The Bullwhip Effect

Originally written in July 2018

The bullwhip effect is a phenomenon where changes in downstream demand are magnified as the information travels imperfectly up the supply chain, causing serious inefficiencies across the entire channel.

Financial investment cycles in commodity industries tend to reflect long-term bullwhip effects, where they are called the capital cycle.

A small flick of the wrist (a shift in point of sale demand) can cause a large motion at the end of the whip (manufacturer’s response). In supply chains, the bullwhip effect is often attributable to two root causes:

The bullwhip effect can feature prominently in the competitive dynamics of commoditized industries, where a few suppliers sell an undifferentiated product.

Bullwhip effects are significant in commodity industries where there is a long delay between demand signal and supply response and demand is highly-cyclical. Examples include semiconductors, housing, and natural resources.

The general pattern:

Because of long-term bullwhip effects, commodity industries companies are difficult to value. This adjacent financial phenomenon to the supply-chain bullwhip effect is called the capital cycle.

The capital cycle is caused by investor optimism about future returns in an under-supplied industry. Invested capital follows supply response, which follows cyclical demand. This second-order investor/supplier/demand relationship causes significant volatility in valuations.

Holistic systems thinking is an effective antidote to bullwhip effects in the supply chain as well as handling complex adaptive system behavior in general.

Specifically, managers can:

From this series:

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