Before explaining the phenomenon, let me give you a really simple example: “ABC Toys Store” that sell toys forecast/predict that next week, their revenues will increase 200%. Currently, their average revenue/week is 500 toys. So next week the forecasting amount will be 1000 toys.
So ABC Toys store ask their distributor/supplier which is “DEF Manufacturer” to make 1100 toys and deliver it the day before next week. The excess 100 is for safety stock. Safety stock is the forecasted amount of demand plus the extra stock just in case there is stock-out. So ABC toys store will not lose any potential sales. Later DEF Manufacturer orders 1200 set of plastic materials to “GHI Chemical”. The excess 100 is for just in case there is some defect when the set of plastic materials delivered.
3 days later, DEF Manufacturer receives 1200 non-defected set of materials, so DEF manufacturer only uses 1100 of them. After that, they send it to ABC Toys store. Unfortunately, ABC only sells 900 toys, because of inaccurate forecasting. So currently there are 100 excess toys and 100 set of materials that will become a burden for ABC Toys and DEF Manufacturer because they need to spend another extra carrying cost (holding cost/ he cost of controlling and monitoring the excess stock).
That what we called the bullwhip effect. Bullwhip effect is a supply chain phenomenon which the amount of product ordered is higher than the real amount demanded, and sometimes the excess will be compounded and magnified as the information is passed to the line of the supply chain. For more simple explanation, this is the illustration of the bullwhip effect :
So as you can see, the number of products increase and compounded as the information passed to the last part of production which is GHI Chemical. They usually produce and order extra stocks for anticipating defective products. Because there is lack of trust and lack of transparency. In supply chain world, those factors are very crucial and could result in a huge consequence. Below is some example of bullwhip effect in real life conditions :
As you can see in the automotive industries, the bullwhip effect impacted by ordering a lot of unnecessary excessive components. If the bullwhip effect is not solved by the company, then it could lead to overhiring, unscheduled assembly line, and other loss sales related impact that could bankrupt the company.
To reduce the bullwhip effect, companies usually use integration system that connects their customers, the company itself, and their supplier or their manufacturer. Such as CRM (Customer Relationship Management), ERP (Enterprise Resource Planning) and MRP (Manufacturing Resource Planning). With those tools, the supply chain process will be more transparent and will decrease the uncertainty of the process.
So what do you think about this phenomenon? I know this is not my usual post about Behavioral Economics, but I think this phenomenon is too good to be missed out! So what is your opinion? Do you ever experience the bullwhip effect? Tell us in the comment box below!
REFERENCES AND SUPPORTING ARTICLES
X. Wang, S.M. Disney, The bullwhip effect: Progress, trends and directions, European Journal of Operational Research (2015), http://dx.doi.org/10.1016/j.ejor.2015.07.022
Russell, R. S., & Taylor, B. W. (2014). Operations and supply chain management.