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The Bullwhip Effect

A must read for all business professionals - read to the end !


Business Continuity Management


Fragility

The current pandemic and its social, commercial and industrial costs have highlighted the fragility of many supply chains. Bluntly, it has also led to panic buying, which in turn has caused “ructions” in the broader supply chain.

This is not rocket science! If many customers descend on a supplier simultaneously, trying to buy the same commodities, then a stock-out situation usually follows. That in turn means that re-ordering creates ripple-effects further up the supply chain.

At the present time, broadly, economic demand is lacking across the world, except in the area of food, where demand never switches off – even if supply does! In USA meat production is presently down at least 20% with hundreds of meat/poultry facilities closed. Added to this swine flu in Asia, and locust swarms across much of Africa, is creating a potential perfect storm for global food supply chains. We are staring at food supply bottlenecks for a number of concurrent reasons.

Despite depressed demand through the global economy (listening to the radio recently I heard that 6,000 Rolls Royce jobs are to go) the demand puzzle remains: small changes in demand can spike big “ripples” in the supply chain. Enter the .......


......Bullwhip Effect


Customer demand is never perfectly stable. Businesses must, in consequence, forecast demand to best position inventory and other resources. Forecasts are based on statistics which are rarely 100% accurate. Because forecast errors are anticipated, so companies often carry a buffer of "safety stock".

Moving up the supply chain from end-consumer to raw materials supplier, each supply chain participant has greater observed variation in demand and thus greater need for safety stock. In periods of rising demand, down-stream participants increase orders. In periods of falling demand, orders fall (or stop), thereby not reducing inventory. The effect is that variations are amplified as we move upstream in the supply chain (further from the customer).


The bullwhip effect (sometimes called the Forrester effect) refers to increasing swings in inventory in response to change in customer demand as one moves further up the supply chain. This effect was so named for the analogy that the amplitude of a whip increases down its length. The further from the originating signal, the greater the distortion. In a similar manner, forecast accuracy decreases as one moves upstream in the supply chain. For example, many consumer goods have consistent consumption levels at retail but this demand signal becomes more unpredictable as the focus moves away from consumer purchasing.


The bullwhip effect today

At Procurement Central we encourage businesses with which we engage to understand and recognise the bullwhip effect within their own commercial context. So, who might be entering the supply market at the same time (e.g. direct competitors)? Are there now discernible shifts in demand and/or supply patterns? So far, so scientific.

Beyond sophisticated measurement, we encourage businesses to engage key internal and external stakeholders to acquire a ‘global’ understanding of supply risk and to link supply risk with a better appreciation of supplier positioning, looking wherever possible for win-win solution and alignment of long term business interests.


Can bottlenecks be avoided?

Risk can certainly be reduced. One way to avoid pain is to maintain a diverse supplier base – but of course this acts against the mantra of reducing suppliers to obtain better control. Retailers have pertinent lessons for other commercial sectors – Zara, the Spanish fashion retailer, exemplifies this approach with different frock lines reaching shops entirely independently. For big purchasers, there may be a case for maintaining spare manufacturing capacity. Companies may pride themselves on lean manufacturing, but factories do not typically run at full tilt. As a buyer, can YOU negotiate a ‘lien’ on some of that latent manufacturer capacity – a first option when things get tight?

Inventory: it is assumed that modern purchasers relentlessly eat away at this source of resilience. Certainly investors will punish firms that pile-up stock, however they also look askance at firms that cut too close to the bone. Since the financial crash of 2007-9 companies have subtly increased stock on hand. The expansion of warehouse space around the world is not just caused by the rise of e-commerce – some is down to firms concentrating on being close to the customer, which increases the need for storage. PWC research indicates that working capital efficiency has not changed since 2016, partly due to an increase in stock holding in recent years.


Have our sourcing strategies been correct?

Pretty much every business will be asking themselves this sixty-four thousand dollar question right now! Well run businesses of course have their supply chain(s) under continuous review. Even so, it is a given that the current Covid incident will cause a major reappraisal. A better and more nuanced appreciation of supply chain efficiencies and of supplier positioning (Peter Kraljic et al) will undoubtedly follow. The more pressing question for procurement professionals, perhaps, is “do we know what to do next”?


Cost saving pressures

The world is looking at a global recession. Even a global depression consequent on this Covid incident. And things will take at least as long (longer?) that the working-out and working-through consequent on the 2008 financial crash. That, in turn, suggests that buyers will come under pressure to reduce supplier base and force suppliers to hold more stock. Ironically this is the obverse message of supply chain flexibility and supplier diversity. CPOs will need to work hard at gaining stakeholder commitment to revised and revitalized supply strategies. They will need to develop fresh ways to more straightforwardly display risk across a number of dimensions. This also creates its challenges on budgeting and cash flow

Therefore the strategic procurement expert needs to understand this as business disruption which can be caused by supply and demand.

At Procurement Central we often speak of * contract value *market concentration * regulatory * reputation and * business risk of change as being measurable dimensions of supply risk. But do we now need to add emerging risks such as *political/trade-war and *pandemic risks into the mix?


A final thought .....

Consequent on the Modern Slavery Act (MSA) legislation and associated pressure group monitoring of supply chains, companies were already waking up to the fact that they were often woefully ignorant of their supply chains, effectively knowing only their Tier-1 suppliers. The present Covid incident has underscored the identical need. We have to drill-down into our supply chains to better understand systemic risk. What we were doing for MSA reasons, we can amplify for pandemic reasons. A different bullwhip effect?

By Peter Sammons, Senior Trainer with Procurement Central

(c) Procurement Central, May 2021


Peter has two publications available on the Procurement Central website, one of which is free to download today 'Cost Cutting - A Cultural Shift to Sustainable Cost-Base Reduction' and 'Contract Management - Core Business Competence'




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