Sarah Chang’s dilemma

Sessions 7 – 8
Accelerated General Management Programme (Batch 09)
December 2021
A model for the problem

How do you represent a solution to the problem at hand?

What is your “bag” of possible solutions?

Given a solution, how do you measure its “goodness”?

What do you mean by the “best” solution?

A model for the problem

How do you represent a solution to the problem at hand?

A. Should Sarah invest in R&D? Yes/No

(Assumption: If she does not, then the new technology is not developed.)

B. Should Sarah bid if she only has the old technology? Yes/No

C. Should Sarah bid if she only has the new as well as the old technology? Yes/No
A model for the problem

What is your “bag” of possible solutions? A B C

Invest,
Yes bid no
YesmatterYes
what

Sarah’s bag of strategies

A. Should Sarah invest in R&D?
B. Should Sarah bid with the old technology? Yes Yes No
C. Should Sarah bid with the new technology?
Invest,
Yes bid only
No if you Yeshave the new technology
Yes No No
No invest,
Don’t Yesbid with
Yesthe old technology
No Yes No
Don’t
No invest,
Nodon’t bid
Yes
No No No
A model for the problem

Given a solution (strategy), how do you measure its “goodness”?

The goodness is measured by the expected profit from the strategy.

What do you mean by the “best” solution (strategy)?

The strategy that has the largest expected profit is the best. This means that we are assuming
a risk neutral decision maker.

Our Guesses (will vary from decision maker to decision maker)

Probability of engineers succeeding: 0.6
Probability of winning the bid with old tech: 0.05
Probability of winning the bid with new tech: 0.80
 s s e s!
tg ue
The
And decision
Now the process
probabilities
adddecision
a decision
maker’s
formaker
uncertain
payoffs events es are j us

y valu
ba bilit
s e pro
The Win bid
+800K
Bid with 0.05
old tech 0.95
Don’t
invest
–50K
Lose bid
Don’t bid 0K
Win bid
+600K
0.8
Bid with
Engg. new tech 0.2
succeeds Lose bid
–250K
0.6 –200K
Invest Don’t bid
Win bid
+600K
Bid with 0.05
0.4
Engg. old tech 0.95
–250K
fails Lose bid … and you have a
Don’t bid
–200K decision tree
time
 Solving the decision tree

Win bid
+800K
Bid with 0.05
old tech –7.5K
Don’t 0.95
invest 0K (Don’t bid) –50K
Lose bid
Don’t bid 0K
Win bid
Solution: +600K
0.8
Bid with
Expected profit: +178K (Invest and bid only if engineers
430Ksucceed)
Engg. new tech 0.2
succeeds +430K (Bid with –250K
new tech)
Lose bid
0.6 –200K
Invest Don’t bid
Win bid
+178K (Bid only if engineers succeed)+600K
Invest, bid no matter what Bid with 0.05
0.4 –207.5K
Invest, bid only if you have the new technology Engg. old tech 0.95
Don’t invest, bid with the old technology fails
–200K (Don’t bid) –250K
Lose bid
Don’t invest, don’t bid Don’t bid
–200K
time
What should Sarah do?
Win bid
+800K Investment: between $200K and $400K
Bid with 0.05 Expected profits (after 6 months): $178K
old tech 0.95 What is the ROI?
Don’t
invest
–50K
Lose bid
 0K Question:
Don’t bid
Win bid How do we build in Sarah’s risk appetite in this analysis?
 +600K
0.8
Bid with
Engg. new tech 0.2 Question:
succeeds Lose bid
–250K What should Sarah do?
0.6 –200K
 Don’t bid Profits +600 with probability 0.48
Invest Win bid
+600K
Bid with 0.05 –200 with probability 0.40
0.4
Engg. old tech 0.95 –250 with probability 0.12
fails –250K
Lose bid
 –200K
Don’t bid