Menu Costs and the Bullwhip Effect: Supply Chain Implications of Dynamic Pricing

Abstract

We study the supply chain implications of dynamic pricing. Specifically, we estimate how reducing menu costs — the operational burden of adjusting prices — would affect supply chain stability. We theorize that reducing menu costs would reduce the bullwhip effect by mitigating Lee et al.’s (1997) first bullwhip driver, demand signal processing. We test this prediction by fitting a structural econometric inventory model to data from a large Chinese supermarket. We estimate that removing menu costs would stabilize the supply chain, but not by mitigating Lee et al.’s first bullwhip driver as we had predicted, but by mitigating Lee et al.’s third bullwhip driver, order batching. Specifically, we estimate that removing menu costs would cut the average batch size by 5.0%, which would decrease the average standard deviation of orders by 3.9%.

Keywords: dynamic pricing, menu costs, supply chain, bullwhip effect, empirical operations management, structural estimation

JEL Classification: L11, L23