Expected value Applied to Business Application

ABCD Manufacturing Company (ABCD) has developed a new product.

The functionality and feasibility of the product has been proven, but each sale will require significant customer support. ABCD must make a decision regarding the level of sales and dedicated to this product. Finally, a complete division (d1~ 4) consisting of about twelve people may be created to fully automate the product and engage in an extensive marketing campaign.

The potential profit from each decision alternative depends on the market acceptance or demand for this product which may be high, moderate or low. If market acceptance is high, each of the four decision alternatives, d1 through d4 will yield a profit of -200, 0, 300, and 900 thousand dollars respectively. If there is a moderate demand, the profits are likely to be 100, 100, 200, and -200 thousand dollars respectively. If the demand turns out to be low, then the profits will be 200, 150, -200, and -500 thousand dollars respectively.

The industry experience with such products provides a probability estimate of demand to be high, moderate and low as 0.3, 0.5, and 0.2 respectively. Which of the four decision alternatives should be selected by ABCD? What will be the expected profit from this decision? If a market research firm can provide perfect information about demand to ABCD (i.e. whether it will be high, moderate, or low) before a product launch decision is made, how much is that information worth to ABCD?

• Hints: To structure this decision making problem, we begin by constructing a payoff table. Our payoff table will, therefore, have 4 rows and 3 columns. The numbers inside the payoff table will represent the profit we will make for each combination of demand and decision alternative.

Demand of Events/Decision Alternative	Low	Moderate	High
D1	Â	Â	Â
D2	Â	Â	Â
D3	Â	Â	Â
D4	Â	Â	Â

• Hint: Probability of each event: The most common approach to solve such decision making problems with known probabilities is to use the expected value approach.