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...Another important hedge against demand uncertainty doesn't involve changing any production processes at all, but understanding where to set your production and inventory targets. In your supply chain, how much revenue do you lose if you underestimate demand and have a stockout situation? What about overstock - what is the cost of producing too much and having to write off inventory or sell it at a discount? The Newsvendor Model, a popular strategy for dealing with this remaining uncertainty, allows us to understand the expected cost of having too much or too little inventory. It simulates running many iterations of a particular inventory strategy (where each iteration is subject to fluctuating demand) and tells us what amount of inventory will, on average, give us the lowest cost in terms of missed revenue versus discounted sales....

...Now consider a product that we manufacture and then sell to customers. The demand uncertainty for our sample product is shown by the following bell-shaped curve, in which we expect to sell 100 units, but there is a certain probability that we will sell more or less than that number:

Now suppose we sell this product for $35/unit during the regular selling season, while our marginal manufacturing cost is $20/unit.⁸ At the end of the selling season, assume any units left over can be sold at a markdown price of $15/unit. Given these economics, is it wise to target the middle of the bell-shaped curve (i.e., the point forecast of 100 units) as the ideal inventory level? Suppose we say that's not the right answer - would you go above or below 100?...