The Bullwhip Effect

Remember 2019, when suppliers and carriers would provide competitive prices and offer discounts to earn your business? Ah, yes.. the good old days! Well, welcome to 2021: where products are scarce, transportation and warehouse capacity are tight, and prices for everything (including labor!) are going through the roof. This week's newsletter explains how these wild swings are actually part of a well-known supply chain phenomenon called The Bullwhip Effect.

What Is the Bullwhip Effect?

The Bullwhip Effect is a pattern that is observed when inventory swings from peaks (overstocks) to valleys (stockouts and backorders), and these swings get amplified as they move up the supply chain. It was first identified by MIT professor Jay Forrester, so it is also known as the Forrester Effect. Forrester observed that this pattern emerged consistently in supply chains when there were rapid changes in demand, and demonstrated it by creating an interactive simulation called the Beer Game. (Check below for a video showing John Sterman leading a group of graduate students through the Beer Game.)

"The bullwhip effect refers to the phenomenon where order variability increases as the orders move upstream in the supply chain."

Xun Wang and Stephen M. Disney

Today, the Bullwhip Effect is in the news. The Wall Street Journal just published a column titled Caution—Bullwhip Effect Ahead by professors Ted Stank, Tom Goldsby and Lance Saunders from the Global Supply Chain Institute at the University of Tennessee. I caught up with Ted to talk about the causes and impacts of the Bullwhip Effect:

There is a LOT of research about the causes of the Bullwhip Effect. A good place to start is a 1997 article in MIT Sloan Management Review called The Bullwhip Effect in Supply Chains, by Hau Lee, et al. They focused on four major causes of the Bullwhip Effect:

• Demand forecast updating
• Order batching
• Price fluctuation
• Rationing and shortage gaming

The following year, Richard Wilding published The Supply Chain Complexity Triangle: Uncertainty Generation in the Supply Chain. He used Chaos Theory to show that the Bullwhip Effect (demand amplification) is an example of how random and unpredictable behaviors can emerge naturally from systems that seem to be well-organized. One of Wilding's main points is that supply chains are systems, and systems generate uncertainty.

"Supply chains do not reach stable equilibrium; small perturbations will always prevent equilibrium being achieved."

Professor Richard Wilding, OBE

In 2016, Xun Wang and Stephen M. Disney from Cardiff University looked at 455 published research articles about the Bullwhip Effect, and shared their findings in The Bullwhip Effect: Progress, Trends and Directions. What does all of this research actually tell us? That the Bullwhip Effect is real, and, well, it's complicated. Which is why using a simulation like the Beer Game is such a powerful teaching method.

What Triggers the Bullwhip Effect?

The Bullwhip Effect can emerge naturally, over time, even in a stable system. But it is usually triggered by rapid changes in supply or demand. Under normal circumstances, an increase in sales from a promotion can be enough to trigger the Bullwhip Effect. But in the past 18 months, COVID has triggered numerous bullwhips. Let's recap:

• Increase in demand for staples like toilet paper, with no increase in consumption.
• Increase in demand for PPE, cleaning products, and vaccines, accompanied by an increase in consumption.
• Decrease in demand for products related to in-person events.
• Interruption in manufacturing and distribution of products due to Covid outbreaks.

In addition, we've seen other supply chain disruptions such as:

• Brexit and the U.S. / China trade dispute
• Suez Canal blockage
• Texas blizzard
• Colonial Pipeline cyberattack

The results of these changes are easy to understand, when viewed through Jay Forrester's lens:

• Outbound containers clogging ports in Asia, while inbound containers are clogging ports in the U.S.
• Warehousing and transportation capacity around the world are strained.
• Prices for commodities such as oil and lumber are swinging wildly.
• Consumers and supply chain managers are concerned about product availability, and are building inventory buffers.

What Can We Do About It?

While it seems we are gaining the upper hand on COVID, there are plenty of other things that could lead to supply chain disruptions in the months ahead. Trade wars, military conflicts, cyberattacks. natural disasters, and COVID variants, to name a few. We may not be able to prevent the Bullwhip Effect, but there are definitely things we can do to reduce it, and protect ourselves from its effects.

• Share information up and down the supply chain
• Reduce lot sizes throughout the supply chain
• Reduce promotions and pricing volatility
• Simplify everything
• Build resilience, flexibility, and agility

Ironically, none of these are terribly controversial, but they are hard to implement because they require investment, commitment, and trust in our supply chain partners.

How this affects supply chain professionals? The Bullwhip Effect is a well-known phenomenon that occurs in supply chains, where inventory levels swing from one extreme to the other. This behavior is often triggered by rapid changes in supply or demand, and it tends to be amplified as it moves upstream because of long lead times, poor communication, and large lot sizes. In a turbulent market, like the one we are all experiencing now, it is important for supply chain professionals to differentiate short term cycles from long term trends, and to be both flexible and responsive to changes.

What do you think? Are you seeing the Bullwhip Effect in your supply chain? What are the impacts on your business (and your customers!) and how can you protect yourself from the dangers?

Additional Resources

• Commentary: Caution—Bullwhip Effect Ahead by Ted Stank, Tom Goldsby and Lance Saunders (WSJ)
• Transportation capacity tightens further in May by Todd Maiden (Freightwaves)
• The Bullwhip Effect in Supply Chains by Hau Lee, V. Padmanabhan, and Seungjin Whang (MIT-Sloan Management Review)
• The Bullwhip Effect: Progress, Trends and Directions by Xun Wang and Stephen M. Disney (European Journal of Operational Research)
• "The Business Cycle" Part 1 / Part 2 an interview of John Sterman by Paul Solman (MacNeil / Lehrer New Hour)
• The Supply Chain Complexity Triangle: Uncertainty Generation in the Supply Chain by Richard Wilding, OBE (International Journal of Physical Distribution & Logistics Management)

Who is Mr. Supply Chain?

Daniel Stanton is a supply chain industry veteran and the best-selling author of Supply Chain Management For Dummies. He is dedicated to empowering professionals through education and technology. His courses on LinkedIn Learning (formerly Lynda.com) have been viewed by students around the world, and he's a frequent speaker at educational conferences and industry events.