Order Volatility and Supply Chain Costs

The bullwhip effect (amplification of order variance from a downstream stage in a supply chain to an upstream stage) is widely observed in practice, and is generally considered a major cause of supply chain inefficiencies. But are supply chains always better off with strategies that are designed to dampen the bullwhip effect? This paper considers a model where a single product is sold through multiple retail outlets. The retailers replenish their inventories from a factory, which in turn replenishes its own finished-goods inventory through production. The factory’s production capacity is finite, and there are transportation economies of scale in replenishing the retailer inventories. We study two types of replenishment strategies that are widely used in practice, and show that a replenishment strategy that reduces the volatility of orders received by the factory does not necessarily reduce the total costs in the supply chain.