Kellogg Operations Workshop 2006

"In Search of the Bullwhip Effect"

Milind Sohoni, Sunil Chopra, Usha Mohan, M. Nuri Sendil

Abstract

In this paper we analyze the impact of stair-step incentive schemes, commonly used in the automotive industry, on both expected sales and sales variability. We model the effect of stair-step incentives in two specific scenarios: an exclusive dealership selling cars for only one manufacturer and a non-exclusive dealership selling cars for multiple manufacturers. For an exclusive dealer we show that appropriate stair-step incentives, with a positive bonus on crossing the threshold, not only increase the expected sales, but more importantly, decrease the coefficient of variation of sales. We show that if the manufacturer associates a positive cost with sales variance, a stair-step incentive, with a positive bonus, is superior to the scheme without a bonus. We then show that manufacturers continuing to offer stair-step incentives to non-exclusive dealers experience an increase in variance and a decrease in profits. This implies that when manufacturers must compete for dealer effort, stair-step incentives can hurt manufacturers.

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