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The phenomenon in which demand variability increases as one moves upstream in the supply chain has been often observed in practice. This so-called “bullwhip effect” often increases upstream operations costs, including inventory holding and transportation costs. Price variations are considered to be one of the primary causes of the bullwhip effect, and thus everyday low price (EDLP) strategies are commonly recommended to counter the negative impacts of the bullwhip effect. However, trade promotions continue to play an important role in the U.S. supermarket industry as well as other industries. This paper investigates this apparent inconsistency between the literature and practice by employing a deterministic, two-stage supply chain model composed of a single supplier and a single retailer. We demonstrate that even though the use of trade promotions can indeed increase a retailer's and supplier's operations costs, these costs may be more than offset by increased revenues, even in the absence of explicit coordination. That is, if the supplier judiciously applies a trade promotion strategy and the retailer passes some of this discount to its customers, then under certain conditions, the resulting supply chain profit can exceed that under an EDLP strategy. We provide a broad set of computational results that validate this conclusion and discuss the resulting managerial insights.

The phenomenon in which demand variability increases as one moves upstream in the supply chain has been often observed in practice. This so-called “bullwhip effect” often increases upstream operations costs, including inventory holding and transportation costs. Price variations are considered to be one of the primary causes of the bullwhip effect, and thus everyday low price (EDLP) strategies are commonly recommended to counter the negative impacts of the bullwhip effect. However, trade promotions continue to play an important role in the U.S. supermarket industry as well as other industries. This paper investigates this apparent inconsistency between the literature and practice by employing a deterministic, two-stage supply chain model composed of a single supplier and a single retailer. We demonstrate that even though the use of trade promotions can indeed increase a retailer's and supplier's operations costs, these costs may be more than offset by increased revenues, even in the absence of explicit coordination. That is, if the supplier judiciously applies a trade promotion strategy and the retailer passes some of this discount to its customers, then under certain conditions, the resulting supply chain profit can exceed that under an EDLP strategy. We provide a broad set of computational results that validate this conclusion and discuss the resulting managerial insights. Highlights ► We analyze the impacts of price promotions on profit levels in a two-stage supply chain. ► We consider how promotions affect forward buying and increased consumption from brand switchers. ► We show that increased profit levels can co-exist with the bullwhip effect. ► We show that the benefits of promotions can outweigh the negative operations cost impacts. Keywords Inventory control; Operations management 1. Introduction The so-called bullwhip effect, referring to the phenomenon of increasing demand variance as one moves upstream in a supply chain, has drawn a surge of research interest in the last 15 years. In the operations literature, this phenomenon is generally viewed in extremely negative terms because of its negative impacts on information distortion, excess inventory, higher raw material costs, overtime expenses, and added shipping costs. Previous research has mainly focused on identifying causes of the bullwhip effect, quantifying the cost impacts of the bullwhip effect, and developing strategies to reduce the bullwhip effect. Arguably the most influential work in recent years was provided by Lee et al. [27] and [28]. Their studies characterized price variations as one of the major causes of the bullwhip effect. In this paper, we consider two distinct types of price fluctuation in supply chains: retail sales promotions and trade promotions. Retail sales promotions target consumers, while trade promotions are offered by an upstream supply chain player to a downstream player. We stress the difference between these two kinds of sales promotions because they affect the supply chain players and consumers in different ways. Companies typically exist to gain profits, and they thus take a profit maximizing view. In contrast, monetary savings is only one of many potential benefits that sales promotions can provide consumers. For example, sales promotions can also enhance a consumer's self-perception as a savvy shopper [13]. Since sales promotions can lead to the bullwhip effect, supply chain management researchers have suggested that suppliers and distributors adopt corresponding management practices (an EDLP strategy, for example) to stabilize prices. Despite these suggestions, trade promotions still play an extremely important role in the U.S. supermarket industry (as well as in many other industries). Supplier trade promotions for consumer packaged goods hit a record of $80 billion in 2004 [21]. More recently, a survey conducted by MEI Computer Technology Group Inc. showed that 42% of the respondents, comprised of consumer packaged goods (CPGs) manufacturers, said they would spend more on trade promotions in 2010 than ever before [26]. Suppliers offer retailers temporary price discounts for several reasons, such as a fall in material prices or a need to clear out inventory. Suppliers may also reduce prices for strategic reasons, so that a temporary price reduction can be transmitted to end consumers in order to stimulate demand. This strategic practice is particularly useful to introduce excitement to mature and mundane products. Miller [29] discusses A.C. Nielsen survey data showing that about 41% of consumers actively look for deals at retail stores. As a result, many suppliers justifiably believe that offering constant prices is not a universally profit-maximizing strategy. This inconsistency between existing bullwhip effect theory and practice leads us to consider the conditions under which the revenue gain from price discounts can compensate for the extra costs induced by the bullwhip effect, and how suppliers and retailers should set pricing and inventory replenishment policies, respectively, in order to maximize total system profit. The remainder of this paper is organized as follows. The following section summarizes related literature. In Section 3 we describe our supply chain model. Section 3.1 states our assumptions about consumer demand, followed by 3.2 and 3.3, which derive mathematical models to optimize retailer and supplier profits, respectively. In Section 3.4, we elaborate on how we compute the variance of retailer orders and the variance of consumer demand, which together permit characterizing the bullwhip effect. Section 4 illustrates how promotions affect profits in our model via a set of numerical tests; we compare the retailer's profit, the supplier's profit, and the total system profit in both the promotion scenario and the constant-price scenario. We conclude in Section 5 with a discussion of the insights provided by our results.

This paper examines the degree to which the bullwhip effect results from price fluctuations in a two-echelon supply chain with deterministic and price-sensitive demand. We provide numerical evidence that increased system profit can coexist with the bullwhip effect as a result of price promotions if: (i) the supplier judiciously sets the price discount; (ii) there is a sufficient number of impulsive customers who buy the product at the discounted price; (iii) the price discount does not induce a high degree of end-customer forward buying. However, even when the total system profit increases, the retailer takes a disproportionately larger share of this profit gain, while the supplier incurs greater operations costs and tends to observe a marginal profit gain. The numerical experiments also illustrate two mechanisms that cause the bullwhip effect. In addition, this paper builds a basic structure for future research. For example, we may consider a generalized model with stochastic demand, treating the supplier's price discount d as a decision variable instead of parameterizing on it. We are also interested in issues related to handling multiple products and designing supplier–retailer contracts for discount policies, both of which serve as interesting directions for further related research