Bullwhip Effect Measurement and Its Implications

Li Chen • Hau L. Lee

Fuqua School of Business, Duke University, Durham, NC 27708

Graduate School of Business, Stanford University, Stanford, CA 94305
li.chen@duke.edu • haulee@stanford.edu

The bullwhip effect, or demand information distortion, has been a subject of both theoretical and
empirical studies in the operations management literature. Empirical studies have shown large
magnitudes of the bullwhip effect at the individual product level, but the effect does not always
exist at the macro level. The majority of studies focusing on the macro level have used monthly
data due to its availability. In practice, however, companies often order more frequently than
monthly, such as at daily or weekly intervals. In this paper, we examine how data aggregation can
affect the observation of bullwhip effect. Specifically, we show how aggregating data over relatively
long time periods can mask the magnitude of the bullwhip effect. In addition, we show that similar
impacts occur when data is aggregated across products, and how the existence of correlated demand,
seasonality, batch order, and finite capacity all can affect the measurement of the bullwhip effect.
Finally, we discuss the cost implications associated with the measured magnitude of the bullwhip
effect.

Key words: Bullwhip Effect, Data Aggregation, MMFE Model, Seasonality, Batch Order, Finite
Capacity, Supply Chain Management.
Department of review: Operations Management.
History: Revised in January, 2010.

1
1. Introduction

The supply chain bullwhip effect, as described by Lee et al. (1997a), is “the phenomenon where
orders to the supplier tend to have larger variance than sales to the buyer (i.e., demand distortion),
and the distortion propagates upstream in an amplified form (i.e., variance amplification).” This
phenomenon has been observed in many supply chains. For example, Hammond (1994) showed
large fluctuations of weekly order quantities in Barilla’s pasta supply chain. Lee et al. (1997b)
observed excess volatility in weekly orders in both Procter & Gamble’s diaper supply chain and
Hewlett-Packard’s printer supply chain. Fransoo and Wouters (2000) reported strong bullwhip
effects in daily data from a supply chain of ready-made meals and salads. Lai (2005) found a
significant level of bullwhip effect at the distribution center of a Spanish retailer. De Kok et al.
(2005) also observed substantial bullwhip effects at Philips Electronics. Most recently, Waller et
al. (2008) studied the weekly order and sales data obtained from a major U.S. retailer and found
strong bullwhip effects in all 115 products.
There also have been accounts of the bullwhip effect in the economics literature. These observa-
tions are primarily based on monthly or quarterly data aggregated across various products or firms.
For example, high production volatility was found in the TV set industry (Holt et al. 1968), retail
industry (Blinder 1981), automobile industry (Blanchard 1983), cement industry (Ghali 1987), to-
bacco, tire, and basic metal industries (Fair 1989), and in many other industries (Allen 1997). In
these studies, researchers searched for explanations to reconcile the bullwhip effect with the classic
production-smoothing theory, which posits that the motive for keeping inventory is to smooth pro-
duction variability rather than to amplify it. In a recent study, Cachon et al. (2007) used monthly
sales and inventory data from the U.S. Census Bureau to examine the bullwhip effect for various
industries. They found that if seasonality is included in the measurement, production smoothing
exists in the retail industry and in some manufacturing industries, but not in the wholesale industry.
Given these discrepant empirical findings, can one propose a unifying framework to bring order
to the observations? Specifically, how should one interpret the empirical measurements of the
bullwhip effect? What cost implications are associated with the measured magnitude of the effect?
Answering these questions requires a consideration of how the bullwhip effect is defined in the first
place.
There are two primary definitions used in the literature. Lee et al. (1997a) originally described
the bullwhip effect as a form of “information distortion,” and measured it by comparing the order
variance with the demand variance (where order can also be interpreted as production release in

2
a manufacturing setting). This definition captures the distortion of information flow that goes
upstream (the downstream stage’s order is the demand input to the upstream stage). A second
definition, used in most empirical studies, compares the variance of order receipts (or shipments)
with the variance of sales. In some cases, the order receipt information, if not available, is inferred
from the sales and inventory data (see Blinder 1981, Miron and Zeldes 1988, Allen 1997, Cachon et
al. 2007). This definition essentially captures the distortion of material flow that goes downstream.
The bullwhip measurements based on these two definitions are usually good approximation to
each other, but they differ in concept. The information-based definition has a direct linkage to
supply chain cost because the upstream inventory/capacity decision is driven by the downstream
order information. Hence, the information-based bullwhip effect is a cost driver. In contrast, order
receipts information is the outcome of the upstream order-fulfillment decision process, and thus
is not a supply chain cost driver. Hence, the material-based bullwhip effect is the consequence of
the information-based bullwhip effect. Moreover, in the information-based definition, the bullwhip
effect is a result of one decision maker, i.e., the unit in question. This decision maker observes
demand, and then makes order decisions based on various structural and economic factors (see Lee
et al. 1997a). In the material-based definition, however, there are three decision effects involved.
First, the sales data is determined by the actual demand and the on-hand inventory, where the
latter is a result of the inventory decisions made in previous periods. Second, as in the information-
based case, the unit makes order decisions, based on structural and economic conditions. Third, the
actual order receipts from the supplier are the result of the supplier’s previous production/stocking
decisions, where the order receipts may not exactly equal the orders (e.g., production shortfall,
transportation constraints, etc.). In view of these differences, we believe one should focus on the
information-based definition for theoretical development purposes. However, we recognize the need
to use the material-based definition as an empirical surrogate in some cases, and thus include a
discussion of the implications of such an approximation in Section 4.
There is also the question of the choice between ratio and difference for variance comparison
purposes. If a binary answer is needed, then both the ratio and difference metrics can be used.
However, if we want to compare the bullwhip effect for different products, the ratio metric, being
unit-independent, is probably a better choice. For example, consider two products: one with
demand variance of 10 and order variance of 20, and the other with demand variance of 40 and order
variance of 80. With the ratio metric, the amplification ratio is 2.0 for both products. However,
with the difference metric, the second product has greater amplification (40 vs. 10). Furthermore,
if we try to calculate the aggregated bullwhip measure over these two products (assuming the

3
demands are independent), the ratio would remain 2.0, but the difference would increase to 50
(10+40). The ratio metric thus appears to be more reasonable for comparison purposes in this
example as it is normalized around the demand variance. In this paper, therefore, we will employ
the ratio metric for analysis.
Before proceeding further, it is useful to discuss the main drivers for order variability. An
optimal order decision from a rational decision maker responds to both the uncertainty of supply
and demand and the cost structure of the situation. On the demand side, it is known in the
literature that positively-correlated demand coupled with long leadtime will amplify the bullwhip
effect, while negatively-correlated demand dampens it (Lee et al. 1997a, Chen and Lee 2009). On
the supply side, potential supply shortages will cause downstream stages to inflate orders and
thus trigger the bullwhip (Lee et al. 1997a). The underlying cost structure also drives the order
variability. For example, fixed ordering costs, such as machine setup costs and truckload costs, will
lead to large batch orders and cause the bullwhip (Lee et al. 1997a, Cachon 1999, Chen et al. 2002).
External cost shocks, such as promotional discounts, will induce forward-buying behavior, which
again causes the bullwhip effect (Blinder 1986, Lee et al. 1997a). Conversely, explicit penalty costs
for order variability will force the decision maker to smooth order quantities (Sobel 1969, Aviv 2007,
Cantor and Katok 2008). Furthermore, an internal capacity limit that truncates the order quantity
is likely to smooth the order sequence. A theoretical treatment for this case will be provided
in Section 4 below. In addition to these rational causes, there are also behaviorial factors. For
example, experimental studies have shown that the bounded rationality of human decision makers
can cause excess order variability (Sterman 1989, Steckel et al. 2004, Croson and Donohue 2006).
On the other hand, van Donselaar et al. (2007) found in an empirical study that store managers
sometimes smoothed system-generated orders by moving orders from peak to non-peak days.
Measuring the bullwhip effect in terms of aggregate data prompts several questions. How does
time aggregation affect the measurement? What about product or location aggregation? A number
of studies in the economics literature have addressed these issues. Christiano and Eichenbaum
(1987) showed that time aggregation causes bias under a macro-level equilibrium model. Caplin
(1985) studied the product aggregation effect under a static (s, S) inventory policy with independent
and identically-distributed (i.i.d.) demands. Caballero and Engel (1991) extended the product
aggregation result to continuous demands. Empirical tests of the aggregation effect were reported
by Mosser (1991) and Seitz (1993). In this paper, we provide a systematic analysis for both time and
product aggregations (location aggregation is omitted as it is mathematically equivalent to product
aggregation). Our time aggregation analysis differs from that of Christiano and Eichenbaum (1987)

4
in that we start with an operational-level inventory model rather than a macro-level equilibrium
model. Our product aggregation analysis generalizes that of Caplin (1985) to systems with a
state-dependent (s, S) inventory policy.

Table 1: Bullwhip Ratio at an European Retail Store

Product Pack Size Weekly Biweekly Four-week

Apple Sauce 12 1.60 1.76 1.17
Mineral Water 6 1.87 1.51 1.32
Peanut Butter 12 1.50 1.25 1.08
Stroopwafels 15 1.31 1.23 1.17
Sugar 10 3.04 2.68 2.03
Tea Bags 15 2.09 2.46 1.70
Aggregate 2.35 2.41 1.99

To motivate our results, consider the following empirical example. Table 1 presents the bullwhip
ratios for six consumer products from an European retail store (data source from Rob Broekmeulen
of Eindhoven University of Technology). The ratios are calculated from the sales and delivery data
during a one-year span, aggregated weekly, bi-weekly, and every four weeks. The bullwhip ratios
under product aggregation are also given in the table. Note that we used store delivery as a
surrogate for store orders in the calculation (see Section 4 for a discussion of the implications of
this approximation). From the table, we can see that the bullwhip ratio tends to decrease as the
aggregation period increases. In particular, for the peanut butter product, the bullwhip ratio at
the four-week level is almost 1.0. In this paper we rigorously analyze both this time aggregation
effect and the product aggregation effect.
Specifically, we consider the following three settings in our analysis: correlated and seasonal
demand, batch order, and finite capacity. We believe these three settings, separate or in combi-
nation, capture the essence of most real-world scenarios. We show that when the demand process
follows the general martingale model of forecast evolution (MMFE) (Hausman 1969, Graves et al.
1986, Heath and Jackson 1994), the bullwhip ratio converges to one as aggregation period increases.
Under the specific autoregressive moving-average ARMA(1, 1) model, we show that if the bullwhip
ratio is greater than one at the decision-period level, then the ratio decreases monotonically under
time aggregation. For product aggregation, the bullwhip ratio depends on the characteristics of
the aggregated demand process. When demands are independent cross products, the aggregated
bullwhip ratio is simply a weighted average of the individual bullwhip ratios. Furthermore, we
show that when an additive seasonality is included in the demand process, the bullwhip ratio will

5
approach to one if the variability of seasonality dominates the random demand shock.
For a system subject to batch ordering, we first show that the existence of a minimum batch
order size increases the order variability. We then show that the bullwhip ratio attributed to
batch ordering converges to one as the aggregation period increases. We further show that the
same convergence result holds for product aggregation if demands are positively-correlated across
products. This result provides a theoretical explanation for the aggregation simulation results
reported by Yan et al. (2009), who observed that under the batch-order policy and positive spatially-
correlated demands, the aggregate bullwhip ratio decreases with the number of retailers.
When a system is subject to finite capacity, we show that the order variability is reduced under
the optimal modified base-stock policy (Federgruen and Zipkin 1986a,b, Aviv and Federgruen 1997,
Kapuscinski and Tayur 1998). Our analysis can also be applied to show that the order receipt
sequence (or shipment sequence), constrained by the upstream order-fulfillment capacity, is less
variable than the original order sequence. This result, combined with our seasonality analysis,
provides a theoretical explanation for the production smoothing effect observed by Cachon et al.
(2007) (see Section 5 for a detailed discussion). We also show that the bullwhip ratio under
finite capacity converges to one as the aggregation period increases. The cost implications of the
(aggregate) bullwhip measure are discussed in Section 5.
The rest of this paper is organized as follows: Section 2 contains the aggregation analysis with
the MMFE demand process and additive seasonality. Section 3 presents the aggregation analysis
with batch ordering. In Section 4, we derive the aggregation analysis under finite capacity. Section
5 contains a discussion of the cost implications of the bullwhip measure and our concluding remarks.
All proofs are presented in the Appendix.

2. Demand Process Analysis

Let us first consider the case where the system is subject to a state-dependent demand process.
Assume no fixed order cost and full backlog of unmet demand. It is well-known in the literature
that a state-dependent base-stock policy is optimal in this case (see Iglehardt and Karlin 1962,
Song and Zipkin 1993). This inventory policy is also a close approximation to what is being used in
practice (such as Manhattan Associates and JDA Software). The order quantity under this policy,
denoted by Ot , is given by

Ot = St − (St−1 − Dt−1 ) = St − St−1 + Dt−1 (1)

6
where St (St−1 ) is the state-dependent base-stock level in period t (t − 1) and Dt−1 is the demand
in period t − 1.
In the above expression, we have implicitly assumed that the order quantity Ot can be negative.
In other words, the retailer can freely return excess inventory to the supplier. This assumption is
needed for tractability. It becomes quite innocuous when the order mean is sufficiently greater than
the order variance (such that the chance of a negative order quantity is negligible). Justifications
for this assumption can also be found in Lee et al. (1997a, 2000), Aviv (2003, 2007), and Chen and
Lee (2009).
Taking the variance on both sides of equation (1), we have

var(Ot ) = var(St − St−1 ) + cov(St − St−1 , Dt−1 ) + var(Dt−1 ).

The order variance var(Ot ) is thus dependent on the covariance between St −St−1 and Dt−1 . Under
i.i.d. demand, the optimal base-stock level is constant across all periods, i.e., St ≡ St−1 . Hence
var(Ot ) = var(Dt−1 ), i.e., the bullwhip ratio equals one. For more general demand processes, we
can deduce from the expression that the bullwhip ratio can be either greater than or less than one,
depending on the demand process characteristics.
To be more specific, let us consider a general demand process that evolves according to the
MMFE process. Specifically, following the notation of Chen and Lee (2009), let us assume that the
demand in a period t is given by
∞
∑
Dt = µ + ϵt−i,t , (2)
i=0

where ϵt−i,t is the incremental information obtained in period t − i with regard to demand Dt . Note
that the process is assumed to start from a distant past, so the summation in (2) is from ϵ−∞,t to
ϵt,t . Each ϵt−i,t is mutually independent, stationary, and normally-distributed with N (0, σi2 ). Let
∑
σ2 = ∞ i=0 σi . For ease of exposition, let us assume σ < ∞, so that the demand in each period
2 2

is stationary, with a normal distribution N (µ, σ 2 ); in the case of σ 2 = ∞, only the conditional
variance would be meaningful, so all the subsequent results should be modified with the conditional
expectation.
The incremental information available at the end of period t with regard to all future demands
can be summarized in a vector ϵt = [ϵt , ϵt,t+1 , ϵt,t+2 , ...]T . Let us assume that ϵt is i.i.d. with
a multivariate normal distribution N (0, Σ), with the variance-covariance matrix given by Σ =
E{ϵt ϵTt }. Let ei be the unit vector with the i-th element equal to one, and also define the following
∑
notation: eji = jk=i ek .

7
 The MMFE model described above generalizes many demand models used in the literature,
such as the i.i.d. normal demand model, the AR(1) model (Lee et al. 2000; Raghunathan 2001),
the IMA(0,1,1) model (Graves 1999, Miyaoka and Hausman 2004), the general ARIMA model
(Gilbert 2005, Gaur et al. 2005), the linear state-space model (Aviv 2003), and the advance demand
information model (Gallego and Ozer 2001).
Under the MMFE model with a replenishment leadtime of L periods, Chen and Lee (2009) have
shown that v
∞ ( )T uL+1
∑ u∑ T
St = i+L+1
ei+1 ϵt−i + (L + 1)µ + z t ei1 Σei1 , (3)
i=1 i=1

where z is the safety stock factor determined by the critical fractile. Substituting this into (1), we
obtain the bullwhip ratio as follows:
∑L+2
var(Ot ) (eL+2 )T ΣeL+2 − (ei )T Σei
=1+ 1 1 i=1
. (4)
var(Dt−1 ) σ2
From the expression, we can see that the bullwhip ratio depends on the variance-covariance matrix
Σ of the demand process. This result holds true under arbitrary time-lag shifts because the demand
and order processes are stationary.
Now let us consider the time aggregation effect. Define the M -period demand and order aggre-
M =
∑M −1 M
∑M −1
gation as Dt−1 τ =0 Dt−1+τ and Ot = τ =0 Ot+τ , respectively. By equation (1), it is easy

to show that
OtM = St+M −1 − St−1 + Dt−1
M
. (5)
M will increase and eventually
Intuitively, as M increases, the variance of the aggregated demand Dt−1
dominate that of St+M −1 − St−1 . The following proposition confirms this intuition:

M ) = ∞, then
Proposition 1 For a stationary MMFE process, if limM →∞ var(Dt−1
∑
var(OtM ) 2 L+1 i T M +i
i=1 (e1 ) Σei+1
M )
= 1 + M )
→ 1, as M → ∞.
var(Dt−1 var(Dt−1
Proposition 1 shows that the M -period aggregated bullwhip ratio converges to one as M goes
M ) = ∞ holds true for common demand models
to infinity. It is easy to verify that limM →∞ var(Dt−1
such as i.i.d., AR(1), MA(1), and ARMA(1, 1). Specifically, for the ARMA(1, 1) model, we can
establish the following monotonicity result:

Corollary 1 Under the stationary and invertible ARMA(1, 1) demand model, where |ρ| < 1,
|θ| < 1, the following holds:
var(OtM ) 2(ρ + θ)(1 − ρL+1 )(1 − ρL+2 + θρ − θρL+1 )
= 1+ → 1, as M → ∞;
M )
var(Dt−1 M
1−ρM
(1 − ρ2 )(1 + θ)2 − 2(ρ + θ)(1 + θρ)

8
and the bullwhip ratio decreases monotonically in M when ρ > 0 and ρ + θ > 0.

When θ = 0 (or ρ = 0), the ARMA(1, 1) model reduces to the AR(1) (or MA(1)) model. So
the above result holds for the AR(1) and MA(1) models as well. This result implies that, insofar as
an empirical demand process can be approximated by the AR(1), MA(1), or ARMA(1, 1) models
(e.g., Erkip et al. 1990), the bullwhip ratio, if greater than one (i.e., when ρ > 0 and ρ + θ > 0),
will decreases monotonically to one as the aggregation period increases.
Now let us consider the product aggregation effect. Assume that there are N products with
the MMFE process vector given by ϵt,n , n = 1, ..., N . For simplicity, let us assume that the
replenishment lead times for these N products are all L periods. Define the N -product demand
N =
∑N N
∑N
and order aggregation as Dt−1 n=1 Dt−1,n and Ot = n=1 Ot,n , respectively, where Dt−1,n is

the demand for product n and Ot,n is the order quantity for product n. By equation (1), it is easy
to show that
∑
N ∑
N
OtN = St,n − N
St−1,n + Dt−1 . (6)
n=1 n=1
N does not necessarily dominate that of
From the expression, as N increases, the variance of Dt−1
∑N ∑N
n=1 St,n − n=1 St−1,n .

∑N
t (ϵt ) }, where ϵt =
Proposition 2 Let ΣN = E{ϵN N T N
n=1 ϵt,n . The bullwhip ratio under N -
product aggregation is given by
∑
var(OtN ) (eL+2 )T ΣN eL+2 − L+2 T N
i=1 (ei ) Σ ei
N )
= 1 + 1 ∑ ∞
1
T N
.
var(Dt−1 i=1 (ei ) Σ ei

The product-aggregated bullwhip ratio thus depends on the variance-covariance matrix ΣN of

the aggregated demand process. If the diagonal elements in ΣN dominate the first L + 2 non-
diagonal elements, then, according to the above formula, the bullwhip ratio will be close to one.
Such a case arises, for example, when a large portion of the products has i.i.d. demand. When the
demands are independent across all products, it is straightforward to show that

var(OtN ) ∑ N
var(Ot,n )
N )
= wn · ,
var(Dt−1 var(Dt−1,n )
n=1
∑N
with wn = var(Dt−1,n )/ n=1 var(Dt−1,n ). Thus, in this case, the aggregated bullwhip ratio is
a weighted average of the individual bullwhip ratios, with the weight being the relative ratio of
demand variance of each product.

9
2.1 Seasonality Analysis

Now let us examine the effect of including seasonality in the demand process. For simplicity, let us
assume that an additive seasonality is present in the demand of each period. Let s0 , ..., sT −1 denote
the normalized seasonality with a regular cycle of T periods, where s0 corresponds to the seasonal
∑ −1
factor of demand D0 . By “normalized” seasonality, we mean Ti=0 si = 0. Let us also define the
variability of seasonality as
T −1
1 ∑ 2
Vs = si . (7)
T
i=0

With this additive seasonality, the demand Dt given in (2) can be rewritten as
∞
∑
Dt = s(t mod T) +µ+ ϵt−i,t .
i=0

Extending the analysis of Chen and Lee (2009) to this additive seasonal demand process, we have
the following result:

Proposition 3 The optimal base-stock level in a period is given by

v
∞ ( )T uL+1
∑ ∑
L u∑ T
St = ei+L+1
i+1 ϵ t−i + s(t+i mod T) + (L + 1)µ + z t ei Σei .
1 1
i=1 i=0 i=1

The bullwhip ratio including seasonality is given by

1 ∑T −1
{ } ∑
j=0 E (Ot+j − µ)
2
var(Ot ) T (eL+2
1 )T ΣeL+2
1 − L+2 T
i=1 (ei ) Σei βσ 2
= 1 ∑T −1 =1+ = 1 + ,
var(Dt−1 ) j=0 E {(Dt+j−1 − µ) 2} Vs + σ 2 Vs + σ 2
T

where 1 + β is the bullwhip ratio without seasonality as given in (4), and Vs is defined in (7).

From Proposition 3, we can see that including seasonality in the measurement will make the
ratio go to one if Vs ≫ σ 2 , namely, if the variability of seasonality dominates the random de-
mand shock. With some algebra, we can show that the time aggregation result of Proposition 1
continues to hold under the seasonal demand process. For product aggregation, if the aggregated
seasonality dominates the aggregated random demand shock, then, by the same reasoning, the
product-aggregated bullwhip ratio (including seasonality) will approach to one.
It is worth pointing out here that the essence of our analysis in this section lies in the order-
demand relationship given in (1), (5)and (6), not in the underlying MMFE demand process. With
additional notation and technicality, our analysis can be directly extended to other state-dependent
demand models, such as the Markov-modulated demand model.

10
3. Batch Order Analysis

In many real-world supply chains, order quantities are rounded to the pallet or carton case unit (a
pallet usually contains multiple carton cases, and a carton case contains multiple sellable units).
These batch order units are usually predetermined either by the physical nature of the products,
such as weight and/or cubic size, or by the economy of scale of the operations, so they cannot be
easily altered. In this section, we examine the bullwhip measurement subject to batch ordering.
Specifically, let us consider the case in which the original order quantity Ot , as given in (1), is
rounded to the nearest multiple of the batch order unit Q, i.e., the rounded order takes values in
the set of {0, Q, 2Q, ...}. As a result of the order rounding, the system inventory position fluctuates
around the original base-stock level St by ±Q/2. This is mathematically equivalent to a system
with a state-dependent (Rt , nQ) policy with Rt = St − Q/2.
Let Õt denote the rounded order quantity in period t. The bullwhip ratio in this batch order
system can be expressed as
var(Õt ) var(Ot ) var(Õt )
= · , (8)
var(Dt−1 ) var(Dt−1 ) var(Ot )
where Ot is the original order quantity as given in (1) (without bath ordering). The first ratio term
has already been studied in Section 2. We will focus on the second ratio term here, which captures
the effect of batch ordering. To facilitate the subsequent analysis, let us assume that both Dt and
Ot take only integer values.
It is useful to first determine the relationship between Õt and Ot . Since Ot takes integer
values, we can express Ot as Ot = mt Q + qt , with mt being a nonnegative integer and qt ∈
{0, 1, ..., Q − 1}. Let It−1 be the inventory position after ordering in period t − 1 and St−1 the
base-stock level for period t − 1. Define ∆t−1 = St−1 − It−1 . Without order rounding, the base-
stock level can be achieved exactly and thus ∆t−1 = 0. With order rounding, ∆t−1 varies in the set
of {−⌊Q/2⌋ + 1, ..., 0, ..., Q − ⌊Q/2⌋} (where ⌊x⌋ denotes the nearest integer below x). The order
quantity before rounding in period t is given by

St − (It−1 − Dt−1 ) = St − St−1 + Dt−1 + St−1 − It−1

= Ot + St−1 − It−1

= mt Q + qt + ∆t−1 .

The rounded order quantity Õt is thus given by


 (mt + 1)Q if qt + ∆t−1 ≥ Q/2,
Õt = (9)

mt Q if qt + ∆t−1 < Q/2.

11
 To determine the variance of Õt , we could establish the probability distribution of ∆t−1 , which
is generally cumbersome to do due to the dynamic nature of St−1 . Instead, we find that the one-step
transition matrix for the Q-modular of the inventory position It−1 can be fairly easily characterized.
Let Iˆt−1 = (It−1 mod Q), where Iˆt−1 takes a value in {0, 1, ..., Q − 1}. Since the rounded order
quantity Õt is always a multiple of Q, i.e., (Õt mod Q) = 0, then Iˆt is given by

Iˆt = [(Iˆt−1 + Õt − Dt−1 ) mod Q] = [(Iˆt−1 − Dt−1 ) mod Q].

Now let gt−1 (·) denote the probability distribution of (Dt−1 mod Q) over the set {0, ..., Q − 1}.
Then the one-step transition matrix from Iˆt−1 to Iˆt is given by
 
gt−1 (0) gt−1 (Q − 1) · · · gt−1 (1)
 gt−1 (1) gt−1 (0) · · · gt−1 (2) 
 
Pt−1 =  .. .. .. .. , (10)
 . . . . 
gt−1 (Q − 1) gt−1 (Q − 2) · · · gt−1 (0)

where Pt−1 (i, j) = Pr{Iˆt = j|Iˆt−1 = i} for i, j ∈ {0, 1, ..., Q − 1}. It is easy to see that Pt−1 given
∑
in (10) is doubly stochastic because Q−1 i=0 gt−1 (i) = 1.

Lemma 1 If Pt is irreducible for all t, then the stationary distribution for Iˆt is a uniform distri-
bution over {0, 1, ..., Q − 1}.

Lemma 1 is essentially a generalization of the uniformity result obtained under the i.i.d. demand
with a static (R, nQ) policy by Simon (1968) and Richards (1975). The irreducibility of the tran-
sition matrix Pt is guaranteed if all states are communicated, which can be achieved by requiring
gt (q) > 0 for all t with q ∈ {1, ..., Q − 1}. A simple example would be to assume that there is a
positive probability for a single unit of demand in any given period, which is not at all restrictive.

Proposition 4 Assume that Pt is irreducible for all t. Let Xt = (Ot mod Q). Then the following
holds:
var(Õt ) E{Xt (Q − Xt )}
=1+ ≥ 1,
var(Ot ) var(Ot )
and when Q = 1, var(Õt ) = var(Ot ).

Proposition 4 generalizes the result of Caplin (1985). He obtained the variance comparison result
between var(Õt ) and var(Dt−1 ) in the case of i.i.d. demand with a static (s, S) policy. Under the
i.i.d. demand, from Section 2, we know var(Ot ) = var(Dt−1 ). Hence, his result is equivalent to
what we have here in terms of var(Õt ) and var(Ot ). But when demand is not i.i.d., his result no
longer holds, whereas our result given in Proposition 4 remains valid.

12
 The above result can be viewed as an alternative proof of the order batching cause of the bull-
whip effect as discussed in Lee et al. (1997a). Proposition 4 also provides a theoretical explanation
for a counter-intuitive observation reported by Baganha and Cohen (1998). In a simulation study,
they found that at the distribution center, order variability dampens because the orders generated
by the downstream (s, S) policy are negatively correlated. They obtained this observation under
the assumption that the distribution center uses an order-up-to policy with no batch orders, i.e.,
Q = 1. Thus from Proposition 4, we have var(Õt )/var(Ot ) = 1. They approximated the demand
process at the distribution center by an AR(1) process with a negative autocorrelation coefficient
ρ in their simulation study; by setting M = 1, θ = 0 and ρ < 0 in the formula given by Corollary
1, it is straightforward to verify that var(Ot )/var(Dt−1 ) < 1. Therefore, in this case, the overall
bullwhip ratio as given by (8) is less than one. If, however, the distribution center orders in large
batches, as is often the case in real life, i.e., Q ≫ 1, then, according to Proposition 4, we have
var(Õt )/var(Ot ) > 1. Factoring this effect into expression (8), the overall bullwhip ratio could be
greater than one, and thus their simulation observation might be reversed.
Now let us consider the time aggregation effect. Define the M -period time aggregation of the
∑ −1 ∑M −1
original order and the rounded order as OtM = M M
τ =0 Ot+τ and Õt = τ =0 Õt+τ , respectively.

By the analogous arguments used for Proposition 4, we can establish the following result:

( )
Proposition 5 Assume that Pt is irreducible for all t, and limM →∞ var OtM = ∞. Then the
following holds:
var(ÕtM ) Q2 /4
1≤ ≤ 1 + ( ) → 1, as M → ∞.
var(OtM ) var OtM

Proposition 5 shows that the M -period aggregated bullwhip ratio converges to one as M goes to
M ) = ∞ implies lim
( M)
infinity. From Proposition 1, we know limM →∞ var(Dt−1 M →∞ var Ot = ∞.
So the above result holds for common demand models such as i.i.d., AR(1), MA(1), and ARMA(1,
1).
Now let us consider the product aggregation effect. Let us assume that there are N products
∑
in the system. Define the aggregated order and rounded order as OtN = N N
n=1 Ot,n and Õt =
∑N
n=1 Õt,n , respectively, where Ot,n (Õt,n ) is the original (rounded) order quantity for product

n. We can expand the Q-modular inventory state space Iˆt for a single product to a vector of
Ît = [Iˆt,1 , ..., Iˆt,N ]T for the N -product case, where Iˆt,n = (It,n mod Qn ) for n = 1, ..., N .
Now let gt (x1 , ..., xN ) denote the joint probability distribution of x1 = (Dt,1 mod Q1 ), ..., xN =
(Dt,N mod QN ) over the Cartesian set A = {0, ..., Q1 − 1} × ... × {0, ..., QN − 1}. Also let Pt−1
N be

13
the one-step transition matrix from Ît−1 to Ît . We can show that

Pr{Ît |Ît−1 } = gt−1 (z1 , ..., zN ),

with zn = [(Iˆt−1,n − Iˆt,n ) mod Qn ] for n = 1, ..., N . Note that for any pairs of Ît−1 and Ît , there is
a unique gt−1 (z1 , ..., zN ). Therefore, for any given vector Ît ∈ A
∑
Pr{Ît | for all Ît−1 ∈ A} = gt−1 (z1 , ..., zN ) = 1.
(z1 ,...,zN )∈A

N is doubly stochastic. Hence, by the analogous arguments used for

Thus, the transition matrix Pt−1
Lemma 1 and Proposition 4, we can establish the following result:
( )
Proposition 6 Assume that PtN is irreducible for all t, and limN →∞ var OtN /N = ∞. Let
Qmax = max1≤n≤N {Qn }. The following results then hold:

var(ÕtN ) N · Q2max /4
1≤ ≤ 1 + ( ) → 1, as N → ∞.
var(OtN ) var OtN
The above result is a generalization of the product aggregation result obtained under the i.i.d.
( )
demands by Caplin (1985). The condition of limN →∞ var OtN /N = ∞ is satisfied when demands
are positively correlated across products. Thus in scenarios such as aggregating across comple-
mentary product categories and/or across neighboring locations (where demands are likely to be
positively correlated), our result suggests that the amplifying effect due to batch ordering will be
less significant. This explains the simulation results reported by Yan et al. (2009), who observed
that under the batch-order policy and positive spatially-correlated demands, the aggregate bullwhip
ratio decreases with the number of retailers.

4. Finite Capacity Analysis

As discussed in the introduction, the existence of capacity limits is also a main driver of order
variability. In this section, we will examine the bullwhip measurement subject to finite capacity.
With a finite capacity constraint, it is well-known in the literature that a modified base-stock
policy is optimal under the state-dependent demand (Aviv and Federgruen 1997, Kapuscinski and
Tayur 1998). The order quantity under this policy is equivalent to truncating the original order
quantity given in (1) with the capacity limit, henceforth defined as B. Let Ōt denote the truncated
order quantity in period t. The bullwhip ratio under the capacitated system then can be expressed
as
var(Ōt ) var(Ot ) var(Ōt )
= · , (11)
var(Dt−1 ) var(Dt−1 ) var(Ot )

14
where Ot is the original order quantity as given in (1) (without capacity limit). We will focus on
the second ratio here, which captures the finite capacity effect.
Let us first determine the relationship between Ōt and Ot . Let It−1 be the inventory position
after ordering in period t − 1 and St−1 the base-stock level in period t − 1. Let ∆t−1 = St−1 − It−1 .
Without capacity limit, the base-stock level can be achieved exactly and thus ∆t−1 = 0. With
capacity limit, we have ∆t−1 ≥ 0, which represents the backlogged order quantity. The truncated
order in period t can then be written as

Ōt = min{St − (It−1 − Dt−1 ), B}

= min{St − St−1 + Dt−1 + St−1 − It−1 , B}

= min{Ot + ∆t−1 , B}.

From the above expression, we see that Ōt is the truncation of the sum of the original Ot and
a random variable ∆t−1 . It is not immediately clear whether Ōt is less variable than Ot or not.
When E{Ot } < B, it is easy to show that ∆t visits the zero point infinitely many times. Now let
us examine a cycle that spans T periods between two consecutive zero-point visits, i.e., ∆t = 0,
Ot+1 > B, Ot+1 + Ot+2 > 2B, ..., Ot+1 + ... + Ot+T −1 > (T − 1)B, and Ot+1 + ... + Ot+T ≤ T B
(such that ∆t+T = 0). In this cycle, the truncated order quantity is given by

 B if 1 ≤ i < T,
Ōt+i =

Ot+1 + ... + Ot+T − (T − 1)B if i = T.

Therefore, we can show that

∑
T ∑
T
2
Ōt+i − 2
Ot+i
i=1 i=1
∑
T
= (T − 1)B + [Ot+1 + ... + Ot+T − (T − 1)B] −
2 2 2
Ot+i
i=1
∑
T
= (T − 1)B 2 + [(Ot+1 − B) + ... + (Ot+T − B) + B]2 − 2
Ot+i
i=1
( )
∑
T ∑
T ∑
T ∑
i−1 ∑
T
2
= TB + (Ot+i − B)2 + 2B Ot+i − T B +2 (Ot+i − B)(Ot+j − B) − 2
Ot+i
i=1 i=1 i=1 j=1 i=1

∑
T ∑
i−1
= 2 (Ot+i − B)(Ot+j − B),
i=1 j=1

where the last quantity can be shown to be negative by an induction proof (see the Appendix).
With this observation, we can use the ergodic theorem to prove the following result:

15
Proposition 7 Assume that Ot is a stationary process and E{Ot } < B. Then the following holds:
var(Ōt )
≤ 1.
var(Ot )
Proposition 7 shows that the order sequence subject to finite capacity is less variable than the
original order sequence without capacity limit. The same analysis can be applied to the order-
fulfillment process where the downstream orders are truncated and backlogged according to the
upstream fulfilment capacity; as a result, we can show var(shipment)/var(order) ≤ 1. Hence,
when we use shipment (or order receipt) data as an empirical surrogate for the original order
data, the variance measurement will understate the original order variance. As we have argued
in the introduction, it is the order variance, not the shipment variance, that drives the upstream
inventory/capacity decisions. Therefore, such an approximation will also underestimate the cost
impact associated with the original order variance.
Now let us consider the time aggregation effect. Define the M -period time aggregation of the
∑ −1 ∑M −1
original order and the truncated order as OtM = M M
τ =0 Ot+τ and Ōt = τ =0 Ōt+τ , respectively.

It is easy to verify that

ŌtM = min{OtM + ∆t−1 , M B}.

Hence, Pr{ŌtM ̸= OtM + j|∆t−1 = j} = Pr{OtM > M B − j|∆t−1 = j} for j ≥ 0. Because

E{Ot } < B, by the ergodic theorem, Pr{OtM /M > B − j/M } → 0 as M → ∞. In other words, we
have Pr{ŌtM ̸= OtM + j|∆t−1 = j} → 0. Therefore, we arrive at var(ŌtM |∆t−1 = j)/var(OtM ) → 1.
By the law of total variance, we can establish the following result:

Proposition 8 Assume that Ot is a stationary process and E{Ot } < B. Then the following holds:
var(ŌtM )
1≥ → 1, as M → ∞.
var(OtM )
Combined with Propositions 1, this result shows that time aggregation will eventually drive the
aggregated bullwhip ratio to one. For product aggregation, we are unable to establish a similar
convergence result under finite capacity. The product-aggregated bullwhip ratio in this case depends
on the fraction of uncapacitated products in the product mix. For uncapacitated products, we have
var(Ōt )/var(Ot ) = 1. Hence, if the fraction of products not subject to finite capacity grows with
the number of products in the mix, then the aggregated bullwhip ratio will again approach to one.

5. Discussion and Concluding Remarks

We have discussed the main drivers for order variability and provided detailed analysis of the
bullwhip measure in three settings: correlated and seasonal demand, batch ordering, and finite

16
capacity. Now let us synthesize these results to provide theoretical explanations for the empirical
observations reported by Cachon et al. (2007).
Consider the general setting with both finite capacity and batch ordering. Here we assume the
truncated order quantity Ōt is further rounded to the nearest multiple of the batch order unit Q
(the capacity limit B is also assumed to be a multiple of Q). Let Ôt denote the final order quantity
in this case. Then the overall bullwhip ratio can be written as

var(Ôt ) var(Ot ) var(Ōt ) var(Ôt )

= · · . (12)
var(Dt−1 ) var(Dt−1 ) var(Ot ) var(Ōt )

Cachon et al. (2007) found variability dampening in the retail industry and some manufacturing
industries when including seasonality in the measurement. According to Proposition 3, strong
seasonality in these industries drives the first ratio in (12) to one. According to Proposition 7, the
prevalence of capacity constraints in these industries, such as limited shelf/warehouse space and
manufacturing capacity, then drives the second ratio below one. In addition, product aggregation
is likely to drive the third ratio to one (Proposition 6). The observation of Cachon et al. (2007)
thus suggests that the finite capacity effect dominates the batch order effect in these industries.
Furthermore, according to Proposition 7, the use of inferred order receipt data as a surrogate for
the order data in the study could also drive the observed bullwhip ratio below one.
When seasonality is excluded from the bullwhip measurement, Cachon et al. (2007) did not
find variability dampening in these industries. In this case, the first ratio of (12) is no longer fixed
around one. This suggests that the demand correlation effect (the first ratio) dominates the finite
capacity and batch ordering effects (the second and third ratio) when seasonality is removed from
the measurement.
Cachon et al. (2007) also observed that variability amplification exists in the wholesale industry
with or without seasonality. As we have discussed in Section 3, large batch order size is a common
practice in the wholesale industry as their business operations hinge upon economies of scale, such
as full truckloads and volume discounts. The wholesalers, unlike the manufacturers facing finite
manufacturing capacity, are less prone to production smoothing. Moreover, wholesalers tend to be
less space constrained than retailers, and so are less prone to smoothing due to shelf capacity. The
batch ordering effect thus is likely to dominate the finite capacity effect in the wholesale industry,
which explains why the overall bullwhip ratio is observed to be greater than one in most cases.
Another interesting point is that, according to Cachon et al. (2007), the bullwhip results with
seasonality are generally less than those without seasonality. This again can be explained by our
seasonality analysis (Proposition 3).

17
 Now let us interpret the cost implications of the bullwhip measure. First of all, it is important to
delineate the different implications of uncertainty and variability. As argued by Aviv (2001, 2003)
and Chen and Lee (2009), demand uncertainty is the conditional variance of demand (conditional
on available information), which is different from the unconditional demand variance (i.e., total
demand variability). Demand uncertainty, measured by forecast error, affects the inventory-related
cost as it determines the system safety stock level. Total demand variability, captured by the
bullwhip measure, is tied to the capacity-related cost, such as warehouse and truckload costs. When
there is no information sharing between the downstream and the upstream stages, the downstream
order variability is the same as the upstream demand uncertainty (conditional variance reduces to
unconditional variance because there is no information). In this case, the bullwhip measure also
captures the supply chain uncertainty amplification effect.
For cost assessment purposes, the bullwhip effect should be measured at the appropriate time
unit. For example, to assess its impact on warehouse and truckload costs, the bullwhip effect should
be measured at the upstream order-fulfillment time interval, i.e., the scheduled shipping interval.
At this time scale, one can also assess the upstream service level based on its shipping and handling
capacity. To assess its impact on inventory-related costs, the bullwhip effect should be measured at
the interval equal to the upstream inventory exposure period, i.e., the upstream reorder period plus
its inventory replenishment lead time. The caveat here is that if there is forecast sharing between
the downstream and the upstream stages, the bullwhip measure should be properly discounted to
account for the actual demand uncertainty (conditional variance) faced by the upstream stage.
It is worth reiterating here the delineation of the two commonly-used bullwhip effect definitions
we have pointed out in the introduction. The original definition of the bullwhip effect by Lee et al.
(1997a) is based on (1) information flow; (2) a single product; and (3) time measurement at the
level of order period, i.e., the decision period. Many of the empirical studies, however, including
that of Cachon et al. (2007), measure the bullwhip effect based on (1) material flow; (2) aggregated
products; and (3) aggregated time to a month, if not a quarter. Hence, these empirical studies are
essentially exploring the existence or the magnitude of “aggregated” bullwhip effects in material
flow. It therefore may not have a direct bearing on the original bullwhip effect described by Lee et
al. (1997a). In this paper, using model-based analysis, we have shown how data aggregation can
actually affect the original bullwhip measure.
Our aggregation analysis (Propositions 1,5, and 8) suggests that the aggregated bullwhip ratio
converges to one as the aggregation period increases. Although not surprising, it has an interesting
interpretation: the upstream stage will be more vulnerable to the bullwhip effect if it moves closer

18
to a just-in-time regime, such as shortening the scheduled shipping interval and reducing the reorder
period and lead time. We have also shown scenarios where the product-aggregated bullwhip ratio
could exhibit a similar convergence effect. In general, our analysis suggests that the bullwhip effect
tends to be less dramatic at the aggregate planning level than at the operational level. Given the
fact that most financial planning and capital investment decisions are based on firm-level aggregate
data on a quarterly or even yearly basis, the underlying bullwhip effect is likely to be hidden from
managers outside the supply chain function.
Finally, we would like to acknowledge the enlightening empirical study conducted by Cachon et
al. (2007), which motivated the present research. We hope our newly-developed theory can further
our understanding of the supply chain bullwhip effect, and we look forward to new empirical studies
to validate the theory.

Appendix

Proof (Proposition 1) By equations (1), (2), and (3), we have

−1
( ∞
) −1 ∑
∞
∑
M ∑ M∑
M
Dt−1 = µ+ ϵt+τ −1−i,t+τ −1 = M µ + (ei )T ϵt+τ −i
τ =0 i=0 τ =0 i=1
∞
∑ ∑
M −1
−i T
= Mµ + (eM +i T
i+1 ) ϵt−1−i + (eM
1 ) ϵt−1+i ;
i=1 i=0

−1
( ∞
)
∑
M ∑
OtM = µ+ (ei+L+1 )T ϵt+τ −i + (eL+2
1 )T ϵt+τ −1
τ =0 i=2
∞
∑ ∑
M −1
M +L+i+1 T
= Mµ + (eL+i+2 ) ϵt−1−i + (e1M +L+1−i )T ϵt−1+i .
i=1 i=0

Therefore,
∑
M ∞
∑
M
var(Dt−1 )= (ei1 )T Σei1 + (eM +i T M +i
i+1 ) Σei+1 ,
i=1 i=1

∑
M −1 ∞
∑
var(OtM ) = (eL+i+2
1 )T ΣeL+i+2
1 + M +L+i+1 T
(eL+i+2 M +L+i+1
) ΣeL+i+2 .
i=0 i=1

And hence,

var(OtM ) var(OtM ) − var(Dt−1

M )

M )
= 1+ M )
var(Dt−1 var(Dt−1
∑M −1 L+i+2 T ∑ ∑L+1 M +i T
i=0 (e1 ) ΣeL+i+2
1 − Mi=1 (e1 ) Σe1 −
i T i M +i
i=1 (ei+1 ) Σei+1
= 1+ M )
var(Dt−1

19
 ∑L+M +1 ∑M ∑L+1 M +i T
i=L+2 (ei1 )T Σei1 − i=1 (e1 ) Σe1 −
i T i
i=1 (ei+1 ) Σei+1
M +i
= 1+ M )
var(Dt−1
∑L+1 ∑L+1 M +i T ∑
− i=1 (ei1 )T Σei1 + i=1 (e1 ) ΣeM1
+i
− L+1 M +i T
i=1 (ei+1 ) Σei+1
M +i
= 1+ M )
var(Dt−1
∑L+1 ∑L+1 i ∑L+1 M +i T
− i=1 (ei1 )T Σei1 + i=1 (e1 + ei+1 ) Σ(e1 + ei+1 ) −
M +i T i M +i M +i
i=0 (ei+1 ) Σei+1
= 1+ M )
var(Dt−1
∑L+1
2 i=1(ei1 )T ΣeM +i
i+1
= 1+ M )
.
var(Dt−1

Since the MMFE process is stationary, we have sup{var((ei1 )T ϵt )} < ∞. From this fact, it is
  i≥1
 L+1
∑ 
 +i 
straightforward that sup 2 (ei1 )T ΣeM  = K < ∞. Hence, the result follows. △
M ≥1  
i+1
i=1

Proof (Corollary 1) For the ARMA(1, 1) model, we have ϵt = [ϵt , (ρ + θ)ϵt , (ρ + θ)ρϵt , (ρ +
θ)ρ2 ϵt , ...]T . Hence,
 
1 (ρ + θ) (ρ + θ)ρ (ρ + θ)ρ2 · · ·
 (ρ + θ) (ρ + θ)2 (ρ + θ)2 ρ (ρ + θ)2 ρ2 · · · 
 
Σ = σ02 ·  (ρ + θ)ρ (ρ + θ)2 ρ (ρ + θ)2 ρ2 (ρ + θ)2 ρ3 · · ·  .
 
.. .. .. .. ..
. . . . .

Substituting this into the formula given in Proposition 1, it is easy to show that

M M (1 − ρ2 )(1 + θ)2 − 2(ρ + θ)(1 + θρ)(1 − ρM )

var(Dt−1 )= ,
(1 − ρ2 )(1 − ρ)2

∑
L+1
(ρ + θ)(1 − ρL+1 )(1 − ρL+2 + θρ − θρL+1 )(1 − ρM )
(ei1 )T ΣeM +i
i+1 = .
(1 − ρ2 )(1 − ρ)2
i=1

Hence, we have

var(OtM ) 2(ρ + θ)(1 − ρL+1 )(1 − ρL+2 + θρ − θρL+1 )

= 1+ ;
M )
var(Dt−1 M
1−ρM
(1 − ρ2 )(1 + θ)2 − 2(ρ + θ)(1 + θρ)

Note that M/(1 − ρM ) is increasing in M for ρ ≥ 0. Also, (ρ + θ)(1 − ρL+2 + θρ − θρL+1 ) ≥ 0 if

and only if ρ + θ ≥ 0. Hence, it follows that the order variance amplification ratio is monotonically
decreasing in M when ρ ≥ 0 and ρ + θ ≥ 0. △

N and O N and equations

Proof (Proposition 2) The result follows from the definition of Dt−1 t−1

(1), (2), and (3). △

20
Proof (Proposition 3) Since the replenishment lead time is L periods and the seasonality is
known, the optimal base-stock level in period t is simply the summation of the seasonality L
periods from now and the original base-stock level given in (3), i.e.,
v
∞ ( )T uL+1
∑ ∑
L u∑ T
St = ei+L+1
i+1 ϵt−i + s(t+i mod T) + (L + 1)µ + z t ei Σei .
1 1
i=1 i=0 i=1

Substituting this into equation (1), we obtain

∞
∑
Ot = s(t+L mod T) + µ + (ei+L+1 )T ϵt−i + (eL+2
1 )T ϵt−1 .
i=2

By including the seasonality in the variability calculation, we have the following:

T −1
1 ∑ { }
var(Ot ) = E (Ot+j − µ)2
T
j=0
( )2 
1 ∑
T −1  ∑∞ 
= E s(t+L+j mod T ) + (ei+L+1 )T ϵt+j−i + (eL+2 )T
ϵ t+j−1
T  1 
j=0 i=2
T −1
{ (∞ )}
1 ∑ 2 ∑
T L+2 T
= sj + var (ei+L+1 ) ϵt+j−i + (e1 ) ϵt+j−1
T
j=0 i=2
∑∞
= Vs + (ei+L+1 )T Σei+L+1 + (eL+2
1 )T ΣeL+2
1 ,
i=2

where the last equality follows from the fact that ϵt is stationary. Similarly, the variability of
demand is given by
T −1
1 ∑ { }
var(Dt−1 ) = E (Dt+j−1 − µ)2
T
j=0
( )2 
1 ∑  
T −1 ∞
∑
= E s(t+j−1 mod T ) + ϵt+j−i,t+j−1
T  
j=0 i=1
T −1
{ (∞ )}
1 ∑ 2 ∑
T
= sj + var (ei ) ϵt+j−1
T
j=0 i=1
∑∞
= Vs + (ei )T Σei = Vs + σ 2 .
i=1

Hence, we arrive at
∑∞ L+2 T
var(Ot ) Vs + T
i=2 (ei+L+1 )∑Σei+L+1 + (e1 ) ΣeL+2
1
=
var(Dt−1 ) Vs + ∞ i=1 (e i ) T Σe
i
T ΣeL+2 −
∑L+2
(eL+2
1 ) 1
T
i=1 (ei ) Σei
= 1+
Vs + σ 2
βσ 2
= 1+ ,
Vs + σ 2

21
where 1 + β is the bullwhip ratio excluding seasonality. △

Proof (Lemma 1) Since the demand process follows the MMFE process defined in (2) and
var(Dt ) = σ 2 < ∞, at steady state, there exists a stationary distribution for Dt . Since Pt is finite
and irreducible for all t, there exists a unique stationary distribution for Iˆt , which is a uniform
distribution because Pt is doubly stochastic. △

Proof (Proposition 4) Let Ot = mt Q + qt . We have

∞ Q−1
∑ ∑
E(Ot ) = (mt Q + qt )Pr{Ot = mt Q + qt }.
mt =0 qt =0

Similarly, we have
∑ ∑[
∞ Q−1
qt Q − qt
]
E(Õt ) = (mt + 1)Q · + mt Q · Pr{Ot = mt Q + qt }
Q Q
mt =0 q=0
∞ Q−1
∑ ∑
= (mt Q + qt )Pr{Ot = mt Q + qt },
mt =0 q=0

where the first equality follows from equation (9) and the uniform stationary distribution of ∆t−1
(because Iˆt−1 follows the uniform distribution by Lemma 1). Hence, we have E(Õt ) = E(Ot ).
Therefore,

var(Õt ) − var(Ot ) = E(Õt2 ) − E(Ot2 )

∑∞ Q−1∑[ ]
2 2 qt 2 2 Q − qt
= (mt + 1) Q · + mt Q · Pr{Ot = mt Q + qt }
Q Q
mt =0 qt =0
∞ Q−1
∑ ∑
− (mt Q + qt )2 Pr{Ot = mt Q + qt }
mt =0 qt =0
∞ Q−1
∑ ∑
= qt (Q − qt )Pr{Ot = mt Q + qt }
mt =0 qt =0

∑
Q−1
= x(Q − x)Pr{x = (Ot mod Q)}
x=0
= E{Xt (Ot − Xt )},

where the second equality follows from equation (9) and the uniform stationary distribution of
∆t−1 , and the last equality follows from the definition of Xt = (Ot mod Q). From the above ex-
pression, it is easy to see that when Q = 1, var(Õt ) = var(Ot ), and the result follows. △

22
Proof (Proposition 5) Let XtM = (OtM mod Q). By analogous arguments used in Proposition
4, it is easy to show that

var(ÕtM ) − var(OtM ) = E{XtM (Q − XtM )} ≥ 0,

with XtM = (OtM mod Q). Note that maxx∈{0,...,Q−1} {x(Q − x)} = Q2 /4, so we immediately have

var(ÕtM ) Q2 /4
1≤ ≤ 1 + → 1, as M → ∞.
var(OtM ) var(OtM )
△

Proof (Proposition 6) By the same arguments used in the proof of Lemma 1, it is easy to show
that the stationary distribution for Ît is a uniform distribution over set A. Let us first show that
for any pair of product-locations i, j (i ̸= j), cov(Õt,i , Õt,j ) = cov(Ot,i , Ot,j ). From Proposition 4,
we know that E{Õt,i } = E{Ot,i } for any i. So it suffices to show that E{Õt,i · Õt,j } = E{Ot,i · Ot,j }.
Let Ot,i = mt,i Qi + qt,i and Ot,j = mt,j Qj + qt,j . By utilizing the property of uniform stationary
distribution of Ît−1 and the equation (9), we have
∞
∑ ∞
∑ ∑
Qi −1 Q
∑j −1 [
qt,i qt,j
E{Õt,i · Õt,j } = (mt,i + 1)Qi · · (mt,j + 1)Qj ·
Qi Qj
mt,i =0 mt,j =0 qt,i =0 qt,j =0
qt,i Qj − qt,j
+(mt,i + 1)Qi · · mt,j Qj ·
Qi Qj
Qi − qt,i qt,j
+mt,i Qi · · (mt,j + 1)Qj ·
Qi Qj
]
Qi − qt,i Qj − qt,j
+mt,i Qi · · mt,j Qj · ·
Qi Qj
Pr{Ot,i = mt,i Qi + qt,i , Ot,j = mt,j Qj + qt,j }
∞ ∞ i −1 Qj −1 [ ]
∑ ∑ ∑
Q ∑
= (mt,i Qi + qt,i ) · (mt,j Qj + qt,j ) ·
mt,i =0 mt,j =0 qt,i =0 qt,j =0
Pr{Ot,i = mt,i Qi + qt,i , Ot,j = mt,j Qj + qt,j }

= E{Ot,i · Ot,j }.

Hence, we conclude that

∑
N
var(ÕtN ) − var(OtN ) = {var(Õt,n ) − var(Ot,n )}.
n=1

Now let Qmax = max{Q1 , ..., QN }. By the above result, we have

N [
∑ ] Q2
0 ≤ V ar(ÕtN ) − V ar(OtN ) = var(Õt,n ) − var(Ot,n ) ≤ N · max .
4
n=1

23
Hence,
var(ÕtN ) N · Q2max /4
1≤ N
≤1+ → 1, as N → ∞.
var(Ot ) var(OtN )
△

∑ ∑i−1
Proof (Proposition 7) Let us first show that Ti=1 j=1 (Ot+i − B)(Ot+j − B) < 0. Note that
∑k ∑T
we have i=1 Ot+i > kB for k = 1, ..., T − 1, and i=1 Ot+i ≤ T B. Let us prove by induction. For
T = 2, we have (Ot+1 − B)(Ot+2 − B) < 0 because Ot+1 > B and Ot+1 + Ot+2 ≤ 2B (which implies
Ot+2 < B). Now assume the result holds true for any cycle period less than T . For the case of T , by
the cycle condition, we have Ot+T < B. Because Ot+1 > B, we can always find k = max{j|Ot+j >
∑
B, 1 ≤ j ≤ T −1}. Now by the cycle condition, Ot+k > B implies i̸=k Ot+i < (T −1)B. Therefore,
∑
we can always find l = min{j| i̸=k,1≤i≤j Ot+i ≤ (j − 1)B, k + 1 ≤ j ≤ T }. Given k and l, we have
∑
Ot+i ≤ B for l + 1 ≤ i ≤ T , and i̸=k,1≤i≤j Ot+i > (j − 1)B for k + 1 ≤ j ≤ l − 1. Hence,

∑
T ∑
i−1
(Ot+i − B)(Ot+j − B)
i=1 j=1
 
∑ ∑ ∑
= (Ot+i − B)(Ot+j − B) + (Ot+k − B)  Ot+j − (l − 1)B 
1≤i≤l,i̸=k 1≤j<i,j̸=k 1≤j≤l,j̸=k
 
∑
T ∑i−1
+ (Ot+i − B)  Ot+j − (i − 1)B 
i=l+1 j=1
< 0,

where the first term is negative because of the induction assumption, the second term is negative
by the definitions of k and l, and the third term is negative due to the definition of k and the cycle
condition. This completes the induction proof.
∑ ∑
Now we have shown that during any such cycle, Ti=1 Ōt+i2 < Ti=1 Ot+i
2 . Also, it is straight-
∑ ∑
forward to verify that Ti=1 Ōt+i = Ti=1 Ot+i . Because Ot is a stationary process, by the ergodic
theorem, we conclude that E{Ōt2 } ≤ E{Ot2 } and E{Ōt } = E{Ot }. Therefore,

var(Ōt ) − var(Ot ) = E{Ōt2 } − E{Ot2 } ≤ 0.

Proof (Proposition 8) Given that Ot is a stationary process and E{Ot } < B, by the analogous
arguments used for Proposition 7, it is straightforward to show that var(ŌtM ) ≤ var(OtM ). Follow-
ing the argument preceding the proposition, we have var(ŌtM |∆t−1 = j)/var(OtM ) → 1. By the

24
law of total variance, we have

var(ŌtM ) E{var(ŌtM |∆t−1 )} + var(E{ŌtM |∆t−1 }) E{var(ŌtM |∆t−1 )}

= = → 1, asM → ∞.
var(OtM ) var(OtM ) var(OtM )

Acknowledgements

The authors would like to thank Rob Broekmeulen and Vishal Gaur for sharing the empirical
data. Thanks also go to Yossi Aviv, the Associate Editor, three anonymous referees, and seminar
participants at Duke University, OCSAMSE Conference, and the INFORMS meetings for their
insightful comments and suggestions.

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