A company that fails to adequately forecast consumer demand can be stuck with a surplus of product.
Demand risk is a potential hazard that all companies must face during the course of normal operations. Every business depends on forecasting tools to determine how much of a product to produce. Demand risk refers to the idea that these forecasts may not accurately predict the amount of product customers want and are able to buy. The risk for a company is that it produces too much or too little product to meet demand, resulting in lost profits and sales opportunities. Companies continually strive to reduce demand risk through more effective forecasting and forecasting techniques.
Automated inventory control systems often use barcode scanners to help maximize profits while reducing the need for excess inventory.
Companies face two basic types of demand risk when it comes to producing multiple products. First, there is the risk that the company will overestimate demand and make more products than it will be able to sell. This leaves the company stuck with excess inventory that takes up resources and storage space. Eventually, the company may be forced to cut prices to sell these products, which can result in reduced profits or even a net financial loss.
Demand risk management is especially important for retailers who don’t keep a large inventory.
The other important type of demand risk is that the company may underestimate demand. This results in insufficient production levels, resulting in shortages. While it may seem less harmful than a surplus of inventory, it still represents a missed opportunity for the company. Given that economic and financial theories assume that companies try to maximize profits, too low a demand forecast is still recognized as profit loss and inefficiency.
Demand risk should not be confused with supply risk, although the two concepts can have similar effects on a business. Supply risk occurs further up the manufacturer’s supply chain. A supply risk means that a business can face losses due to an inability to ensure adequate supplies, even when demand forecasts are accurate and in line with actual demand.
Companies have two basic options to minimize demand risk. The first is to invest in better forecasting tools that allow the company to forecast demand more accurately. This may involve collecting better data from customers or simply aggregating and analyzing that data more effectively. It also requires reviewing historical trends in demand and being aware of possible future economic changes that could impact demand. For example, a rise in the unemployment rate could be a sign that demand for certain types of goods will soon drop, as people will have less money to spend overall.
Another technique used to reduce demand risk is to change the way products are manufactured. Instead of forecasting demand for some time in the future and then using that data to control production, companies are turning to techniques like just-in-time manufacturing. In this type of manufacturing plan, a company does not start producing a product until it receives an order from the customer. This requires companies to maximize the speed and efficiency of the entire company, from order takers to line workers. It may also not be suitable for all types of products.