Decision Bias and Bullwhip Effect in Multiechelon Supply Chains: Risk Preference Models

Abstract

In this article, we investigate whether risk aversion, risk seeking, loss aversion, or prospect theory could explain the ordering decisions in multiechelon supply chains. First, we develop analytical models based on various theories of risk preference to predict order quantities of decision-makers. Then, using controlled laboratory experiments with participants from universities in the U.S. and Australia, we assess if the models predict the ordering behavior of decision-makers in profit-maximization and loss-minimization settings. For the profit-maximization setting, two variations of the beer game are tested, namely, games with purchase cost and games without purchase cost. The results for games with no purchase cost are consistent with loss-averse and risk-averse preferences, while the results for games with purchase cost are partially consistent with risk-seeking preferences. For loss-minimization games, the results are consistent with loss-averse preferences. We examined our results using two different reference points, namely, wealth at the beginning of each period of the game and changes in payoffs between two consecutive periods. Furthermore, we find that, based on the Berlin numeracy test, decision-makers with greater comprehension of risk usually order with lower variation. Finally, we find that decision-makers in a supply chain increase their order quantities when the objective is to maximize profit and reduce their order quantities when the objective is to minimize loss. Therefore, if the profit margins are higher in the supply chain, then the likelihood of a bullwhip effect increases.

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