The impact of order variance amplification/dampening on supply chain performance

We consider a two echelon supply chain where a single retailer holds an inventory of finished goods to satisfy an i.i.d. customer demand, and a single manufacturer produces the retailer’s replenishment orders on a make-to-order basis. The objective of this paper is to analyse the impact of the retailer’s replenishment policy (order variance amplification/dampening) on supply chain performance. Inventory control policies at the retailer often transmit customer demand variability to the manufacturer, sometimes even in an amplified form (known as the bullwhip effect), thereby imposing high inventory and capacity costs on the manufacturer. Reducing the retailer’s order variability is desirable for the manufacturer, but inflates the retailer’s inventory requirements. We consider two strategies with regard to the production capacity. In a flexible capacity strategy, the manufacturer invests in excess capacity to guarantee constant lead times in order to keep inventories low. The amount of investment depends on the retailer’s order pattern. In an inflexible capacity strategy, the capacity is limited and independent of the retailer’s replenishment decision. This results in stochastic lead times, thereby inflating the retailer’s inventory requirements.