Vertical Contracts in a Supply Chain and the Bullwhip Effect
Authors: Zhan Qu and Horst Raff (Forthcoming, Management Science)
This paper shows that decentralized supply chains, in which upstream firms use linear wholesale prices, may experience lower upstream production and downstream sales volatility than vertically integrated supply chains, and may be less susceptible to the bullwhip effect where the variance of upstream production exceeds the variance of downstream sales. The reason is that decentralized supply chains exhibit a price effect, whereby upstream producers raise wholesale prices in the case of positive demand shocks and lower wholesale prices in the case of negative demand shocks. Whereas upstream producers benefit from the price effect and thus from a dampening of the bullwhip effect, downstream firms may lose and overall supply chain profit may decrease.
Keywords: bullwhip effect, production smoothing, inventory, supply chain, demand uncertainty