The Bullwhip Effect
The Diff, 2020-07-24
What is it and how does it look?
Def: a bullwhip effect is the observation that a small change in demand can lead to larger changes down the supply chain. [think of a literal bullwhip: a small flick of a wrist leads to a huge trajectory of the whip (aka a supply chain)]
The longer the chain, the more magnifications.
Toilet Paper Example
Crazy people buy all the tp. Retailers have to order much more (say, 3x) because of the negative impact on their image.
Tp manufacturers see that their orders are 3x. They increase their wood pulp order 4x to prepare for further demand spikes.
More trees harvested, planted, more equipment bought, etc.
Everyone stocks up for years ahead, and demand plummets. And then the reverse cycle starts. Rinse and repeat.
Why is all this?
Information asymmetry between links in the supply chain for a good with a value add.
Many industries are cyclical with different time scales for demand and supply (and different approaches to supply).
Cruise lines or airlines: plan demand based on the ‘business as usual’ models with capital outlays’ timing lagging the recovery. Hence, their suppliers (shipbuilders, Boeing/Airbus, etc) are even in a worse position as they supply those capital goods.
Information asymmetry is prevalent as it’s believed transparency reduces the strength of a negotiation position [now always correct, though].
How far can it go?
Bad news: being part of someone’s supply chain is being in a constant state of uncertainty (price-taking, no control over volume): boom or bust.
Good news: the longer the value chain, the less the bullwhip effect is pronounced.
o “Gravity” (the longer the whip, the harder to move it) – increased use of multi-purpose raw materials to de-risk and have lower cost structure. Unless the materials are rare to obtain.
o Effects can’t magnify indefinitely, mistakes diminish.
If your information consists of other people’s reactions, ask yourself: is everyone misreading things in the same direction?
Other examples
Supply chain of education (undergrad degrees). Lagging indicator, joining a uni at peak usually means graduating in a bust. Maybe vice versa, too.
Supply chain of US dollars. In many developing countries it’s cheaper/more reliable to borrow and transact in USD. Hence the demand for USD via banks —> central banks —> US Federal Reserve. Introducing layers of political and business risks.
Supply chain of opinions. Some writers are widely-read and rarely-cited due to many good ideas and poor filter for bad ideas.
Supply chain of hiring and management methodologies. Hires from big firms bring their methodology and philosophy —> amplification of big firms’ approaches (esp. including the hiring process) in smaller companies.