Dynamic Strategic Planning Casablanca, Morocco March 23-28, 2009 Course Overview

General Information l Instructor: Richard Roth l Course Website then click on Morocco l Text: Applied Systems Dynamics by R. deNeufville, Chapters 13 – 20, but focused on (chapters are available on the website) l Based on MIT course 3.57: Dynamic Strategic Planning & research at the MIT Materials Systems Laboratory

Class Structure l Each Day Will Have Three Parts –Lecture –Problem Session –Working Session l Lectures will review & introduce new topics l Problem sessions will reinforce topics through selected problems l Working sessions will focus on development of the case assignment

Course Outline/Schedule DateLecturesProblem Session Working Session Monday March 23 Course Introduction Impact of Uncertainty Business Case Requirements Group Business Case Selection Tuesday March 24 Process Based Cost ModelingReview of Business Case Requirements Develop Cost Models for Business Case Wednesday March 25 Dynamic Strategic Planning/ Decision Trees Decision Tree Problems Market Analysis for Business Case Thursday March 26 Probability Assessment/ Bayes Theorem Bayes Theorem & Multi-period Decision Problems Plant Sizes & Prices for Business Case Friday March 27 Value of Information Perfect & Sample Information Information Problems Finalize Business Case Analysis Saturday March 28 Presentations of Business Cases

Course Requirements & Grading l Business Case Group Presentation (30%) –Presentation in class on Saturday describing the recommended business strategy l Individual Final Report (30%) –Students will turn in an INDIVIDUAL final report describing the groups business case analysis and their recommendations l Homework (20%) –Each working session will have a short assignment addressing the business case topic for that day. Each student must turn in their own homework assignment, although the answers can be developed as a group l Class Participation (20%) –During General Class Sessions –Group Participation

Introduction to Uncertainty

Why is Uncertainty Important? l Uncertainty EXISTS!!! –No amount of analysis can eliminate the fact that future events are uncertain. –But uncertainty can be understood and prepared for. l Uncertainty Impacts Results –Outcomes of strategic decisions is strongly influenced by future events which CANNOT be fully predicted –Therefore, methods that incorporate uncertainty into the decision making process yield better results l Uncertainty Comes in Many Forms –Market Uncertainty –Cost Uncertainty –Technological Uncertainty –Etc.

Examples of Uncertainty: Predicting Automotive Production l Predictions of automobile production during the product planning stage are highly inaccurate l Predictions can vary by as much as 200% from the actual production l This can have a major impact on: –Costs –Designs –Profitability

Impact of Inaccurate Forecasts/Predictions l Poor predictions lead to excess capacity –More investment made than was required l Poor predictions lead to poor capacity utilization –Under utilized equipment leads to high costs

Other Examples of Uncertainty: Oil Prices

More Predictions for Oil Prices

Impact of Uncertainty on Costs l Uncertainty in underlying factor prices –Raw material costs –Energy costs –Etc. l Technological/Process Uncertainty –Uncertainty production conditions Process cycle times Downtimes Etc. l Market Uncertainties –Uncertain demand –Uncertain production levels

Market Uncertainty & The Impact on Costs l Structural reasons why market uncertainty impact costs –Economies of Scale –Economies of Scope –Capacity Utilization Issues –Etc. l Fixed & variable costs behave differently under market uncertainty l Dedicated vs. non-dedicated equipment behave differently under market uncertainty

Fixed vs. Variable Costs l Variable Costs –Raw Materials –Labor –Energy –Etc. l Generally variable costs scale with the number of parts to be produced l Market uncertainty has no impact on unit costs –Each unit requires the same level of variable costs regardless of the number produced l Fixed Costs –Equipment Investments –Tooling Investments –Building Investments l Generally fixed costs involve one time spending that does not change with the number of parts to be produced l Market uncertainty has a strong effect on fixed cost portion of unit costs –Investments are spread across the number of products produced

Economies of Scale Variable Costs Fixed Costs

Low Fixed Cost Lead to Reduced Impact of Production Volume Variable Costs Fixed Costs

Dedicated vs. Non-Dedicated Equipment l Dedicated Equipment: –Equipment that can only be used to produce a single product –For example: Tooling, Part specific production systems,… l Non-Dedicated Equipment: –Equipment which can be used to make multiple products –Usually used in combination with part specific tooling l Market uncertainty has a large impact on products that use a lot of dedicated equipment –Low market demand leads to low production and therefore low capacity utilization

Capacity Utilization Impacts Unit Costs Full Utilization Overtime

Impact of Market Conditions on Unit Costs l Market size affects unit cost –Due to economies of scale –Strongest impact on products/processes with high levels of fixed costs l Market uncertainty affects unit cost –Due to issues of capacity utilization –Strongest impact on products/process with high levels of dedicated investments

Course Assignment: Develop A Business Case for a New Business Venture with Explicit Consideration of Market Uncertainty & Its Impact on Production Costs

Case: Business Plan Development l For a new business venture of your choosing –Determine optimal business size –Price of product l Practical limitations for this course: –Business size/price fixed for the first period (5 years) –After first period opportunity to expand, stay same, close the business –Business must have significant fixed costs (otherwise the decision about size is not very relevant) –Demand for the product must show some price sensitivity (otherwise always ask for a high price )

Business/Case Requirements l You MUST select a business with high levels of fixed costs which are dedicated to the production of your product. l You MUST select a product where the market/demand is highly sensitive to the price of the product. This will ensure that market uncertainty affects unit costs This will ensure that market uncertainty cannot be easily compensated for simply by raising prices

Business Case Tools l Cost Modeling –Essential to understand costs of the product as a function of the business size (plant planned capacity) and actual production volume (market size) l Decision Trees (tree04_v3.xls) –Tool to investigate the choices of plant sizes & product prices –Tree04_v3.xls is provided as a tool for this analysis (see website)

Cost Modeling l Cost model must have the following features: –Production capacity (representing plant size) –Actual production volume (amount actually produced in response to the market demand) –Unit cost of the product l Model development –Based on information about the product manufacturing –Use of costskel.xls or simple_cost.xls as a template if necessary (see website)

Decision Tree l Tree04_v3.xls provided for case analysis –Considers 3 possible plant sizes and 2 possible prices –Considers decisions over two five year periods l Development of alternate tree structures possible using Tree_plan, although students are strongly encouraged to use Tree04_v3 due to time constraints of the course