Dynamic Strategic PlanningCasablanca, Morocco

March 23-28, 2009

Course Overview

General Information Instructor: Richard Roth

email: rroth@mit.edu

Course Websitehttp://msl1.mit.edu/mib, then click on Morocco 2009

Text: Applied Systems Dynamics by R. deNeufville, Chapters 13 – 20, but focused on 15-17(chapters are available on the website)

Based on MIT course 3.57: Dynamic Strategic Planning & research at the MIT Materials Systems Laboratory

Class Structure Each Day Will Have Three Parts

– Lecture– Problem Session– Working Session

Lectures will review & introduce new topics Problem sessions will reinforce topics through

selected problems Working sessions will focus on development of

the case assignment

Course Outline/Schedule

Date Lectures Problem Session

Working Session

MondayMarch 23

Course IntroductionImpact of Uncertainty

Business Case Requirements

Group Business Case Selection

TuesdayMarch 24

Process Based Cost Modeling Review of Business Case Requirements

Develop Cost Models for Business Case

WednesdayMarch 25

Dynamic Strategic Planning/ Decision Trees

Decision Tree Problems

Market Analysis for Business Case

ThursdayMarch 26

Probability Assessment/Bayes Theorem

Bayes Theorem & Multi-period Decision Problems

Plant Sizes & Prices for Business Case

FridayMarch 27

Value of InformationPerfect & Sample Information

Information Problems

Finalize Business Case Analysis

SaturdayMarch 28

Presentations of Business Cases

Course Requirements & Grading Business Case Group Presentation (30%)

– Presentation in class on Saturday describing the recommended business strategy

Individual Final Report (30%)– Students will turn in an INDIVIDUAL final report describing

the groups business case analysis and their recommendations

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

Class Participation (20%)– During General Class Sessions– Group Participation

Introduction to Uncertainty

Why is Uncertainty Important? Uncertainty EXISTS!!!

– No amount of analysis can eliminate the fact that future events are uncertain.

– But uncertainty can be understood and prepared for.

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

Uncertainty Comes in Many Forms– Market Uncertainty– Cost Uncertainty– Technological Uncertainty– Etc.

Examples of Uncertainty: Predicting Automotive Production

Predictions of automobile production during the product planning stage are highly inaccurate

Predictions can vary by as much as 200% from the actual production

This can have a major impact on:– Costs– Designs– Profitability

Impact of Inaccurate Forecasts/Predictions

Poor predictions lead to excess capacity– More investment made

than was required

Poor predictions lead to poor capacity utilization– Under utilized equipment

leads to high costs

Other Examples of Uncertainty: Oil Prices

0

20

40

60

80

100

120

1975 1980 1985 1990 1995 2000 2005 2010

1994

$/B

AR

RE

L

ACTUAL

1981 FORECAST

1984

19881992

1995

More Predictions for Oil Prices

$0.00

$50.00

$100.00

$150.00

$200.00

$250.00

$300.00

1980 1985 1990 1995 2000 2005 2010 2015 2020

1994

$/B

AR

RE

L

ACTUAL

AVERAGE

IPE

HIGHEST

LOWEST

Impact of Uncertainty on Costs Uncertainty in underlying factor prices

– Raw material costs– Energy costs– Etc.

Technological/Process Uncertainty– Uncertainty production conditions

• Process cycle times• Downtimes• Etc.

Market Uncertainties– Uncertain demand– Uncertain production levels

Market Uncertainty & The Impact on Costs Structural reasons why market uncertainty

impact costs– Economies of Scale– Economies of Scope– Capacity Utilization Issues– Etc.

Fixed & variable costs behave differently under market uncertainty

Dedicated vs. non-dedicated equipment behave differently under market uncertainty

Fixed vs. Variable Costs Variable Costs

– Raw Materials– Labor– Energy– Etc.

Generally variable costs scale with the number of parts to be produced

Market uncertainty has no impact on unit costs– Each unit requires the

same level of variable costs regardless of the number produced

Fixed Costs– Equipment Investments– Tooling Investments– Building Investments

Generally fixed costs involve one time spending that does not change with the number of parts to be produced

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

Production Volume

Uni

t Cos

t

Variable Costs

Fixed Costs

Low Fixed Cost Lead to Reduced Impact of Production Volume

Production Volume

Uni

t Cos

t

Variable Costs

Fixed Costs

Dedicated vs. Non-Dedicated Equipment Dedicated Equipment:

– Equipment that can only be used to produce a single product

– For example: Tooling, Part specific production systems,…

Non-Dedicated Equipment:– Equipment which can be used to make multiple

products– Usually used in combination with part specific tooling

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

Capacity Utilization

Uni

t Cos

t

FullUtilization

Overtime

Impact of Market Conditions on Unit Costs Market size affects unit cost

– Due to economies of scale– Strongest impact on products/processes with high

levels of fixed costs

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 For a new business venture of your choosing

– Determine optimal business size– Price of product

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 You MUST select a business with high levels of

fixed costs which are dedicated to the production of your product.

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 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)

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 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

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 Tree04_v3.xls provided for case analysis

– Considers 3 possible plant sizes and 2 possible prices– Considers decisions over two five year periods

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