Over-reaction to Demand Changes due to Subjective and Quantitative Forecasting

In this paper, we study managers’ errors in decision making for inventory replenishment and how these errors affect their inventory system. In particular, primarily for its expected relationship with the bullwhip effect, we focus on the error of the over-reaction to demand changes and a common contributor of decision making biases: forecasting of demand. By over-reaction we mean that the manager over (under) orders when seeing a change in demand. We show that our representative manifestations of forecasting managers’ subjective response to demand signals and the use of simple quantitative forecasting techniques share similar consequences: both can result in an increase in internal costs and in the uncertainty and volatility of the system’s replenishment orders. Further results of this paper provide argument and thus incentive for mitigating the bullwhip effect by relating it to decision making that would help reduce costs for the manager as well.