The bull whip effect in supply chain
The bull whip effect illustrates how small changes in demand could significantly oscillate the inventory you're carrying and impact cost
Do you deal with inventory in your operations? You might find this useful. Today, we’ll talk about the Bullwhip effect in supply chain management. In simple terms, it’s how small changes in your demand could lead to huge oscillations in the inventory you carry. (And this gets amplified at the higher levels of your supply chain).
Say you have an e-commerce clothing store. You must be carrying inventory. A very crude summarization of your supply chain process will look like this:
Purchase items → keep in inventory → Receive orders → Deliver items
We spoke extensively about how the amount of inventory you hold can make or break your business.
Now, you’d always be carrying a limited amount of inventory (probably for the next 30 days) at any time along with a buffer stock of 10 days in case there’s a sudden spike in volume. Whenever the stock reaches below that level, you’d be ordering more items. This way, you try to hold less items and you don’t run out of stock.
Imagine that your sales suddenly goes up by 10%. You see that for the last 3 days. Now, you might run out of inventory sooner than you expected.
This process will lead to your inventory on hand oscillating. Something like this.
This effect of oscillating inventory is called the “Bull whip effect” (for obvious reasons).
Before we jump into why this happens, let’s understand the parameters that are at work here.
The number of orders you get every day. This typically varies daily and seasonally.
This is the no of items you hold in stock at any point in time
No of days of inventory you want to hold as a safety stock so you don’t stock out where there’s a sudden spike in demand.
This is the time it takes for you to make up you mind to place an order when there’s a change in demand. Let’s elaborate. When you see that there’s a sudden spike in demand, you’ll not directly go ahead and place an order to the supplier. You’ll wait for 2-3 days to understand if it’s an anomaly or the new pattern. This delay in making the decision is called purchase delay.
This is the amount of time your seller takes to fulfill your request. Meaning, a delivery delay of 10 days states that it take 10 days for the orders you placed with a supplier to reach your warehouse.
Now that we know the factors involved, let’s jump into what’s happening.
The bullwhip effect happens primarily due to incomplete information. In this case, the delays outside of your control. In the process we discussed, there are multiple delays. The purchase delay and the delivery delay. Purchase delay is in your control but delivery delay is not. Just this single external factor, especially a delay, leads to inconsistent experience across your supply chain.
This delay in waiting for the results causes wide oscillations temporarily.
Bull whip effect in your supply chain will lead to two problems:
This leads to high inventory holding cost resulting in losses
This results in stock outs and lost revenue.
It’s quite hard to know at a given point in time. Because you are working based on the latest market information which could be either bullish or bearish.
It can only be seen when the impact has settled in where you’re left with huge excess inventory or completely stocked out.
Controversially, reducing the purchase delay does not result in reducing oscillations. In fact, it leads to even more intense oscillations. The problem gets solved when you add further delay at your end.
A simple way to understand this is in a system where the external delay is high, corresponding higher internally delays will lead to more stable operations. If you reduce internal delays, a small change in the market will result in huge oscillations in the process, since you do not have any control over the process here.
Start with longer forecast windows to understand broader trends in demand. This lets you not swayed too much by temporary changes in the market.
Identify suppliers who can serve you at a shorter time period even at a higher cost. Use them in case of emergencies to address sudden surges.
This is probably the most underrated by easy to implement solution. Make sure all parts of your supply chain has a very streamlined communication channel so you get accurate information on time.
The bull whip effect is a classical illustration of the problems with complex supply chain models. The objective of any company would be to keep costs low by holding the right amount of stock. If demand is oscillating, a good idea is to play with the constraints you have control over, like price, supply time, suppliers to work with and the products to sell.
Hopefully, this note gave you an understanding of how the bull whip effect works so you can make better decisions.
