From boom to bust: an operational perspective of demand bubbles

When demand exceeds supply, retailers hedge against shortages by placing multiple orders with multiple suppliers, exceeding customer demand and leading to excess capacity, excess inventory, low capacity utilization and financial losses. This paper provides a comprehensive causal loop diagram and a formal mathematical model of a subset of supplier–retailer relationships. We obtain closed‐form solutions when supplier capacity is fixed, and analyze simulation dynamics when it is variable. Sensitivity analyses provide a deeper understanding of parameters that contribute to demand bubbles and insight on improvement policies. For instance, the ability of the supplier to build capacity quickly can reduce bubble size. The time it takes retailers to perceive and react to supply availability is an important lever in controlling demand bubbles. When retailers learn of shortages with a delay, their reaction is also delayed, which stabilizes the supply chain.