The bullwhip effect is one of the main reasons for inefficiencies in supply chains.
The bullwhip effect describes the phenomenon that the variation of demand increases up the supply chain from customer to supplier. The further away a company from the end customer (in terms of lead time), the larger is this variation. Considering a supply chain that consists of an OEM (original equipment manufacturer) and a 1st-, 2nd- and 3rd-tier supplier, the OEM faces the lowest and the 3rd-tier supplier the largest variation of demand.
This effect leads to inefficiencies in supply chains, since it increases the cost for logistics and lowers its competitive ability. Particularly, the bullwhip effect negatively affects a supply chain in three respects:
* Dimensioning of capacities: A variation in demand causes variation in the usage of capacities. Here companies face a dilemma: If they dimension their capacities according to the average demand, they will regularly have delivery difficulties in case of demand peaks. Adjusting their capacities to the maximum demand leads to poorly used resources.
* Variation in inventory level: The varying demand leads to variation in inventory levels at each tier of the supply chain. If a company delivers more than the next tier passes on, the inventory level increases. Vice versa, the inventory is reduced in case a company delivers less than the next tier passes on. A high level of inventory causes costs for capital employed while a low level of inventory puts the delivery reliability at risk.
* High level of safety stock: The safety stock that is required to assure a sufficient service level increases with the variation of demand. Thus the stronger the bullwhip effect is in a supply chain, the higher is the safety stock required.
Hence, an important issue for supply chains is to cope with the bullwhip effect.