Supply Chain Analytics

Dr. A. Ramesh
Department of Management Studies
Indian Institute of Technology Roorkee
Roorkee – 247 667

Dr. A. Ramesh
 Steps in Decision-making
1. Identification of various possible outcomes,
called states of nature or events(Ei).
2. Identification of all courses of action, or
acts(Aj).
3. Determination of pay-off function (Vij)which
describes the consequences resulting from
different combinations of acts and events.
4. Choosing from among alternatives on the
basis of some criterion.
Dr. A. Ramesh
 Problem
• A bookstore sells a particular book of tax laws for
Rs.100. It purchases the book for Rs.80 per copy. Since
some of the tax laws change every year, the copies
unsold at the end of a year become outdated and can be
disposed of for Rs.30 each.
• According to past experience, the annual demand for
this book is between 18 and 23 copies.
• Assuming that the order for this book can be placed
only once during the year, the problem before the
store’s manager is to decide how many copies of the
book should be purchased for the next year.

Dr. A. Ramesh
Events
• E1 :18 copies are demanded
• E2 :19 copies are demanded
• E3 :20 copies are demanded
• E4 :21 copies are demanded
• E5 :22 copies are demanded
• E6 :23 copies are demanded
Actions
• A1 : buy 18 copies
• A2 : buy 19 copies
• A3 : buy 20 copies
• A4 : buy 21 copies
• A5 : buy 22 copies
• A6 : buy 23 copies

Dr. A. Ramesh
 Pay-off and Regret Tables
• D = Demand
• Q = quantity decided to be purchased
• P = profit
• When D ≥ Q,
P = 100Q-80Q = 20Q
• When D < Q,
P = 100 D + (Q-D) 30–80 Q

Dr. A. Ramesh
 Pay-off Matrix
Event Ei Act Aj

A1:18 A2:19 A3:20 A4:21 A5:22 A6:23

E 1:18 360 310 260 210 160 110

E 2:19 360 380 330 280 230 180

E 3:20 360 380 400 350 300 250

E 4:21 360 380 400 420 370 320

E 5:22 360 380 400 420 440 390

E 6:23 360 380 400 420 440 460

Dr. A. Ramesh
 Opportunity loss or Regret Matrix
Event Ei Act Aj

A1:18 A2:19 A3:20 A4:21 A5:22 A6:23

E 1:18 0 50 100 150 200 250

E 2:19 20 0 50 100 150 200

E 3:20 40 20 0 50 100 150

E 4:21 60 40 20 0 50 100

E 5:22 80 60 40 20 0 50

E 6:23 100 80 60 40 20 0
Dr. A. Ramesh
 Decision Rules
• Decision under uncertainty
– Laplace Principle
– Maximin or minimax principle
– Maximax or minimin principle
– Hurwicz principle
– Savage principle

Dr. A. Ramesh
 Laplace Principle
Event Ei Act Aj
A1:18 A2:19 A3:20 A4:21 A5:22 A6:23
E 1:18 360 310 260 210 160 110
E 2:19 360 380 330 280 230 180
E 3:20 360 380 400 350 300 250
E 4:21 360 380 400 420 370 320
E 5:22 360 380 400 420 440 390
E 6:23 360 380 400 420 440 460
Mean Rs.360 Rs.368.3 Rs.365 Rs.350 Rs.323.3 Rs.285
Value of (Highest Avg)
Pay-of
Dr. A. Ramesh
 Maximin or Minimax Principle

• Pessimistic Decision Makers

• Conservative Approach
• Minimum pay-off resulting from adoption of
various strategies are considered and among
these values the maximum one is selected

Dr. A. Ramesh
 Maximin Principle
Event Ei Act Aj
A1:18 A2:19 A3:20 A4:21 A5:22 A6:23
E 1:18 360 310 260 210 160 110
E 2:19 360 380 330 280 230 180
E 3:20 360 380 400 350 300 250
E 4:21 360 380 400 420 370 320
E 5:22 360 380 400 420 440 390
E 6:23 360 380 400 420 440 460
Minimum 360 310 260 210 160 110
Value
Maximu
m Value
Dr. A. Ramesh
 Maximax or minimin principle
• Optimists’ principle of choice
• Optimist desire a chance for the maximum
pay-off in the decision matrix.

Dr. A. Ramesh
 Maximax
Event Ei Act Aj
A1:18 A2:19 A3:20 A4:21 A5:22 A6:23
E 1:18 360 310 260 210 160 110
E 2:19 360 380 330 280 230 180
E 3:20 360 380 400 350 300 250
E 4:21 360 380 400 420 370 320
E 5:22 360 380 400 420 440 390
E 6:23 360 380 400 420 440 460
Maximu 360 380 400 420 440 460
m Value
Maximu
m Value
Dr. A. Ramesh
 Hurwicz Principle
• Decision-maker’s view may fall somewhere
between the extreme pessimism of the
maximin principle and the extreme optimism
of the maximax principle.
• α  (0 to 1)
• 0 extreme pessimism
• 1  extreme optimism
• Hurwicz Criterian Value = Max. Value x α + Min. Value x (1- α)

Dr. A. Ramesh
 Hurwicz Principle (α = 0.6)
Event Ei Act Aj
A1:18 A2:19 A3:20 A4:21 A5:22 A6:23
E 1:18 360 310 260 210 160 110
E 2:19 360 380 330 280 230 180
E 3:20 360 380 400 350 300 250
E 4:21 360 380 400 420 370 320
E 5:22 360 380 400 420 440 390
E 6:23 360 380 400 420 440 460
Max. Value 360 380 400 420 440 460
Min. Value 360 310 260 210 160 110
Criterion 360 352 344 336 328 320
value
Dr. A. Ramesh
 Savage Principle
• Selecting the course of action that minimizes
the maximum regret
• Minimax Regret

Dr. A. Ramesh
 Savage (Minimax Regret) Principle
Event Ei Act Aj
A1:18 A2:19 A3:20 A4:21 A5:22 A6:23
E 1:18 0 50 100 150 200 250
E 2:19 20 0 50 100 150 200
E 3:20 40 20 0 50 100 150
E 4:21 60 40 20 0 50 100
E 5:22 80 60 40 20 0 50
E 6:23 100 80 60 40 20 0
Max. va 100 80 100 150 200 250
Min.
Value Dr. A. Ramesh
 Decision Making Under Risk

No. of 18 19 20 21 22 23
Copies
Sold

Probability 0.05 0.10 0.30 0.40 0.10 0.05

Dr. A. Ramesh
 Decision Making Under Risk
• Maximum Likelihood Principle
• Expectation Principle
•
n
EPj  Pi aij
i1

Dr. A. Ramesh
 Calculation of expected Pay-Off
Event Proba Act Aj
Ei bility
A1:18 A2:19 A3:20 A4:21 A5:22 A6:23

E 1:18 0.05 360 310 260 210 160 110

E 2:19 0.10 360 380 330 280 230 180
E 3:20 0.30 360 380 400 350 300 250
E 4:21 0.40 360 380 400 420 370 320
E 5:22 0.10 360 380 400 420 440 390
E 6:23 0.05 360 380 400 420 440 460
Expected 360 376.5 386 374.5 335 288.5
Pay-Of

Dr. A. Ramesh
 Calculation of expected Regrett
Event Proba Act Aj
Ei bility
A1:18 A2:19 A3:20 A4:21 A5:22 A6:23

E 1:18 0.05 0 50 100 150 200 250

E 2:19 0.10 20 0 50 100 150 200
E 3:20 0.30 40 20 0 50 100 150
E 4:21 0.40 60 40 20 0 50 100
E 5:22 0.10 80 60 40 20 0 50
E 6:23 0.05 100 80 60 40 20 0
Expected 51 34.5 25 36.5 76 122.5
Regret

Dr. A. Ramesh
Expected Pay-Off of Perfect Information
Event Proba Act Aj
Ei bility
A1:18 A2:19 A3:20 A4:21 A5:22 A6:23

E 1:18 0.05 360

E 2:19 0.10 380
E 3:20 0.30 400
E 4:21 0.40 420
E 5:22 0.10 440
E 6:23 0.05 460
EPPI = Rs. 411
EVPI = EPPI-EP=Rs.411-Rs.386=Rs.25
Dr. A. Ramesh
• The book seller, should not pay more than
Rs.25 (per year) for obtaining the demand
information.

Dr. A. Ramesh
Newsboy Problem
 Example -2
▶ News Paper buying price = 30
▶ Selling price = 50

Number of Days Probability of Each

Daily Sales Sold Number Being Sold
300 15 0.15
400 20 0.2
500 45 0.45
600 15 0.15
700 5 0.05
Sum 100 1
 Example -3
▶ Strawberry buying price = 20
▶ Selling price = 50
• Marginal Profit = $50 -$20 = $ 30
• Marginal Loss = $20
 Marginal Analysis
▶ Marginal analysis is based on the fact that when
an additional unit of an item is bought , two fates
are possible:
▶ That one unit will be sold or it will not be sold.
▶ the some of the probabilities of these two
events must be 1.
▶ For example, if the probability of selling an
additional unit is 0.6, then the probability of not
selling must be 0.4
 Pay off Matrix
Marginal Profit = $50 -$20 = $ 30
Marginal Loss = $20

Possible Probabili Possible Stock Actions

Demand ty
10 11 12 13

10 0.15 300 280 260 240

11 0.20 300 330 310 290
12 0.40 300 330 360 340
13 0.25 300 330 360 390
 Derivation for Stocking rule
▶ Additional units should be stocked as long as the
expected marginal profit from stocking each of them
is greater than the expected marginal loss from
stocking each.
▶ The size of the each day order should be increased up
to the point where the expected marginal profit from
stocking one more unit if it sells is just equal to the
expected marginal loss from stocking that unit if it
remain unsold.
Calculating optimal P*

p (MP) = (1-p) ML
p (MP) = ML-pML
p (MP)  pML=ML
p(MP+ML)=ML
ML
p* 
MP  ML
 Calculating optimal P*

ML 20
p*   0.4
MP  ML 30  20
▶ The value of 0.4 for p* means that in order to
make the stocking of an additional unit
justifiable, we must have at least a 0.40
cumulative probability of selling that unit or
more.
 Calculating optimal P*

Sale units Probability Cumulative

probability

10 0.15 1
11 0.20 0.85
12 0.40 0.65
13 0.25 0.25
Marginal Profit and Loss Calculation

Stocking 11 units
p(MP) = 0.85 x 30 = $25.50
1-p (ML) = 0.15 x 20 = $ 3.00
Stocking 12 units
p(MP) = 0.65 x 30 = $19.50
1-p (ML) = 0.35 x 20 = $ 7.00
Stocking 13 units
p(MP) = 0.25 x 30 = $7.50
1-p (ML) = 0.75 x 20 = $ 15.00
 Inference
• Stock 12 Units

Dr. A. Ramesh
Newsboy for Continuous Demand

Dr. A. Ramesh
 Inventory Management on
Perishable Products
▶ Acme Fruit and Produce Wholesalers buys tomatoes,
then sells them to retailers.
▶ Acme currently pays $20 a box.
▶ Tomatoes sold on the same day bring $32 a box.
▶ Extremely perishable, tomatoes not sold on the first
day are worth of $2 a box.
▶ Acme has calculated that the mean past daily sales is
60 boxes and standard deviation is 10 boxes.
 Optimal Probability
▶ Marginal Profit (MP)= 32-20 = 12
▶ Marginal Loss (ML)= 20-02 = 18

ML 18
p*   0.60
MP  ML 12  18
Normal Probability Distribution with
0.60 of the area under curve

0.6

0 Point Q 60 90

57.46

Z = - 0.25335
Thank you

Dr. A. Ramesh