The Stabilizing Effect of Inventory in Supply Chains

This paper presents a hierarchical model framework for the analysis of the stabilizing effect of inventories in multiechelon manufacturing/distribution supply chains. This framework is used to compare the variance of demand to the variance of replenishment orders at different echelons of the system (e.g., retailer, wholesaler). Empirical data and experience with management games suggest that, in most industries, inventory management policies can have a destabilizing effect by increasing the volatility of demand as it passes up through the chain (the “bullwhip” effect). Our model helps to explain these observations and indicates mechanisms that can promote stabilization. The analysis results also define sufficient conditions for the existence of stabilization and relate these conditions to the optimality of myopic control policies.