How Recessions Create a Bullwhip Effect
Any action by a player in the supply chain has a ripple effect, whether they're a supplier, distributor, customer, or manufacturer. The supply chain bullwhip effect is one example of such a reaction. The bullwhip effect results from each party along a supply chain inflating orders in response to a smaller initial demand spike to gain product buffer. This phenomenon can lead to high storage and labor costs, wasted inventory, and unmet customer expectations.
When businesses notice signs of an impending recession, such as rising inflation, interest rate hikes, and a slowdown in consumer spending, the bullwhip effect may be close behind. As companies witness recession symptoms, they may stock up on their inventory to prepare for production slowdowns and stay ahead of customer demand.
While you can't control the economy at large or the actions of your supply chain partners, you can take steps to mitigate the bullwhip effect as you face a recession. Learn how recessions create the bullwhip effect so you can prepare your supply chain to weather the storm.
How Recessions Lead to the Bullwhip Effect
It's common for supply chains to experience fluctuations as customer demand ebbs and flows, and companies continuously readjust their inventory strategies to meet it. However, a recession is a period of pronounced and prolonged economic downturn that can cause several challenges, including inaccurate demand forecasting, reduced cash flow, and difficulty scaling. Recessions can be especially problematic for companies when they produce the bullwhip effect.
Several factors that occur during a recession can lead to the bullwhip effect. For example, during the COVID-19 pandemic, economic activity slowed due to customer fears and government mandates. Yet many customers increased their spending through eCommerce channels, causing many big box retailers to increase their inventory in hopes of staying ahead of demand. When supply outpaced demand, the bullwhip effect happened.
Recessions can also lead to the bullwhip effect if trading partners resort to ration gaming. Ration gaming occurs when manufacturers, distributors, and suppliers see upstream inventory becoming scarce due to supply chain disruptions and inflate their order quantities to ensure they have enough stock to meet demand. Ration gaming can quickly lead to the bullwhip effect when multiple trading partners increase their orders, harming the entire supply chain in the process.
Another way a recession could lead to the bullwhip effect is when lead times lengthen. Supply chain disruptions during a recession can draw out lead times, preventing sellers from receiving the inventory in time to fulfill customer demand. Sellers may increase their orders to account for the delay, leading to the bullwhip effect.
The Negative Effects of the Bullwhip Effect During Recessions
The bullwhip effect is never an ideal place for the supply chain to be. When the bullwhip effect collides with a recession, it can spell disaster. A looming recession influences a slowdown in consumer spending, yet the bullwhip effect creates inventory overstock that consumers can't support.
Consider some of the consequences of the bullwhip effect in a recession:
- High storage and labor costs for excess stock: When customer demand is lower than supply, companies must continue paying to store their inventory. Overstock isn't cheap — expenses range from transportation and handling to maintaining physical storage space. The bullwhip effect also makes storage and labor costs less predictable, as businesses have difficulty predicting customer demand.
- Wasted inventory: Excess inventory can also cause waste, depending on the type of items your company works with. Certain raw materials and products, such as foodstuffs and pharmaceuticals, could expire before demand picks up. Other products may be replaced with newer versions or withdrawn from the market. When customers don't buy all of your stock, you waste inventory and money.
Preparing for a Recession and Taming the Bullwhip Effect
Recessions and the bullwhip effect don't happen overnight — they take time to build, with multiple factors compounding over time. Fortunately, you can take several steps to protect your supply chain from a recession and keep the bullwhip effect to a minimum. Take the following steps to prepare for an economic downturn and the bullwhip effect and limit their impact on your business:
1. Automate Your Supply Chain
The bullwhip effect worsens when companies don't understand consumer demand well, communicate poorly with trading partners, and have difficulty managing complex supply chains. Investing in automation is one of the first steps in preparing your supply chain for a recession. The digital transformation of the supply chain isn't new, but it can still revolutionize how you oversee your supply chain. Automating multiple processes throughout your supply chain can provide the vital insights you need to drive proactive change.
You can implement various automation technologies, from collaboration tools to warehouse management systems, to help your supply chain prepare for and remain secure through a recession.
2. Increase Transparency and Collaboration Between Suppliers and Buyers
When a recession hits, you need increased visibility along your supply chain to gain a complete picture of its effects. A lack of transparency between suppliers and buyers can also worsen the bullwhip effect, making it difficult to know why demand is spiking. Improving collaboration between your business and your supply chain partners provides valuable insight into the context of demand shifts at every point of the chain.
Collaboration tools such as an electronic data interchange (EDI) solution enable you to share key order documents with your trading partners. Automation replaces manual order processing to streamline data transmission, accelerating the flow of data to increase accuracy and improve supplier relationships.
3. Implement Vendor Managed Inventory
One of the most effective tools for mitigating the bullwhip effect in a recession is vendor managed inventory (VMI). VMI is an inventory model that empowers suppliers to make replenishment order recommendations for their buyers based on shared data and aligned business objectives. VMI uses automation to share inventory data and create a proactive, demand-driven supply chain that can more easily handle shifts in customer demand.
VMI can increase your recession readiness in several ways. The solution automates replenishment to reduce the burden on your team and enable more strategic decisions. With VMI, you can more accurately forecast demand and prevent overstock, reducing the impact of the bullwhip effect on your supply chain.
Use the Right Technology to Prepare for a Recession and Reduce the Bullwhip Effect
When a recession leads to the bullwhip effect, companies along the supply chain must deal with unpredictable customer demand, difficulty forecasting, higher costs, and potential inventory waste. Some of your best tools for combatting these adverse effects are increased visibility into your supply chain and transparency with your suppliers and buyers.
TrueCommerce provides supply chain optimization solutions for any member of the supply chain, whether you're a manufacturer, 3PL, distributor, or supplier. Our solutions include a comprehensive VMI solution and fully managed EDI services. TrueCommerce helps you connect with your trading partners to create a supply chain that can withstand a recession and the bullwhip effect. To request a demo of TrueCommerce solutions, contact our team today.