Demand Risk The Power of Flexibility via Postponement

Postponement, or delayed differentiation, is an increasingly popular strategy for managing demand risk. By postponing the point of differentiation, a firm has 

To simplify our exposition, we restrict attention to this particular type of system configurations, which Jordan and Graves have referred to as chain configurations. We note that our usage of / for the level of flexibility corresponds to the parameter h in Jordan and Graves (1995). The reader is referred to Jordan and Graves (1995) for an in-depth analysis of a model in which different plants are capable of producing different numbers of products. 

Let Di(t) denote the demand for product / to be realized t periods in the future, where i = 1, 2. Let the demand follow a Random Walk (RW) model e.g., A(t) =/ri + ii + i2+. .. + i,t-i + it, where i= 1, 2, t= 1,. .., T, and the it are independently and identically distributed normal random variables with mean 0 and standard deviation a. Lee and Whang (1998) proved the following result V f) is increasing and concave in f. Therefore, significant benefits associated with postponement can be obtained even if the point of differentiation is placed at an early stage of the production process, e.g., when/ is small. Again, we find that limited flexibility delivers much of the benefits. 

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