Quantifying the Value of Flexibility in Supply Chains for High-Risk Products

Abstract

A model is developed to motivate financially-driven decision makers in companies that make high-risk products to invest in infrastructural changes to support postponement or other forms of flexibility. Data collected at the manufacturer of a high-risk product forms the basis of the effort. The model is used to estimate the magnitude of costs associated with a traditional speculative supply strategy. A customized version of the classic newsvendor model is developed and applied, based on non-normal demand distributions and carrying costs. It is shown that a speculative strategy based on capacity smoothing and production cost minimization can result in excessive overstock, understock, and inventory carrying costs. Specifically, a cost increase of 52% can be expected when production is initiated nine months prior to peak sales. The cost increase is reduced to 24% if the product is produced three months prior to peak sales. The model can help supply chain managers convince corporate executives of the need to redesign the supply chain for speed and flexibility.