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The bullwhip effect is caused by fluctuations in information supplied to firms

further up the supply chain. Distorted information causes firms to forecast

demand incorrectly. Thereby, many unnecessary costs are put upon each of

the firms along the supply chain.

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Most firms are affected by the bullwhip effect. The bullwhip effect used to be

considered a normal phenomenon. However, recently, many firms have been

trying to focus on how to improve communication along the supply chain.

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The bullwhip effect can inflict many unnecessary costs on business firms.

Inventory costs from stored inventory, problems with quality caused from rapid

production, overtime expenses for increased employee labor, and increased

units being shipped create costs far and beyond normal levels of production.

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Customers can also lose faith in a firms ability to deliver products. This is

because firms are having trouble meeting demand. Likewise, firms often must

lengthen lead time for finished goods, which also may discourage customers,

which in turn leads to lost sales. In a worst case, incorrect forecasts may

entice a company to adjust capacity which could be detrimental to the overall

success of the company.

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To reduce stocked product, retailers may offer sales promotions to customers.

If retailers fail to notify firms upstream in the supply chain, these firms may

forecast increased sales as legitimate demand. Thereby producing product

that was not wanted by the customer in the first place. Furthermore, sales

incentives for salesman may entice salesman to sell products to firms to meet

incentives. This may cause large inventories for the firm, or the firm may

cancel the orders, which causes demand fluctuations in the supply chain.

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In this example is only one of many that may occur for firms. A retailer of a

good may indeed offer lower prices so as to reduce the amount of inventory

sitting on store shelves. A problem may occur if the retailer fails to notify other

firms upstream in the supply chain.

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Firms upstream in the supply chain may feel that the increased demand may

be legitimate and increase production and inventory levels to produce more.

However, in reality, the product hardly moved and required a drop in price to

be moved off of retailer’s shelves. Each firm upstream in the supply chain will

feel the whip effect.

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Each of the firms along the supply chain are producing at a constant rate

because demand is easily forecasted; the supply chain is in equilibrium. Each

of the firms are forecasting demand accurately.

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In this example, demand has increased by 10 units over equilibrium. To meet

the demand, the distributor doubles inventory to meet production and to meet

any other demand fluctuations. The producer further up the chain also notices

the increased demand of the distributor and doubles their demand forecast to

40 units and hold 80 units in inventory to meet demand and hedge against any

other demand fluctuations. The supplier (or top of the supply chain) receives

the blunt of the whip effect. Costs for individual firms, in this example, increase

the further you move up the supply chain,

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Improved communication from retailers will assist firms upstream in the supply

chain in determining what is actual product demand. Improved communication

and reliable information helps firms to develop forecasts that are effective and

accurate.

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Determining product demand from actual data entered into point of sale (POS)

computer systems and electronic data interchange (EDI) systems will result in

accurate sales forecasts. In contrast, determining sales forecasts on

experience or hunches may be risky.

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Ordering products up and down the supply chain in smaller increments

reduces the time between orders and allows for timely information to be

available to your firm. Receiving information in real-time is a great advantage

to a firm when forecasting data is essential to reducing costs.

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Some keys to reducing costs to your firm: stabilize prices along the supply

chain and be sure your information along the supply chain is timely and

accurate. This will enhance decision making and allow your company to be

responsive to customer demand.

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Reduce the speculative decisions in your firm by using actual sales of product

entered into point of sale or EDI computer systems. This will help your firm

base their decisions on actual demand and not on demand based upon

speculation or demand derived from a zealous salesman reaching a sales

quota.

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Small orders and reduced batch orders increase information quality and

contact with vendors up and down the supply chain.

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Every firm should look to reduce costs and help them gain competitive

advantage. Reducing costs along the supply chain is a new phenomenon.

Perhaps your firm can gain a competitive edge by reducing fluctuations in the

information along your supply chain.

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