Volatility has always played a crucial role in supply chains, hence in supply chain management. Maybe there is a sudden surge in demand for bottled water because a hurricane is approaching – or perhaps there is a sudden drop in demand for LCD screens because of newer technologies. Inchainge believes it is important that companies make conscious choices about how to deal with volatility and make that a part of how they manage their business.
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What is the definition of supply chain volatility?
Supply chain volatility is defined as unplanned variation of upstream and downstream material flows resulting in a mismatch of supply and demand at the focal firm. Managing supply chain volatility is often identified as one of the major challenges of modern supply chain management, as even the most accurate calculations cannot prepare you for the completely unforeseen.
When volatility exists, processes across the supply chain are being challenged. Failure to adapt can lead to demand being unmet – and unmet demand translates into lost sales, lost profit, lost customers and eventually loss in market share, especially when competition surfaces.
What causes volatility?
Volatility is a reality in many supply chains. Not only are retailers serving end consumers facing volatile demand. This volatility is being passed on to manufacturers and distributors at different stages of the industry value chains. Many factors contribute including:
- Increased customer choices,
- Product customization
- Rapid technological improvements
- Global competition
- Promotion policies
- Supply chain bullwhips.
How is Volatility Calculated?
Decades of research have been dedicated to calculating supply chain volatility. Calculating is often done by using complex systems and formulas, that rely not only on the company’s own numbers, but also factor in external influences like e.g. weather. Here, several forms of volatility have to be accounted for and calculated individually:
- Organizational volatility: occurs within the company itself
- Behavioral volatility: changes in demand
- Market-related volatility: changes in the market
- Institutional volatility: changes in regulations
- Environmental volatility: changes in the environment, such as natural catastrophes
Why managing volatility is important
Managing volatility in a cost-effective manner can lead to significant benefits for a company from lower supply chain costs to improved customer service levels. Managing volatility effectively can be a huge competitive differentiator for companies, for example by being prepared for a sudden surge in demand by having the right amount of inventory stored. Competitors that do not have enough inventory to deal with the increase in demand will have to face unsatisfied customers and lost revenue.
Managing volatility efficiently in a demand driven environment is a significant challenge and requires companies to employ robust supply chain tactics. Often, the focus tends to be on one area of the supply chain (e.g. inventory optimization). Without the consideration of all aspects of the supply chain, this may result in sub-optimal results. A holistic system approach is more effective. This holistic approach contains:
- Complexity reduction: Complexity has increased due to a growing number of products, channels, customers, and geographies – managing this complexity is crucial in addressing potential volatilities.
- Lead time reduction: Lead time is the amount of time that passes from the start of a process until its conclusion. The less time passes between start and finish, the smaller are the chances for something to go wrong.
- Cycle time reduction: Having shorter cycle times allows information to flow more quickly throughout the whole organization, enabling businesses to react to changes swiftly.
- Postponement: While there are numerous postponement strategies, one strategy is to store inventory at sub-assembly level and only assemble the product after an order has been placed. This allows for more flexibility.
- Buffer management: This can include inventory buffers. If you have sufficient stock, volatility will not damage your supply chain as immediately.
- Visibility and collaboration: Collaborating with customers, suppliers, and partners allows for more open and clear communication and increased flexibility should demand suddenly change.
The right mix of the above strategies depend on the specific context of a company.
Want to know more? Experience volatility in our business simulation games!
In Inchainge’s business games, managing volatility is an important recurring topic. It needs a good understanding of the system and its trade-offs. And a cross functional approach. All departments can help to reduce and/or to manage the volatilities in the goods flow and financial flow. By experiencing the cause and effect relations in the simulations a deep understanding is created. Do you want to know more? Have a look at our business simulation games.
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