example.
Example of the bullwhip effect
If your historical average demand is 100 units per week and your lead time is five weeks, your pipeline is full at around 550 units: 500 units to meet the average demand (working stock) and 50 units for exceptions (safety stock). Suddenly, your sales level increases to 150 units. After asking around in the market, you discover that this could be a structural rise. So you now have a shortage of 250 units (5×150-5×100) in your working stock. To avoid similar surprises in the future, you also decide to increase your safety stock from 50 units to 150. As a result, you place an order with your supplier for 500 units – but your supplier was expecting an order for 100 units. Hence, a potentially structural sales increase of 50 units leads to a (hopefully one-off) volume increase of 400 units. Just imagine what would happen if your supplier were to assume your increase to be a structural one, and the supplier of your supplier, and so on.
How to reduce the effect
The above example demonstrates that the bullwhip effect is not caused by irrational behaviour, but is instead the consequence of demand uncertainty and lead time – two phenomena that are present in pretty much every supply chain.
It is therefore not possible to completely eliminate the bullwhip effect, but luckily it can be considerably reduced. After all, if the effect is caused by demand uncertainty and lead time, it can also be mitigated by reducing that demand uncertainty and shortening the lead time.
Staying with the same metaphor: if we replace the long whip with a short one, even the most forceful arm movement will no longer be enough to bother the bull.