SP ECIAL GLOBAL

SUPPLEMENT

Supply Chain Planning for

Demand Uncertainties
By Kyle D. Cattani A crystal ball is not available. But

here are four approaches to planning

S
upply chain planning is difficult because for demand uncertainty that can help
of uncertainty. It would be much easier if
we could predict the future exactly. A per- reduce costs while keeping
fect crystal ball would help us reduce sup-
ply chain costs and keep customers happy. customers happy.
Unfortunately, crystal balls are hard to find.
Fortunately, other slightly-less-effective tools exist. customers turn to competitors. Though diffi-
This article highlights some easily overlooked cult to measure, these undersupply costs can
strategies for managing demand uncertainty. It be significant. If ignored, the problem of man-
describes strategies that improve the forecast aging demand uncertainty can result in major
process and that make the supply chain more impediments to success and profitability.
robust toward demand uncertainties.
While working as a production planning Four Ways to Address Demand Uncertainties
manager at Hewlett-Packard (HP), I developed HP is not alone in its struggle to manage its
an acute awareness of the inventory issues supply chains in the face of demand uncertainty.
resulting from demand uncertainties, especial- Nearly all high-technology companies, as well
ly for products with short life cycles. as companies in other industries, face
The costs can be staggering. similar struggles. How can
Inventory stacks up for companies proactively
slow-moving products, design and operate sup-
while orders for hot ply chains in the pres-
products remain ence of demand
unfilled. Not only is uncertainty?
inventory expen- The most obvi-
sive to carry, but ous approach is to
the costs of write- reduce demand
offs mount quick- uncertainty by
ly when customer improving fore-
tastes change or casting techniques.
technologies become Researchers have
obsolete. In contrast, studied the topic to
too little inventory when exhaustion. Many com-
a product is hot can cause panies have invested in bet-
lost revenue and goodwill as ter forecasting systems,

Kyle D. Cattani is a professor at the Kenan-Flagler Business School, the University of North Carolina at Chapel Hill.

Winter 2000 Supply Chain Management Review Global Supplement 25

 SPECIAL GLOBAL SUPPLEMENT
although frequently with disappointing results.
Instead of investing in better forecasting sys-
tems, an alternative approach is to recognize
that demand uncertainty exists and to develop
strategies for mitigating its effects. In other
words, it is possible to achieve the same results
that you would with a better forecast without
actually addressing the forecast at all. In particu-
lar, it is possible to develop and invest in strate-
gies for dealing with demand uncertainties that
include, and for many situations focus on, prod-
uct and process configurations that make the
supply chain robust to demand uncertainty.
Some possible approaches to planning for
demand uncertainty include the following:
improving the forecast processes, designing
products and processes for supply chain man-
agement, influencing demand, and ensuring
operational basics.
Improving the Forecast Processes
A popular operations textbook1 identifies the
following characteristics of forecasts:
䡲 Forecasts are usually wrong.
䡲 Good forecasts are more than a single
number.
䡲 Forecasts at the aggregate level are more
accurate.
䡲 The longer the forecast horizon, the less
accurate the forecast will be.
These four characteristics of forecasts pro-
vide a rationale for some strategies for planning
for demand uncertainty.
While the first characteristic
may seem obvious, many supply
chains use processes that
An alternative to investing in better forecasting
assume the forecast will come to systems is to recognize that demand uncertainty
pass exactly as specified. Month
after month, forecasters may be exists and to develop strategies for mitigating its effects.
pressed to explain forecast
errors that might have arisen
solely because the underlying demand was ran-
dom. Inventory-control systems such as materi-
als-requirements planning start with the
assumption that demand is known and must be
updated constantly as forecasts evolve. Excessive
demand uncertainty saps these systems of their
effectiveness.
Complicating the story, demand forecasts
do not consistently become more accurate as
they are updated from month to month. In
26 Supply Chain Management Review Global Supplement
numerous examples from industry and under
various theoretical models involving demand
randomness alone, updated forecasts prove to
be less accurate as much as 50 percent of the
time.2 In short, forecasts are educated guesses,
but they remain guesses and cannot fully rein
in uncertainty.
An innovative approach to planning for
uncertainty is based on the second character-
istic and is described as accurate response by
Fisher et al.3 It is especially relevant for fash-
ion goods or products with a short product
life cycle. Using this approach, demand for
ski parkas for Sport Obermeyer is forecast as
a mean and a variance by gathering forecasts
individually from the members of a buying
committee. The parkas with the least consen-
sus from the committee about the demand
forecasts are considered to have the most
uncertain demand. The supply chain is man-
aged by producing first the parkas with the
most consensus about demand forecasts and
waiting as long as possible, in hopes of gath-
ering improved data, to produce the parkas
with hard-to-predict demand. In this
approach, the demand forecast is considered
to be more than a single number and the
early production, which requires the longest
forecast horizon, is reserved for the most pre-
dictable products.
Understanding the other characteristics of
forecasts can be helpful as well. In particular,
product and process changes that don’t direct-
ly affect the forecasts can help the forecasting
process by capitalizing on the third and fourth
characteristics of forecasts. A strategy that has
received increased attention in the last few
years involves designing the products and/or
the processes to be more robust toward
demand uncertainty. The strategy is effective
because it allows forecasts to be made at the
aggregate level and/or closer to the time of the
demand.
Winter 2000
 SPECIAL GLOBAL SUPPLEMENT
Designing for Supply Chain Management
With product proliferation, forecasting can
become futile, unless the product and
process designs facilitate supply chain man-
agement tasks. It is possible to design prod-
ucts and/or processes to take advantage of
statistical economies of scale that arise when
demand is aggregated through pooling and
postponement.
A pooling strategy allows forecasting to occur
at an aggregate level, by aggregating across
geographical regions and/or across a mix of
products. Demand for the aggregate is easier to
predict because variations in demand for the
different regions or products sometimes cancel,
a form of statistical economics of scale.
Demand may be above forecast for one location
or product but below for another so the aggre-
gate forecast may be accurate while
the specific forecasts are not.
One strategy for addressing demand uncer-
tainty is to consider demand as something to be
made into what you want.
Pooling benefits across regions
arise naturally in e-commerce sup-
ply chains as orders can be supplied
from a single—or limited number of—ware-
house(s). Amazon is able to offer a wide selec-
tion of titles and yet requires relatively little
safety stock because of the statistical econom-
ics of scale that arise from pooling.
Pooling benefits across products arise when
the products or processes are designed to be
indifferent to the mix of products. For exam-
ple, a manual printed with multiple languages
allows the same product to be sold in multiple
countries. To the extent that universal prod-
ucts can be developed, the third characteristic
of forecasts can be exploited.
A related strategy is postponement, which
seeks to keep the product and/or process gener-
ic as long as possible, postponing the point of
differentiation. As long as the product and
process are generic, all demand is aggregated,
or pooled. Postponement allows us to capitalize
on the fourth forecast characteristic.
Winter 2000 Supply Chain Management Review Global Supplement 27
The ultimate postponement strategy is to
build, or assemble to order. Dell Computer
Corporation combines an assemble-to-order
strategy with a streamlined supply chain (i.e., a
direct channel) to effectively manage costs in
an industry that has much demand uncertainty.
HP produces printers for both Europe and the
United States.4 The different versions require dif-
ferent power supplies as well as software and
manuals. A pooling strategy would be to produce
the product with a universal power supply that
could be used in either market. If the universal
power supply is more expensive, then it should
be treated as an investment in the forecasting
process and an analysis should occur to deter-
mine whether the investment is warranted. To
complete the strategy, the supply chain might be
designed so that further localization of the print-
ers (software, manuals, power cords, etc.) might
be handled at distribution centers close to the
customer and right
before the product is
shipped to the final cus-
tomer. Thus, in this strat-
egy, the product and
processes in the supply
chain have been designed
to be generic as long as
possible, allowing all
demand to be aggregated. The impact of demand
uncertainty is mitigated through statistical
economies of scale that are potentially as effective
as a direct investment in forecasting processes.
Influencing Demand: Mattel’s Rolling Mix
In addition to strategies that improve the abil-
ity to predict the uncertain demand or the sup-
ply chain’s ability to respond to uncertain
demand, it is also sometimes possible to reduce
the demand uncertainty by influencing demand.
One strategy for addressing demand uncer-
tainty is to consider demand as something to
be made into what you want. Traditional
implementations of this strategy include
advertising, promotions, and off-peak dis-
counts. However, it is possible to find even
more creative ways to influence demand. The
toy industry faces tremendous demand vari-
ability coupled with extreme seasonality. Toy
manufacturers use various strategies to cope
with demand uncertainty in an environment
of short product life cycles, brief but well-
 SPECIAL GLOBAL SUPPLEMENT
defined selling seasons, significant overage
and underage costs, and long global supply
chains. 5 Toy companies seek to stabilize
demand through various strategies that
include licensing agreements that link
demand to movies.
Mattel has a particularly innovative
approach to influencing demand in a strategy
called “rolling mix.” Before 1994, total sales of
Hot Wheels cars were flat,
while demand for individ-
ual styles was hard to pre-
dict. Since then, Mattel has
With product proliferation, forecasting can
incorporated a strategy become futile, unless the product and process
that modified the supply
chain to process Hot designs facilitate supply chain management tasks.
Wheels at an aggregate
level with retailers receiv-
ing a “rolling mix” of cars that Mattel deter-
mined. Each retailer received a 72-car assort-
ment mix that changed by 7 percent to 8
percent every two weeks. The strategy allowed
Mattel to have an organized process for product
rollover while creating urgency for customers
who were buying the individual cars; cus-
tomers could never be sure a car would be
available the next time they shopped. Sales have
steadily increased, while demand uncertainty
at the SKU level has become less of an issue.
Ensuring Operational Basics
Even if investments in improving the fore-
casting process or in making the supply chain
more robust to uncertainty are not viable,
some operational basics exist that can be used
to deal with demand uncertainty for any given
product offering and supply chain. For exam-
ple, the appropriate use of safety stock can
ensure adequate supply in the face of uncer-
tain demand.
A surprising number of companies set safe-
ty stock (that is, inventory in place as a hedge
against uncertainty) by using a number of
“weeks of supply.” Consider two products, each
with an average weekly demand of 1,000 but
with very different demand streams:
Product A: 999; 1,000; 1,000; 998; 1,003;
1,001; 1,000; 998; 1,001; 1,000; ...
Product B: 333; 1,476; 1,507; 742; 544; 1,004;
992; 1,607; 420; 1,375; ...
Using a safety stock of one week (that is,
1,000 units), for example, would be overkill for
28 Supply Chain Management Review Global Supplement
Product A but may be insufficient for Product B
if leadtimes are long. Safety stock should be set
based on the standard deviation of demand dur-
ing the leadtime required to replenish inventory.
A good rule of thumb is to set safety-stock levels
to twice the standard deviation of demand dur-
ing the leadtime.
Other operational basics include ensuring
that leadtimes are as short as possi-
ble and that variances other than
demand, which may be easier to con-
trol, are minimized throughout the
supply chain.
Strategies to reduce demand uncertainty, or
the effects of demand uncertainly, are rarely
implemented for free. Yet they might be cheap,
given the alternatives. They should be consid-
ered as investments that mitigate the effects of
demand uncertainty. Each of these invest-
ments can be considered based on its merits:
some will be accepted, others rejected. But a
thoughtful approach to planning for demand
uncertainty does not require a crystal ball and
can free us from the tyranny of the market.
References
1
Nahmias, Steven, Production and Operations
Analysis, 3rd ed., Irwin, 1997.
2
Cattani, Kyle D. and Warren H. Hausman, “Why
are Forecast Updates Often Disappointing?” forth-
coming in Manufacturing & Service Operations
Management.
3
Fisher, Marshall L., Janice H. Hammond, Walter
R. Obermeyer, and Ananth Raman, “Making Supply
Meet Demand in an Uncertain World,” Harvard
Business Review, May-June 1994.
4
Lee, Hau L. and Edward Feitzinger, “Mass
Customization at Hewlett-Packard: The Power of
Postponement,” Harvard Business Review, January-
February 1997.
5
Johnson, M. Eric, “Lessons in Managing
Demand from the Toy Industry,” Discount
Merchandiser, February 1999.
Winter 2000