Model Answer
0 min readIntroduction
In the realm of business strategy and operations management, organizations frequently encounter situations where future outcomes are uncertain. Effective decision-making under such conditions necessitates a systematic approach to evaluate potential options, considering both the potential payoffs and the likelihood of various scenarios. This question presents a classic scenario involving a company facing a sourcing decision – whether to manufacture in-house, procure locally, or import – amidst fluctuating demand forecasts. Utilizing the principles of Expected Value analysis, we can determine the optimal course of action that maximizes the company’s expected profit.
Calculating Expected Monetary Value (EMV)
The Expected Monetary Value (EMV) is a statistical concept used in decision-making to determine the average outcome that can be expected if a decision is made, considering the probabilities of different scenarios. For each option, we will calculate the EMV as follows:
EMV = (Probability of Demand Increase * Profit with Increased Demand) + (Probability of Demand Decrease * Profit with Decreased Demand) + (Probability of Demand Remaining Constant * Profit with Constant Demand)
Profit Table (Given)
Let's assume the following profit values from the provided table (since the table itself wasn't provided in the prompt, we'll use example values for demonstration. The solution process remains the same regardless of the actual values):
| Option | Demand Increase | Demand Decrease | Demand Constant |
|---|---|---|---|
| Make In-House | 100 | -20 | 50 |
| Buy Locally | 80 | -10 | 40 |
| Import | 120 | -30 | 60 |
Probabilities (Given)
- Probability of Demand Increasing: 0.3
- Probability of Demand Decreasing: 0.45
- Probability of Demand Remaining Constant: 0.25
EMV Calculation for Each Option
1. Make In-House
EMV (Make) = (0.3 * 100) + (0.45 * -20) + (0.25 * 50) = 30 - 9 + 12.5 = 33.5
2. Buy Locally
EMV (Buy) = (0.3 * 80) + (0.45 * -10) + (0.25 * 40) = 24 - 4.5 + 10 = 29.5
3. Import
EMV (Import) = (0.3 * 120) + (0.45 * -30) + (0.25 * 60) = 36 - 13.5 + 15 = 37.5
Decision
Comparing the EMVs calculated for each option:
- EMV (Make) = 33.5
- EMV (Buy) = 29.5
- EMV (Import) = 37.5
The option with the highest EMV is Import, with a value of 37.5. Therefore, the company should choose to import to maximize its expected profit.
Sensitivity Analysis
While the EMV provides a clear recommendation, it's crucial to acknowledge the sensitivity of the results to changes in probabilities or profit estimates. A slight alteration in the probability of demand increasing or decreasing could shift the optimal decision. Therefore, conducting a sensitivity analysis – examining how the EMV changes with varying input values – is a prudent step to assess the robustness of the recommendation.
Conclusion
Based on the provided probabilities and profit estimates, the company should opt for the import option, as it yields the highest expected monetary value of 37.5. This decision aligns with the principles of rational decision-making under uncertainty. However, it is essential to remember that EMV is just one tool, and a comprehensive risk assessment, including sensitivity analysis, should be conducted before finalizing the strategy. Continuous monitoring of market conditions and adjustments to the sourcing strategy may be necessary to maintain optimal profitability.
Answer Length
This is a comprehensive model answer for learning purposes and may exceed the word limit. In the exam, always adhere to the prescribed word count.