GEOP 4355 Supply Networks: Decision Models Outline Supplier decision models Supply decision models Sources/references used in the preparation of this presentation are listed in the Introduction presentation

Supplier decision models Decision Analysis Theory models Based on the concept of relating multiple alternatives to multiple possible futures. DA = Decision alternatives SN = states of nature = possible futures. Each relation is called a payoff. Assumptions All alternatives are considered All futures are considered

Supplier decision models Alternatives: Supplier A = high quality but low capacity Supplier B = high technology and expensive Supplier C = high capacity and moderate costs Future (SN = States of Nature) Two elements: Competition focus and market trend Market trend: up, down (Up, Down) Competition: focuses on new technology (T) or focuses on efficiency (E) Four SNs: Up/T; Up/E; Down/T; Down/E Market Competition Up T E Down Probability 35% 30% 25% 10%

Supplier decision models The table presents the effect on Market Share given each supplier and state of nature combination. We want the highest market share possible. States of Nature (SNs) Market Competition Up T E Down Supplier A 5% 12% -3% -9% Supplier B 11% 4% 6% Supplier C 1% 3% Alternatives For example. If we select supplier B and the Market is Up, and the competition focuses on Technology our market share will increase by 11%

Supplier decision models What supplier should be selected? Four decision models (called decision theory models). Optimistic Conservative Minimize Maximum Regret (Regret = Error) Expected value

Supplier decision models Optimistic. Select alternative provides the best result across all possible futures. Market Competition Up T E Down Supplier A 5% 12% -3% -9% Supplier B 11% 4% 6% Supplier C 1% 3% The optimistic decision is to select Supplier A

Supplier decision models The conservative decision aims to minimize risk. Selects the best of the worst. Add a column with the worst for each alternative. Market Competition Up T E Down Worst Supplier A 5% 12% -3% -9% Supplier B 11% 4% 6% Supplier C 1% 3%

Supplier decision models The conservative decision aims to minimize risk. Selects the best of the worst. Market Competition Up T E Down Worst Supplier A 5% 12% -3% -9% Supplier B 11% 4% 6% Supplier C 1% 3% The conservative decision is to select Supplier C

Supplier decision models The minimize maximum regret (error) method considers the effect of a wrong selection. It minimizes the maximum error. A “middle” of the road recommendation. Process has 3 steps.

Supplier decisions models Step 1. Add a row with the best payoff for each possible SN Market Competition Up T E Down Supplier A 5% 12% -3% -9% Supplier B 11% 4% 6% Supplier C 1% 3% Best

Supplier decision models Step 2. Create an error (regret) table. Difference between each payoff and the best payoff for that SN. Market Competition Up T E Down Supplier A 5% 12% -3% -9% Supplier B 11% 4% 6% Supplier C 1% 3% Best 6% - - 3% = 9% 11% - 5% = 6% 12% - 12% = 0% Market Competition Up T E Down Supplier A 6% 0% 9% 15% Supplier B 8% Supplier C 10% 2%

Supplier decision models Step 3. Add a column with the maximum value for each alternative (for the error table!). Market Competition Up T E Down Max Error Supplier A 6% 0% 9% 15% Supplier B 8% Supplier C 10% 2%

Supplier decision models The min-max regret solution has the smallest maximum error. Market Competition Up T E Down Max Error Supplier A 6% 0% 9% 15% Supplier B 8% Supplier C 10% 2% The min-max regret decision is to select Supplier B

Supplier decision models Expected value is based on the weighted average of payoffs EV(X) = 𝑦= 𝑎𝑙𝑙 𝑆𝑁 𝑝𝑟𝑜𝑏𝑎𝑏𝑖𝑙𝑖𝑡𝑦 𝑦 ×𝑝𝑎𝑦𝑜𝑓𝑓(𝑦,𝑋) Market Competition Up T E Down Probability 35% 30% 25% 10% Market Competition Up T E Down Supplier A 5% 12% -3% -9% Supplier B 11% 4% 6% Supplier C 1% 3% EV(Supplier A) = 35% × 5% + 30% × 12% + 25% × -3%+ 10% × -9% = 3.7% EV(Supplier B) = 35% ×11% + 30% × 4% + 25% × 6%+ 10% × -3% = 6.25% EV(Supplier C) = 35% × 1% + 30% × 3% + 25% × 4%+ 10% × 6% = 2.85% The EV decision is to select Supplier B

Supplier decision models Thus different models have different recommendations. Optimistic: Supplier A Conservative: Supplier C Min-max regret: Supplier B EV: Supplier B Which model to use depends on the decision maker’s attitude towards risk, and the confidence on any probability estimates available.

Supply decision models A purchasing manager must determine the amount of a key raw material to buy for a new product. This is a made to order raw material with a long lead time, thus additional material cannot be procured in this cycle. They must buy the raw material in lots of 400 and each lot costs $10,000. Raw material not used is lost due to a fast deterioration. Cost to produce and deliver the final product is $10/unit and will be based only on the demand.

Supply decision models Demand for the new product is not known. However the sales department has provided three estimates of how much they will sell and the price customers will be willing to pay for it. Low demand, low prices: Market for about 1,220 at an average of $45/each. P = 60% Medium demand/ medium prices: Market for about 1,530 at an average of $55/each. P = 20% High demand/ high prices: Market for about 2,250 at an average of $60/each. P = 20% States of nature: the demand and prices Decision alternatives: how much raw material to order from the supplier ahead of the production cycle.