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Bullwhip effect - what’s the big story?

The disruption to global supply chains, caused by the pandemic, was an early harbinger of the soaring prices that have fuelled multi-decade highs in inflation. When squeezed supply meets a rebound in demand, prices for manufactured goods inevitably rise. But could these supply chain dynamics be about to change? We take a look at the phenomenon known as the ‘bullwhip effect’. And the impact it could be about to have on inflation.

Components required by manufacturing industry, from semiconductors to automotive parts, were in short supply following the first Covid lockdowns. And the shipping used to transport these essential elements to manufacturing plants around the world was often held up in the wrong place. Delivery rosters yawned. And manufacturers scrambled to get hold of the semi-finished goods needed to complete their products.

What is the instinctive response to a forecast shortage? Often it is to order more and more of the missing components in the hope that some will get through. Order books explode and new capacity is commissioned by suppliers to deal with this glut of orders. And what happens next? Typically, the supply and demand imbalances resolve themselves over time. Then inventories begin to build up again and demand fades.

The CEO of shipping giant Maersk recently stated that the container shipping boom seen since the pandemic could be about to reverse sharply.  He cited the ‘bullwhip effect’ where demand contracts and supply increases, which could swiftly replace the opposite phenomenon, where shipping groups were powerless to respond to surging consumer demand. He added “When it happens, it could go quite quickly.”

As orders, even if currently at overblown levels, are finally fulfilled and demand settles back, there could be an adjustment among component suppliers. Faced with expanded capacity and shrinking orders, they are likely to cut prices sharply to attract buyers. The reversing of the supply chain squeeze might bring an end to post pandemic price hikes. And provide a much-needed cooling influence on global inflation.