Posted by: Matthew Molinari | May 22, 2012

If You Supply It, Will They Demand It?

One of the most important aspects of a business is determining how much of your product you should produce to keep up with customer demand. There are so many different things that can influence the demand levels which in turn can dramatically change how much supply you should produce. On the one hand, if you produce items and demand suddenly drops, you’ll be stuck with an inventory surplus; but you may also find that your demand forecasting was off and you ended up not producing enough which created a shortage in the market.

Neither situation is ideal obviously because either you are stuck holding onto inventory you can’t sell which costs you money or you can’t meet demand which means you are leaving sales revenue on the table.

Take a look at the simple graphic below as it details the basic thought process you should follow when trying to determine the levels you need to produce to keep up with demand. Point “A” represents the natural equilibrium when the demand from customers matches exactly with the supply that is being produced. This is the ideal situation but more often than not you will not be able to hit this point exactly.

If you were, you would never have excess inventory at the end of the month, you would not need any safety stock and a customer would never have to wait for their item to ship because it is currently out of stock. That point is reached in a perfect world and quite frankly, you’ll never get to that point – not in a million years.  However, the idea is to get as close as possible to decrease costs and increase sales.

The spot located within the triangle created by points A,B,Q is the cost associated with producing the item (all your expenses) and the area labeled as Producer Surplus is the revenue earned by selling above the costs incurred to produce.

The main goal is to determine a price that maximizes your surplus without creating a decrease in demand from pricing customers out of the market or pushing them to a competitor. None of this is simple, if it were everyone would be an economics professor. That doesn’t mean that you can’t take a hard look at your supply chain to try to determine some of these factors and how you can maximize your outputs while creating the largest profit.

How does your company look to improve the supply and demand issues it faces?

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