Recently, Michael Burry (Michael Lewis’ book and film “The Big Short” featured Mr Burry) has suggested that the Federal Reserve could unexpectedly reverse its course on a planned series of interest rate increases due to a phenomenon known as the “Bullwhip Effect”.
In this article, we explain what the “Bullwhip Effect” is and how it’ll affect the economic state as we know it.
-Your Local Bullwhip Team
A Logistics and Supply Chain Management term, the Bullwhip Effect refers to fluctuations of orders, parts, or inventory upstream in a supply chain (the manufacturer end), caused by interpretations of demand signals downstream (the end consumer).
A little more detail
The Bullwhip Effect can be caused by both over and under-estimations in demand. A little like the tail wagging the dog, if the customer demand was holding a whip, and raw materials suppliers were a dog. Hmmm…
Demand forecasting can be data-based, trend-based, or a combination of these and other variables. A little like weather predictions, they are the result of information, intelligence, and intentions, and are therefore never perfect.
A lack of visibility on inventory (in-stock, in transit, and on order), transportation delays, and lead time can contribute to the Bullwhip Effect,
Because orders are usually based on demand forecasts, the fluctuations increase in severity the further upstream the orders are placed in the supply chain.
Over-estimation can lead to costly inventory surpluses, while under-estimation leads to lost sales, and frustrated customers.
A dramatic example of over-estimation:
A retailer puts on a big sale to clear out their stock of blue hula hoops, selling more in 1 month than they have all year.
Their distributor sees the sales numbers, then mistakenly assumes that blue hula hoops are trending due to some Kardashian exposure (rather than a lower price).
The distributor orders replacement stock, plus 33% more in “safety stock”, so they don’t run out of supply for their retail customers.
The wholesaler assumes the same, and orders 33% more from the manufacturer, who then produces 33% more than what’s needed for replenishment.
The retailer does not reorder blue hula hoops, as they were not selling well at retail price.
Now the supply chain is crowded with twice as many blue hula hoops as would sell in one year, and need to find extra space to put the inventory, or liquidate it.
An also-dramatic example of under-estimation:
Red hula hoops are spotted in some Tik Tok video of a famous person eating a plant-based banana nut muffin. The retail store orders more, but since the blue hula-hoop fiasco, their distributor underestimates their ability to sell so many, produces fewer, and puts out MySpace videos of blue hula hoops and bowls of millet.
Now the supply chain is suffering from back-ordered (or lack of) product, which they could have sold at a profit. Unfortunately, Tik Tokers move on and the fad dies 17 minutes later.
So…beware The Bullwhip Effect!