There’s a classic scene in “Jurassic Park” where Jeff Goldblum’s character discusses chaos theory with the paleobotanist played by Laura Dern, and he uses a quick water drop experiment to explain the consequences of unpredictability in complex systems. You’ve no doubt heard of what’s kind of the supply chain’s version of this phenomenon: “The Bullwhip Effect.” The more accurate business term is demand amplification – but no matter what you call it, you’d better be prepared for it.
Over the past few years, the COVID-19 pandemic and its consequences unleashed the bullwhip effect on supply chains worldwide. And some factors are pointing toward the possibility that we could be in for another snap.
The Cumulative Effect of Demand Distortion
When we talk about the bullwhip effect in supply chain management, we’re referring to the process by which actual demand from the customer is distorted by the time it gets to the manufacturer. The more complex a supply chain is – the more people or processes that the demand signal interacts with between manufacturer and customer – the more likely it becomes that the signal will be amplified along the way.
For example: Sales is worried about stockouts, so they bloat the demand forecast by 1 to 5 percent. When the demand signal reaches the planner, maybe they aren’t fully confident in the factory or transportation to deliver exactly what they need and when, so the planner also adds 1 to 5 percent to the demand signal to compensate for the uncertainty. The more decision points there are along the way where orders can be adjusted, the more likely it is that orders will be adjusted. Add all these changes together, and you can wind up with a variation of demand in the 35 percent range.
The Risks of Overreaction and Overproduction
Scarcity also creates conditions which can lead to the bullwhip effect.
- Major shifts in demand as people spent most of their time at home due to lockdowns;
- COVID-related labor shortages reduced both manufacturing capacity and the ability to deliver goods;
- Port congestion which slowed the flow of goods from source to destination; and
Under these conditions, the natural reaction in the supply chain world tends to be to expand orders slightly at all those points along the way, to avoid getting caught short. This distortion of the demand signal can lead manufacturers to make capital investments or expand hiring based on inaccurate information, and leave them with a glut of inventory or lead to perishable goods spoiling when the demand signals return to normal. And retail demand planning plays an increasingly important role in supply chain optimization.
How Communication, Information, and Variable Resources Can Make the Difference
Looking back, it’s easy to see how all of this unfolded: Demand slowed at the beginning of the pandemic, and manufacturers scaled back production. As the world adjusted to life under lockdown, demand surged for certain items, leading to increased production that helped contribute to backlogs in transportation. Finally, as things opened back up, surging demand for a wider range of goods led to oversupply in the market.
Supply chains are generally not designed to handle these dramatic swings – and now, there are indicators of a possible recession on the horizon, along with a daily discussion of efforts to prevent it.
Hopefully, manufacturers and supply chain professionals have learned the lessons of the past few years about the bullwhip effect: Asking the right questions about the demand signals they’re getting is crucial, along with knowing when and why the signals bear a closer look.
Most supply chain professionals have played some version of the “beer game” distribution simulation where orders are passed from the retailer through multiple people in the supply chain – but only the person playing the retail knows the logic behind their orders. Invariably, one or more players along the supply chain overreact either positively or negatively to the signal that’s been sent, passing along a higher or lower number than was actually ordered.
A lack of information sharing and an incomplete understanding of a changing demand signal is a major driver of the bullwhip effect – communication alone won’t eliminate it completely, but it can help to mitigate it.
It’s also key to remember that meeting a sudden increase in demand is better achieved using variable resources – over time, for instance, or toll or contract manufacturing – as opposed to investing in a permanent solution that becomes a cost sink down the road. Profit Point’s expertise in supply chain design and optimization solutions that deliver flexibility and agility can help you prepare for the risks of the bullwhip effect – and learn how to avoid its sting.