The bullwhip effect occurs in a supply chain because buyers for a business overreact to fluctuation in customer demand. Overbuying goods leads to a costly surplus, whereas underbuying leads to shortages that alienate customers.
Distributors and retailers manage inventory processes in different ways. Some use manual buying systems where a buyer monitors inventory levels and places replenishment orders as needed. Others have automated ordering systems where vendors send new batches when given products reach minimum inventory thresholds. While automated and pre-planned systems often help deter the bullwhip effect, they don't always allow for rapid reactions to unexpected demand activity. In some cases, retailers maintain their own distribution centers to hold goods closer to retail locations for faster order filling.
An inventory shortage means you don't have enough of a product on-hand to meet immediate customer demand. This scenario generally is worse than a surplus, because you miss on out revenue opportunities and risk driving customers away to competitors that have goods available. A surplus means you ordered too much and have more inventory than is necessary for near-term demand. The problem with this scenario is that inventory is costly to manage. Retailers have limited store space, and they prefer to use most of that space to merchandise and sell goods. Extra space for storage requires additional utilities and manage costs. You also run into problems with items perishing or expiring.
Numerous factors contribute to the bullwhip effect. Inconsistent customer demand is a central problem. When you experience consistent and predictable demand, ordering inventory to keep up is relatively simple. However, companies that have wild swings based on product innovations, seasonality or societal trends have more difficulties with precise ordering. Delays in order processing are problematic as well. A buyer may order more goods in time to meet demand, but delays in pulling and shipping orders by a vendor may cause the new supplies to arrive late. Human emotion plays a role as well. Buyers don't like to make the same mistake twice. Therefore, the tendency is to overcompensate for a shortage by purchasing too much inventory the next time, or to cover for a surplus by buying too little.
One of the best ways to reduce the bullwhip effect is to adjust ordering processes. Switching from larger batches to smaller, more frequent batches adds to shipping costs, but improves precision. Consistent pricing strategies also contributes to steadier or more predictable customer demand than constant raising and lowering of prices. Closely syncing inventory systems with vendors strengthens automated ordering processes. Some retailers use vendor managed inventory systems where supplies monitor store product levels and automatically send out new shipments when necessary.