Hedging weather risk and coordinating supply chains

• Published date: 01 November 2018
• Author: Xavier Brusset,Jean‐Louis Bertrand
• DOI: http://doi.org/10.1016/j.jom.2018.10.002
• Date: 01 November 2018

Contents lists available at ScienceDirect

Journal of Operations Management

journal homepage: www.elsevier.com/locate/jom

Hedging weather risk and coordinating supply chains

Xavier Brusset

a,∗

, Jean-Louis Bertrand

b

a

SKEMA Business School, Universite Côte d'Azur, Lille, France

b

ESSCA School of Management, Angers, France

ARTICLE INFO

Accepted by: Joan Ernst van Aken

Keywords:

Design science

Weather sensitivity

Risk management

Supply chain

Coordination

Weather hedge

ABSTRACT

The sales of many products can be influenced by weather conditions, positively or negatively. For the manu-

facturers in question, one of their entrepreneurial risks is to incur lower than expected sales because of adverse

weather conditions. The variability of weather conditions is expected to continue 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 others. This paper presents an approach to transfer weather risks to risk takers and

reduce sales volatility using weather index-based financial instruments. 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 man-

ufacturing automotive replacement parts, a clothing company and a company producing of sunscreen products.

We demonstrate its efficiency in reducing cash-flow uncertainty and potential losses caused by adverse weather,

and in influencing sales to the next tier.

1. Introduction

Weather plays an important role, directly or indirectly, in de-

termining both the demand and sales for many products (Chen and

Yano, 2010;Lazo et al., 2011). The fact that temperature, rainfall and

other weather variables have direct effects on various economic series is

not new (Steele, 1951;Granger, 1978). In retail, weather determines

the decisions of consumers as to what they buy, in what quantity, when

and even where (Agnew and Thornes, 1995).

Weather conditions do not only influence store traffic. They also

change consumers’ purchasing decisions about the product and the

amount of product they buy (Parsons, 2001;Kirk, 2005). Even as retail

is shifting from brick and mortar stores to online shopping, the weather

continues to exert its influence on consumer behavior (Starr-McCluer,

2000;Lazo et al., 2011;Steinker et al., 2017;WeatherUnlocked, 2014).

Although many studies have been done to analyze the direct impact

of weather on retailers’ sales (Starr-McCluer, 2000;Lazo et al., 2011),

no similar research analyzes the indirect influence of the weather in the

case of manufacturers standing one or more echelons away from the

end-user market. Additionally, the risk of adverse weather conditions

has increased over time and is expected to continue to do so because of

climate change, not because of higher temperatures or increased rain-

fall, but because of a higher variability (WMO, 2013;IPCC, 2014).

Within the framework of Design Science Research (van Aken et al.,

2016), we apply the so-called CIMO-logic (Denyer et al., 2008) to de-

velop a new body of prescriptive knowledge for management science.

The problem-in-Context (the C in CIMO) is the sensitivity of manu-

facturers’ sales to the erratic behavior of the weather. In the event of

adverse weather conditions over an extended period of time, manu-

facturers may suffer a loss of sales as replenishment orders drop in the

current season, and carried-over inventories and precautionary beha-

viors lead to lower orders for the following season. Manufacturers can

choose not to do anything about this entrepreneurial risk and bear the

financial consequences, or transfer it partly or wholly to others. This

paper presents an approach to transfer this type of entrepreneurial risk

to one or more risk takers using weather index-based financial instru-

ments in the form of insurance or option contracts that compensate for

losses due to adverse weather.

This article proposes an Intervention based on the design of a be-

spoke financial instrument that allows each manufacturer exposed to

weather risks to transfer this risk and mitigate her

1

exposure to weather

variability. We develop a Design proposition which proceeds in several

steps: We identify the most significant weather variables, evaluate the

sensitivity of a manufacturer's sales to a change in those significant

weather variables, and estimate the potential losses based on historical

observed weather conditions. Knowledge of the significant weather

https://doi.org/10.1016/j.jom.2018.10.002

Received 14 May 2017; Received in revised form 16 October 2018; Accepted 17 October 2018

∗

Corresponding author.

E-mail addresses: xavier.brusset@skema.edu (X. Brusset), jean-louis.bertrand@essca.fr (J.-L. Bertrand).

1

Following convention, we refer to the upper echelon in a supply chain dyad as a ‘she’ and to the downstream partner as a ‘he’.

Journal of Operations Management 64 (2018) 41–52

Available online 17 December 2018

0272-6963/ © 2018 Elsevier B.V. All rights reserved.

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