Updated: Sep 23, 2022
The previous post talked about managing inventory within one business. Adding supply chain partners or considering the whole system together adds difficulty in optimizing inventory. The bullwhip effect is a supply chain phenomenon where the uncertainty of product demand causes successive higher levels of inventory upstream (upstream refers to the direction from the demand to supply side and downstream refers to the direction from the supply to demand side) the supply chain. Arm’s length suppliers cannot perfectly predict the quantity required by their customers and a larger safety stock is used to hedge against this uncertainty. The same risk mitigation strategy is then magnified at each supplier tier. As a result of the increasing volatility at each supplier tier, the order quantity and inventory levels resemble a cracking of the whip where a flick of the wrist from the end user (demand) at one end causes a large motion at the end of the whip (supply).
Here is a graph to illustrate:
The bullwhip effect causes supply chain system inefficiency in that resources are tied up in excessive inventory which includes opportunity costs and a higher rate of inventory wastage and de-valuation. The further away your business is to end-user demand, the greater the effort that may have to be made to counter this effect.
Ways to reduce the bullwhip effect include but are not limited to:
Reducing uncertain by increasing communication throughout the supply chain
Reducing lead time
Reduce order size and increase order frequency
Improve forecasting and demand management
Reduce the number of tiers in the supply chain if possible
With the development of telecommunication technologies, inventory managers are able to improve upon uncertainty in demand and supply. Cooperation among supply chain partners can significantly reduce the bullwhip effect. Information can be transferred instantly and almost at no cost while moving physical goods are expensive and time-consuming. Unless the information is of strategic importance, it is a good idea to lead supply chain management with communication.