A customer wants 10 widgets. The retailer, in turn, orders 12 from his vendor (the extra two are to ensure that the retailer does not suffer a stock-out on the item). The vendor, in turn, can save money if he orders a bulk of 20 widgets from his distributor. The distributor looks for his best deal (naturally) from the manufacturer and learns that an order of 30 will cost him the least per unit, so he orders the 30.

In this example, the actual demand from a retail customer has only been eight, but the item’s manufacturer has spent enough funds to produce 30. Now the manufacturer has a surplus of 22 units beyond his demand rate. The distributor has a surplus of 12 over his demand rate. The retailer has a surplus of 2 over his demand rate. All have now spent an excess of capital over their demand rate, which each of them must try to recoup as soon as possible.

While having more on hand is less daunting for the upward links in the supply chain, it falls to the retailer to ultimately sell 22 items that so far no customer has ordered. Marketing and advertising (to increase the number of customers) and price drops (at the retail level only) produce a bullwhip effect back on the retailer, whose onus it is to sell the surpluses. So while it is not bad for vendors or distributors or manufacturers to have too much stock (because they all are likely to have numerous retailers to reduce the stock) the detriment is at the retail level because although in the above example he physically has only two units to sell at his shop, he’ll wind up with everyone above him beleaguering him to promote the items beyond his current level of expenditures.

The result of this Bullwhip Effect is exaggerated variances in the estimation of product demand, meaning that forecasting at the top end of the supply chain will be far from accurate. The Bullwhip is a common challenge for supply chain management, and appreciating its causes will lead to your business to implement a strategy to lessen its negative effects.

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