The impacts of the supply chain bullwhip and brewing economic recession have recently come to a head. As the economy has stretched its legs from the Covid-19 pandemic, supply chain issues continue and are exacerbated by ongoing economic challenges. A combination of inflationary pressures, interest rate hikes, and supply chain problems could spell disaster for shipping markets and companies involved in logistics. This article will look at the so-called “bullwhip effect,” its origins, and how it’s creating a perfect storm with the potential economic recession.
What is the ‘bullwhip effect?’
The bullwhip effect is a type of economic scenario where minimal changes in supply chain demand cause increasingly large demand changes as they move up the supply chain. The term references the effect generated when a whip is cracked, and the subsequent wave generated down the whip becomes larger as it moves towards its end.
Bullwhips are generated at the retail level first, then move from retailers to wholesalers and then up to manufacturers. Typically, consumer demand for goods (real or predicted) changes; then, in conjunction with a lack of information on demand, wholesalers will increase their orders, and manufacturers will change their production by an even larger amount.
Unfortunately, supply chains are not perfect, and as a result, they suffer from inefficiencies. The bullwhip effect amplifies these inefficiencies and can result in several different problems. Ultimately, it can mean inflated inventories, lost revenue, poor customer service, schedule delays, and even larger economic problems like layoffs and bankruptcies.
Why are we experiencing a supply chain bullwhip?
Supply chain bullwhips don’t just happen overnight; they take time to build up as different sections in the supply chain adjust to changing demand pressures. That being said, the most recent bullwhip originated from the Covid-19 pandemic.
Measuring container shipments over time can give us an idea of how the issue has evolved. Before Covid-19, the ratio of containers per shipment was relatively static; however, in the summer of 2020, the container-to-shipment ratio bubbled. So-called Big Box retailers (like Walmart and Target) used their leverage to increase the number of containers in their already scheduled shipments. Comparatively, smaller importers kept a more static ratio due to difficulty securing additional container capacity.
Continuing economic trends worsen the supply chain
As you probably recall, the economic shutdown in April 2020 essentially brought global supply chains to a halt. The subsequent uptick in the container-to-shipment ratio was an effort by retailers to resupply dwindling inventories. One way to track these inventories is using tools like Visualping, which monitor websites for changes (like product availability) and can email you when a web page is changed or updated.
These trends continued until the end of 2021 when Big Box retailers returned to pre-Covid ratios. One theory is that they believed they had generated sufficient inventory to handle consumer demand. Through the end of 2021, consumer demand remained stable, and, normally, the bullwhip effect would have slowly resolved itself as retailers worked their way through their excess inventories over time. However, the Russian invasion of Ukraine in February of 2022 upended everything.
The real effects of oversupply and dwindling demand
In response, food prices began to surge, and out-of-control inflation set in, resulting in price surges that hadn’t been since the 80s. With inflation rising, consumers reacted by clamping down on their spending. Retailers, with their excess inventories, were faced with a dilemma and had to reduce subsequent container orders.
Big Box retailers, like Target and Walmart, have since reported having too much inventory. And these two companies are the two largest importers of container freight in the United States. Together, they account for close to 7% of all container imports to the United States. Another large importer, Samsung, also faced similar problems and requested suppliers to reduce production by up to half in July. (Last year, in 2021, Samsung was the 7th-largest importer into the United States.)
Finally, other events, like the transport worker strike in Chennai last month, further compound the bullwhip effect because it further constrains demand up and down the supply chain.
How does the bullwhip effect impact a potential recession?
One issue with the bullwhip is that consumer demand is being destroyed by the Federal Reserve through interest rate hikes. These hikes, designed to slow demand and limit the impact of inflation, have concerned economists and financial experts because of their potential to cause a recession. Normally, demand would stabilize, and excess product inventories could be sold. Instead, fears of the recession and other economic pressures are reducing demand further when inventories are already at extreme highs.
What are the economic dangers?
Unfortunately, there is no clear answer to whether the U.S. has entered a recession. Economists define a recession as “an economic contraction starting at the peak of the expansion that preceded it and ending at the low point of the ensuing downturn.”
The National Bureau of Economic Research (NBER), a nonprofit, nonpartisan organization, is one of the most frequently cited organizations when determining whether or not the economy is in a recession. As of early August, NBER has not yet claimed that the U.S. has entered one, despite the U.S. experiencing two straight quarters of GDP decline; a so-called “technical recession.”
Moody’s analyst Scott Hoyt argues the “technical recession” many are referring to most likely comes from other countries without an organization like NBER to declare an official recession. Other experts have argued that demand fluctuations are not a demand problem but really just a coordination problem and not a sign of a recession.
Despite suggestions that there is no looming recession, over 30,000 tech employees have lost their jobs as of July, and housing markets are beginning to slow. Cryptocurrency markets have been decimated since their highs earlier this year, giving investors the chance to buy any crypto at a discount.
The combination of inflationary pressures, interest rate hikes, and GDP regression all have a significant impact on supply chains and thus worsen the effects of the bullwhip.
