What Is Demand Uncertainty?
Demand uncertainty occurs during times when a business or an industry is unable to accurately predict consumer demand for its products or services. This can cause a number of problems for the business, especially in managing orders and stocking levels, with effects magnifying through the supply chain
The causes of demand uncertainty may result from inherent qualities of the business and its customer base, or from external factors. Seasonal fluctuations, for example, are a type of inherent uncertainty, although industries that experience seasonal fluctuations can often use records from past years to anticipate and estimate the current seasonal shift. Businesses with a very innovative product or service will face a great deal of demand uncertainty, simply because their uniqueness means that there is no track record from which to draw conclusions about demand.
Customer preference, however, can shift rapidly and without warning, sometimes because a new trend or fashion emerges. Consumer demand can shift due to technological advances that make familiar products obsolete; demand can also be diluted by the entry of new competitors into the industry. The state of the economy affects consumer demand, with a strong economy leading to increased demand while a weak economy depresses it. Natural or human-caused disasters and times of political unrest are examples of external factors that contribute to both demand and supply uncertainty.
When demand is uncertain, it’s difficult to determine the right quantity of supplies and goods to order for the next sales cycle. A business that anticipates a normal or high level of sales, only to see the demand drop, will have leftover goods that must be stored, returned or discarded. Each of these scenarios leads to extra costs. If demand increases, however, and the company does not have a sufficient supply of goods to sell, the result is dissatisfied customers, some of whom may purchase from a competitor that does have a supply of the desired goods. Some customers may never return to the original seller, resulting in loss of business for that company.
Problems caused by demand uncertainty aren’t limited to stocking of goods. When demand fluctuates, it becomes difficult to achieve appropriate staffing levels, especially for retail companies. Other areas of expenditure, such as equipment purchases or facility development, may also be affected.
Demand uncertainty at the retail customer level has a way of becoming magnified down the supply chain. When wholesalers notice that the retail outlets they serve have cut back or increased their orders, the wholesalers are likely to cut back or increase purchases from manufacturers by a greater percentage, in order to hedge their bets. Manufacturers, in turn, may hedge their bets even further on their orders from suppliers of raw materials. As result, raw materials suppliers may end up with a six month or greater backlog, on a supply chain that began with retailers ordering an extra supply of only one month. This is known as the bullwhip effect, because it charts in a way that resembles the action of a bullwhip when the “handle” is moved slightly while the “tail” swings in wider and wider fluctuations.
Certain industries are more vulnerable to demand uncertainty than others. A study reported in Harvard Business Review compared industries on two scales, demand uncertainty and technological uncertainty. Ranked high in demand uncertainty, while low in technological uncertainty, were consumer-level industries, such as as restaurants and hotels, healthcare services, and retail. However, materials suppliers such as coal, mining and steelworks ranked even higher in demand uncertainty. Furthermore, some industries face high demand uncertainty, along with high technological uncertainty. These industries include transportation, computers, software, medical equipment and pharmaceuticals. The study authors recommend close monitoring of consumer demand, along with better communication along the supply chain, as a way to deal with demand uncertainty. Industries that experience high technological and high demand uncertainty should also pay close attention to innovation management.