Minimizing
your Maximum Regret
Sounds confusing or
complicated? Not really. I hear people say it all the time. “I
regret robbing that store, now I am in jail” or “I regret going
out with that person, she put a bugger on me” or “I regret
raising my prices, now I have no customers”
Making a decision
to do or not to do something is easy most of the time because of
trial and error. For instance: If I don’t tie my shoes the
chances of me falling is greater than if I do tie my shoes.
However, making a decision with
an unknown outcome can be devastating. Most small and a lot of
large businesses make devastating decisions every day and then
ponder the question, “what happen?”
In business there is a cost
associated with everything and those decisions affect the cost,
profit and loss.
Ill will is one of the biggest costs that
impacts a bottom line in any business defined as: hostility,
spite, dislike, hatred, envy, resentment, grudge, malice,
animosity, aversion, venom, antagonism, antipathy, enmity,
acrimony, rancor, bad blood, hard feelings, animus, malevolence,
unfriendliness. Imagine someone wanting to buy from you but has
ill will feelings toward you, your abilities, your products all
because you made the wrong decision: Dropped a 747 in the ocean,
could not fix a flat tire, raised the price of admission, or ran
out of product when your customer wanted them.
The Cost of “ill will”
Let’s assume there is an additional “ill will” cost of 75
cents associated with every unit of demand not filled because of
an inventory shortage. Consider these definitions and data:
Let the probability of selling an additional unit (or more) be
designated by þ; then (1- þ) is the probability of not selling
the additional unit or more
Let k0
be defined as the unit cost of overage.
Let ku
be defined as the unit cost of underage.
k0
= unit cost of overage = $2. The $2 is the difference between
the cost per unit ($2.50) and the distress price ($0.50).
ku
= unit cost of underage = $3.75. The $3.75 is equal to the sum
of the gross profit lost by underordering a unit ($5.50 – 2.50 =
$3.00) and the cost of ill will ($0.75) for each unit of
underage, ie., when there is demand and there are no units to
sell.
The inventory decision of whether to increase
the order by a marginal unit may again be considered in terms of the
additional expected cost of underage (þku)
and the additional expected cost of overage [(1-
p)k0].
As before, the optimum is obtained by adding additional units until
(1-þ)k0
= þku
The critical ratio is obtained
as above [equation (10-1)]
þc =
Modified example:
þc =
=
= 0.35
The increased penalty for not filling and order has had the
same effect as an increase in the profit margin (i.e., and
increase in the regret of not having a unit on hand when a unit
is demanded), and it will tend to increase the size of the order
by decreasing.
Conclusion: Retailers and Manufactures
Kryptonite = Demand
Demand: Certain or
Uncertain
To make a good decision also information
about the demand is important. Is the information for demand
perfect? Is the demand fixed? Is the information for demand
certain or uncertain? Let’s say demand is certain and the
information is almost perfect.
The new bulldozer CPU by AMD
is coming out on September 26, 2011. AMD the manufacturer, has
done their job with marketing by leaking it is faster than any
Intel cpu ever made, you have done your research by looking at
the trend when AMD exceeded Intel the last time and over 30
cpu’s were sold by your company in the first month, but that was
over 6 years ago and money is tight today with a 20% drop in
business how many do you order so there is no ill will toward
your company. The almost perfect part is that the CPU is not
faster than Intel because the information was leaked and may not
be accurate.
Do you order 30 – 20% or do you wait for
someone else to get the first month’s customers which could be
1000’s of dollars you past up, and we will stop here.
