1 IES 303 Supplement A: Decision making Week 3 Nov 24, 2005 Objective: - Amazon.com Case discussion: competitive advantage - Understand practical techniques in making operational decisions

IES 303 Engineering Management & Cost Analysis | Dr. Karndee Prichanont, SIIT 2 Case Discussion – Amazon.com  Discussion Question 1 (pg 79) The onset of exponential growth in the development of information technologies has encouraged the birth of many “dot-com” companies. The Internet has enabled these companies to reach customers in very effective ways. Consider Amazon.com, whose web site enjoys millions of hits each day and put customers in touch with more that 18 million services and products. What are Amazon.com’s competitive priorities and what should its operations strategy focus on? In addition to Amazon.com, suggest one other dot-com company or website and discuss about its competitive priorities.

IES 303 Engineering Management & Cost Analysis | Dr. Karndee Prichanont, SIIT 3 Break-Even Analysis  Break-even point The volume at which total revenue = total cost  Break-even analysis can be used to compare processes by finding the volume at which two different processes has equal total costs  Variable costs: Total cost varies directly with volume of output  Fixed costs: Total cost remains constant regardless of changes in levels of output 400 – 300 – 200 – 100 – 0 – Figure A.1 Total annual revenues Total annual costs Patients (Q) Dollars (in thousands) |||| Fixed costs Break-even quantity (2000, 400) (2000, 300) Profits Loss

IES 303 Engineering Management & Cost Analysis | Dr. Karndee Prichanont, SIIT 4 Ex 1: Break-even analysis [Break even volume] The owner of a small manufacturing business has patented a new device for washing dishes and cleaning dirty kitchen sinks. Before trying to commercialize the device and add it to her existing product line, she wants reasonable assurance of success. Variable costs are estimated at $7 per unit produced and sold. Fixed costs are about $56,000 per year. If the unit selling price is set at $25, how many units must be produced and sold to break even? Forecasted sales for the first year are 10,000 units if the price is reduced to $15. With this pricing strategy, what would be the profit in the first year?

IES 303 Engineering Management & Cost Analysis | Dr. Karndee Prichanont, SIIT 5 Ex 2: Break-even analysis [Process selection] (Midterm exam 04) The bakery owner is now deciding on replacing the current oven. There are 2 oven systems from 2 companies in consideration. The first company proposes “Oven A” in which can bake two 8-inch pies simultaneously. In other words, there are 2 pies can be processed in a baking batch. On the other hand, Oven B can bake four 8-inch pies simultaneously. The details of relevant costs and oven capacities are as follows: Oven A Oven B Capacity Number of pies that can be baked simultaneously (number of pie per baking batch) 2 pies4 pies Variable Cost per baking batch  Electricity  Cleaning Staff $6 $10 $8 $10 Fixed Cost per month - Loan payment Depreciation and others $400 $100 $800 $200 Determine the break-even point for the two oven alternatives. Which oven should the owner select and why?

IES 303 Engineering Management & Cost Analysis | Dr. Karndee Prichanont, SIIT 6 Ex 3: Break-even analysis [Multiple process selection] Nano Tech is ready to begin production of its exciting new technology. The company is evaluating three methods of productions A: a small production facility with older equipment B: a larger production facility that is more automated, and C: subcontracting to an electronics manufacturer in Singapore Fixed CostVariable Cost ABCABC $ 200,000 $ 600,000 $ 0 $40 $20 $60 Determine for what level of demand each production process should be chosen.

IES 303 Engineering Management & Cost Analysis | Dr. Karndee Prichanont, SIIT 7 Group Discussion: Real life example of break-even analysis  Suggest the scenario  What information do you need to perform this analysis correctly?  How can you obtain those information

IES 303 Engineering Management & Cost Analysis | Dr. Karndee Prichanont, SIIT 8 Decision Theory  General approach to decision making when the outcomes associated with alternatives are often in doubt by following these processes 1. List the feasible alternatives 2. List the events (chance events or state of nature) 3. Calculate the payoff for each alternative in each event 4. Estimate the likelihood or probability of each events, using past data, executive opinion, or forecasting method 5. Select a decision rule to evaluate the alternatives Ex: Decision on process capacity; location; inventory Assume finite number of alternatives Events that have impact on outcome of choice but are not under manager’s control Ex: total profit or total cost Ex: minimize cost; maximize profit; maximize productivity Ex: 40% chance for economic growth’ 20% chance for stable; 40% for decline

IES 303 Engineering Management & Cost Analysis | Dr. Karndee Prichanont, SIIT 9 Example A.5 AlternativeLowHigh Small facility Large facility Do nothing00 Possible Future Demand Under certainty: If future demand will be low – Choose the small facility. Decisions Under Certainty Simplest method but unlikely situation Events Base line Payoff – in this example is profit If future demand will be high – Choose the large facility.

IES 303 Engineering Management & Cost Analysis | Dr. Karndee Prichanont, SIIT 10 Decision Under Risk  Lists of events with estimated probability  Use “expected value” decision rule AlternativeLowHigh Small facility Large facility Do nothing00 Possible Future Demand P low demand = 0.4 P high demand = 0.6 Example A.7 From experiment, past data, business trend -Weighing each payoff with its probability and then add them up - Choose the best expected value Small: 0.4(200) + 0.6(270) = 242 Large: 0.4(160) + 0.6(800) = 544 Choose large facility

IES 303 Engineering Management & Cost Analysis | Dr. Karndee Prichanont, SIIT 11 Decision Trees  A schematic model of alternatives available to the decision maker, along with their possible consequences  Used in product planning, process analysis, process capacity, and location  Square nodes: decision points  Circle nodes: state of nature (event)  Branch: events Select the alternative with the best expected payoff Calculate the event’s expected payoff Σ E i [P(E i )]

IES 303 Engineering Management & Cost Analysis | Dr. Karndee Prichanont, SIIT 12 Decision Trees = Event node = Decision node E i = Event i P(E i ) = Probability of event i 1st decision Possible 2nd decision Payoff 1 Payoff 2 Payoff 3 Alternative 3 Alternative 4 Alternative 5 Payoff 1 Payoff 2 Payoff 3 E 1 [P(E 1 )] E 2 [P(E 2 )] E 3 [P(E 3 )] E 2 [P(E 2 )] E 3 [P(E 3 )] E 1 [P(E 1 )] Alternative 1 Alternative 2 Payoff 1 Payoff 2 12 Figure A.5 Read the problem from left  right Solve the problem from right  left Calculate the event’s expected payoff Σ E i [P(E i )] Select the alternative with the best expected payoff

IES 303 Engineering Management & Cost Analysis | Dr. Karndee Prichanont, SIIT 13 Example: Southern Textile Company adapted from Russell & Taylor III (2003) See detail in additional handout Warehouse (-$600,000) Sell land Market growth 0.70 Market growth Sell land Expand (-$800,000) Purchase Land (-$200,000) Expand (-$800,000) No market growth $225,000 Market growth $2,000,000 $3,000,000 $700,000 $2,300,000 $1,000,000 $210,000 No market growth No market growth 0.30 No market growth (3 years, $0 payoff) Market growth (3 years, $0 payoff)

IES 303 Engineering Management & Cost Analysis | Dr. Karndee Prichanont, SIIT 14 Next week  Read Case: Jose's Authentic Mexican Restaurant; pg166  And prepare to discuss the posted questions  Read chapter 4-5