The term bullwhip effect illustrates how a demand curve moves along the supply chain. Like cracking a whip, a small movement (change) at the beginning of the whip is enough to cause a large movement at the end of the whip. In this analogy, the material suppliers are the end of the whip, and customers trigger the motion at the beginning of the whip.
To illustrate, let’s look at a more detailed example of the bullwhip effect:
For example, the demand for a particular product increases as customers buy more of it. There may be various reasons why, which we will not go into at this point. In response to increased demand, the retailer will order more from wholesalers to meet customers’ requirements and to have the product in stock when needed. This in turn requires the wholesaler to increase stock and order a larger quantity from the manufacturer. The manufacturer then requires more materials from suppliers to meet the increasing order volume.
Usually, order quantities increase at each point in the supply chain because the number of customers at each point is bigger, and therefore delays due to shipping and production can be expected. As the distance from the customer increases, it becomes more important to have the required products or the necessary raw materials in stock so that customer needs can be met as quickly as possible. As a result of this, even a slight increase in retail demand is noticeable for suppliers.
This example covers the entire supply chain, from the material supplier to the customer. However, the bullwhip effect does not necessarily have to start with the customer. It can also originate from any other part in the product chain.
The bullwhip effect can be caused by any of the following factors:
- Demand: A company has or expects an increase in demand. It responds by increasing the demand for the products from its suppliers. In doing so, the company not only orders the quantity actually requested, it also orders more inventory in order to respond faster to other increases, and to maximize its profits. This sequence of events increases demand along the supply chain.
- Order bundling: Many companies consolidate their orders, or order far more than what they actually need to benefit from volume discounts or save on shipping costs.
- Expecting bottlenecks: A company may expect bottlenecks in the supply of certain materials or products and therefore increase their order.
- Price fluctuations: Increased demand can cause prices to rise, as explained in our article on price elasticity of demand, leading a company to increase its order quantities in order to maximize its profits. In addition, discounts sometimes lead retailers to acquire larger goods inventories.