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Bullwhip effect

24 February, 2015 - 17:30

A major goal in supply chain management strategy is to minimize the bullwhip effect. The bullwhip effect occurs when inaccurate or distorted information is passed on through the links in the supply chain. As the bad information gets passed from one party to the next, the distortions worsen and cause poor ordering decisions by upstream parties in the supply chain that have little apparent link to the final end-item product demand. As information gets farther from the end customer, the worse the quality of information gets as the supply chain members base their guesses on the bad guesses of their partners. The results are wasteful inventory investments, poor customer service, inefficient distribution, misused manufacturing capacity, and lost revenues for all parties in the supply chain.

For example, Open Range Jeans (a fictitious company) are sold in a popular retail store chain. The retail chain decides to promote Open Range Jeans and reduce the price to boost customer traffic in its stores, but the chain does not tell the Open Range manufacturer of this promotion plan. The manufacturer sees an increase in retail orders, forecasts a long-term growth in demand for its jeans, and places orders with its suppliers for more fabric, zippers, and dye.

Suppliers of fabric, zippers and dye see the increase in orders from the jeans manufacturer and boost their orders for raw cotton, chemicals, etc. Meanwhile, the retail chain has ended its Open Range promotion, and sales of the jeans plummet below normal levels because customers have stocked up to take advantage of the promotion prices. Just as end-customer demand falls, new jeans are being manufactured, and raw materials are being sent to the jeans factory. When the falling end-customer demand is finally realized, manufacturers rush to slash production, cancel orders, and discount inventories.

Not wanting to get burned twice, manufacturers wait until finished goods jean inventories are drawn down to minimal levels. When seasonal demand increases jeans purchases, the retail stores order more Open Range jeans, but the manufacturers cannot respond quickly enough. A stockout occurs at the retail store level just as customers are purchasing jeans during the back-to-school sales season. Retail customers respond to the stockout by purchasing the jeans of a major competitor, causing long-term damage to Open Range’s market share.