Supply and demand uncertainty reduction efforts and cost comparison

Abstract

In industries like health care, consumer goods and agriculture, shortages are widely observed and the consequences can be costly. One of the main drivers of such shortages is the uncertain nature of supply and demand. To reduce uncertainties, sufficient information about supply and demand can be obtained by gathering relevant data (e.g., auditing suppliers and conducting market research). In this paper, we conduct an analysis to examine the impacts of supply uncertainty, demand uncertainty and uncertainty reduction efforts on production quantity and total cost. We show that in the absence of uncertainty reduction efforts, when the financial consequences of shortages are large or when the unit benefit is large, supply uncertainty is more costly than demand uncertainty. In addition, exerting supply uncertainty reduction effort always causes the firm to produce fewer units than exerting demand uncertainty reduction effort. Although supply uncertainty reduction effort delivers a larger degree of improvement to total cost (and hence, is more efficient), reduced supply uncertainty still leads to a higher system cost than does reduced demand uncertainty.