Abstract for: Supplier Capacity Decisions Under Retailer Competition and Delays: Theoretical and Experimental Results

Inflated orders by retailers competing for scarce supplies are a common cause of the bullwhip effect, a frequent and costly problem in supply chains. This paper presents a formal model describing the impact to suppliers of retailer order inflation and describes an experiment to explore a supplierís reaction. We provide experimental evidence that shows that a reinforcing loop created by retailersí inflated orders leads to excessive capacity, backlog and costs for the supplier. Subjects making capacity investment decisions for a supplier perform poorly compared to an optimal benchmark. In particular, long times to build capacity and aggressive retailer competition for scarce resources lead to poor subject performance. Furthermore, when subjects face retailers that moderately inflate orders (10% order inflation), the majority of the supplier costs are due to changes in capacity (investment/divestment). The costs associated with frequent changes in capacity capture the inherent complexity of setting the proper capacity level. In contrast, when subjects face retailers that aggressively inflate orders (50% order inflation), the majority of the supplier costs are due to supplier backlog. Costs associated with inadequate backlog management capture the inherent complexity of managing the positive feedback loop of retailersí order inflation.