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Northwestern University

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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