Strategic Decision Making The new clothing line AB Designs h

Strategic Decision Making

The new clothing line AB Designs has undertaken is a seasonal line of clothing for which demand can be high, medium, or low. AB Designs can order one, two, or three lots of the product before the season begins but cannot reorder later. Profit projections (in thousands) relative to the expected demand are shown below:

                                                State of Nature

High Demand

Medium Demand

Low Demand

Decision Alternative

Order 1 lot

60

60

50

Order 2 lots

80

80

30

Order 3 lots

100

70

10

Your research has shown that prior probabilities for the three states of nature are 30%, 30%, and 40% respectively. Given that, determine what is the recommended order quantity?

Later, you receive information from the VP of sales in preparation for a budget meeting this week. She is excited that AB Designs is taking on the investment of the new clothing line and is optimistic about its success, given the competitive landscape of their industry. Market predictions from her research have always been either excellent or very good. The probabilities are as follows:

Excellent Market Conditions               70%

High Demand                                      34%

Medium Demand                                32%

Low Demand                                       34%

Very Good Market Conditions            30%

High Demand                                      20%                            

Medium Demand                                26%

Low Demand                                       54%

Given the VP of Sales market predictions for the success of the new clothing line, what is the optimal buying decision strategy?

Solution

Without research

EMV of Order 1 lots = 60*0.3 + 60*0.3 + 60*0.4 = 60

EMV of Order 2 lots = 80*0.3 + 80*0.3 + 30*0.4 = 60

EMV of Order 3 lots = 100*0.3 + 70*0.3 + 10*0.4 = 55

Order 1 and Order 2 have the highest EMV. Therefore, recommended order quantity is Order 1 or Order 2 lots.

With market research

Given prediction of Excellent Market Conditions, EMV of Order 1 lots = 60*0.34+60*0.32+60*0.34 = 60

Given prediction of Excellent Market Conditions, EMV of Order 2 lots = 80*0.34+80*0.32+30*0.34 = 63

Given prediction of Excellent Market Conditions, EMV of Order 3 lots = 100*0.34+70*0.32+10*0.34 = 59.80

Maximum EMV is of Order 2 lots, therefore given prediction of Excellent market conditions, recommended decision is Order 2 lots.

Given prediction of Very Good Market Conditions, EMV of Order 1 lots = 60*0.20+60*0.26+60*0.54 = 60

Given prediction of Very Good Market Conditions, EMV of Order 2 lots = 80*0.20+80*0.26+30*0.54 = 53

Given prediction of Very Good Market Conditions, EMV of Order 3 lots = 100*0.20+70*0.26+10*0.54 = 43.60

Maximum EMV is of Order 1 lots, therefore given prediction of Very goog market conditions, recommended decision is Order 1 lots.

Optimal buying strategy: If the prediction is Excellent Market conditions, then Order 2 lots, otherwise Order 1 lot.

Overall EMV of this decision strategy = 63*0.70 + 60*0.30 = 62.10