Hedging weather risk and coordinating supply chains

Hedging weather risk and coordinating supply chains

The weather affects sales of most products

The sales of many products can be influenced by weather conditions, positively or negatively. The risk for manufacturers is to incur lower than expected sales because of adverse weather conditions. Moreover, the variability of weather conditions is expected to rise because of climate change. Manufacturers can choose to do nothing and suffer the financial consequences, or transfer the weather risk partly or wholly to risk takers such as insurance companies. This paper presents a methodology to transfer weather risks to risk takers and reduce sales volatility. In our approach, the risk of adverse weather conditions is calculated on the basis of adverse conditions observed in the past. We do not use forecasts of weather conditions. We illustrate our action design with case studies of three companies: a company manufacturing automotive replacement parts, a clothing company and a company producing sunscreen products. 

Cleaning sales of the weather’s impact. Understanding the link between weather and sales yields considerable value to manufacturers. They can better measure ex post the contribution of the weather to sales. Marketing, financial or sales reports benefit from increased objectivity, and managerial effectiveness clearly emerges as a result.

Research is now available to reduce the impact of adverse weather

We apply the Design Science Research framework which consists in a four-step research approach of true life organisation problems named CIMO-logic. In the first step, the context of the organisation is described (the C in CIMO-logic). The research leads to an intervention (the I) in the way the organisation works so as to correct the problem.  The results are then modelled as a tool which will be applicable in more instances of similar situations (the M). The outcome (the O) of the application of the mechanism is observed and compared to the state of things ex ante so as to show the result of the mechanism.

The Intervention provides weather sensitive manufacturers with an innovative and effective Mechanism to understand and mitigate the impact of adverse weather on sales with bespoke weather index-based financial cover.

Automotive parts, apparel and skin care products all benefit

We examine the case of three manufacturers who experienced losses caused by adverse weather. They represent a cross-section of the types of weather risks to which manufacturers are exposed. In each case, the manufacturer sells through different channels and has limited access to end-consumer sales data.

In all the cases given as examples, it was possible to identify the most significant weather variables, determine how these variables affect manufacturers’ sales, and construct efficient index-based protection that compensates manufacturers for sales losses caused by adverse weather. Manufacturers were able to significantly reduce their exposure to adverse weather, both in terms of the size of the potential losses and the uncertainty of sales cash-flows (the Outcome). Moreover, sharing the benefits of the proposed Intervention with retailers leads to enhanced coordination and customer service.

From a cope and avoid to a prepare and manage attitude towards weather risks

Our research breaks new grounds for supply chain and operations managers to apply instruments such as futures, swaps, or options which have been used traditionally in the energy and agricultural sectors by financial managers to cover the climate effects. For insurance companies, new business opportunities arise as they can now diversify their weather risk portfolios away from the energy and agriculture sectors.

Hedging weather risk and coordinating supply chains, Xavier Brusset Jean-Louis Bertrand 2018 Journal of Operations Management Volume 64  doi.org/10.1016/j.jom.2018.10.002

Xavier BrussetProfessor of Supply Chain Management, PRISM Research Centre, SKEMA Business School - University Côte d'Azur, France

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Jean-Louis BertrandProfessor of Finance, ESSCA

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