You are the CTO for a start-up that makes instrumentation payloads for geophysical surveying. The company has good financing and has developed a working demonstration prototype of the technology, but the company does not yet have the capability to manufacture the instruments. You have estimated that it will take six months to design a manufacturing process. The technical staff can be contracted and the equipment can be rented until the company grows to the point of needing permanent staff and dedicated equipment. As well as the choice to build in-house, you are considering hiring an established company that builds custom instrumentation that is somewhat similar to your product. The instruments have to be built and tested within eight months to meet obligations to your customers.
There is no way to test the process during fabrication, so all of the payloads must be built. There is not enough time to make extras, and so if any of the payloads do not work then the revenue from customers will be reduced. There is a firm deadline for instruments to be deployed for the next surveying season, and so there are revenue losses if any instruments do not work.
Your colleagues have put together the following information about the two choices:

a) Which choice do you make? Show your work.

Assume now that the company had decided to pursue the contract approach, and after signing the contract your company paid the contractor $500,000 in advance. (This is reasonable because there are significant up-front subsystem purchases that have to be made quickly.) After two months, the project manager for this product development tells you that there appears to be very little progress on the contract. You call the CEO of the other company and eventually learn that they have been having trouble delivering to customers due to supply chain issues as well as
having lost several key staff.
You get your team together to brainstorm alternatives and then different team members investigate the feasibility and financial implications of each alternative, including what might be done with the contracting company to get back on track. Two days later, you meet with the executive team and present the following information about alternatives for getting the work done:

“Do nothing” case: at best you think that you will get the minimum number of instruments needed to fulfill basic customer needs, and at worst, based on the lack of confidence in the company you think that you will get half that amount.
“Reducing scope” case: at best there will be significant revenue loss, and at worst you will only get 2/3 of the reduced amount.
“Renegotiating” case is likely to yield a $100,000 refund of what has already been spent, but you will have to provide $150,000 extra in order to expedite purchases of equipment at a premium, plus putting the time of your own people into the project, and the failure rate is still elevated because of the rush plus possible inter-company work issues.
“Alternative contractor” case has an additional cost to get a different contractor to do the scope of work, but that extra money comes with a high probability that all of the instruments will work (although not as high a probability as the original scope because there will be some rush
 necessary), and there is still the chance that some products will not work.
“Build in-house” case has additional cost over initial estimate because of the need to rush, and a higher chance of failure because of the need to rush.
The assumptions with each cost estimate and probability are based on a trade study and evidence from the history of other instrument development programs that your company knows about.
You note that all of the cost estimates for the future scope of work that are shown do not include the $500,000 that has already been paid to the contractor. The CEO makes the comment that reducing the number of instruments below what has been promised may impact whether future
investors will want to invest in the next round of fund-raising.
b) Draw the decision tree (clearly labeling the amounts and related probability)
c) Show the expected outcomes (with your calculations).
d) Which decision do you make?
e) Provide at least two other factors that might be considered in the decision (in no more than three sentences)
 
 

Transcribed Image Text:

Decision build in-house build in-house contract contract Outcome all work some fail all work some fail Future cost Benefit $ 750,000 $ $ 750,000 $ $ $ 880,000 $ 880,000 $ 1,350,000 950,000 1,350,000 1,100,000 P(outcome) 0.75 0.25 0.90 0.10 Decision build in-house build in-house contract contract Outcome all work some fail all work some fail Future cost Benefit $ 750,000 $ $ 750,000 $ $ $ 880,000 $ 880,000 $ 1,350,000 950,000 1,350,000 1,100,000 P(outcome) 0.75 0.25 0.90 0.10

Answer rating: 100% (QA)

a Decision Analysis Decision 1 Initial Manufacturing Decision 1 Build InHouse All work Cost 750000 Benefit 1350000 Poutcome 075 Some fail Cost 750000 ... View the full answer