COLLEGUE OF LEADERSHIP AND GOVERNANCE
DEPARTMENT OF PROJECT LEADERSHIP AND MANAGEMENT
PROJECT RISK AND DECISION ANALYSIS
INDIVIDUAL ASSIGNMENT-2
TITTLE:
A case study involving a make-or-buy decision for Smith Industry
BY MIKIYAS DESSIE
ID No……………………………………ECSU 2301321
Submitted to: Meseret G. (PhD)
March 2025, Addis Ababa
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To help you analyze the payoff table for the make-or-buy decision and guide you through
possible decision-making strategies, we’ll go through the steps needed for evaluating the risk
and potential outcomes. Here's how we can approach this:
Step 1: Understand the Case
In this scenario, Smith Industry needs to decide whether to manufacture a new component in-
house or purchase it from an external supplier. The decision must be made before the
demand level for the product is known, which means the company is facing uncertainty in its
decision-making process.
The decision will depend on two potential demand outcomes:
1. High Demand (more profitable to manufacture in-house)
2. Low Demand (more profitable to buy from the supplier)
The company must balance the risk of uncertain demand against the profit from each choice.
Step 2: Payoff Table
The payoff table is a table that displays the potential outcomes (profits) for each possible
decision under different scenarios of demand. Based on the case provided, the table might look
something like this (values are in thousands of dollars):
Decision High Demand Low Demand
Manufacture 500 200
Buy 300 300
Step 3: Decision-Making Strategies
To decide which option to choose, several decision-making strategies can be applied. Below are
common strategies used for such problems under uncertainty:
1. Maximax (Optimistic Approach)
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Maximax focuses on the maximum possible profit, assuming the best-case scenario
(high demand) will occur.
Step: Choose the decision that provides the highest potential payoff.
For Smith Industry:
o Manufacture: Highest payoff = 500 (in case of high demand)
o Buy: Highest payoff = 300 (in both high and low demand)
Decision: Manufacture because the maximum possible payoff (500) is greater than the
maximum payoff for buying (300).
2. Maximin (Pessimistic Approach)
Maximin focuses on the best worst-case scenario, assuming the worst outcome (low
demand) will occur.
Step: Choose the decision that maximizes the minimum payoff.
For Smith Industry:
o Manufacture: Worst-case payoff = 200 (in case of low demand)
o Buy: Worst-case payoff = 300 (in case of low demand)
Decision: Buy because the worst-case payoff (300) is higher than the worst-case payoff for
manufacturing (200).
3. Hurwicz (Weighted Average Approach)
The Hurwicz criterion is a compromise between optimism and pessimism. It assigns a
weight to the best-case and worst-case outcomes and calculates the weighted average.
Formula: Expected payoff=α(Best outcome)+(1−α)(Worst outcome)\text{Expected
payoff} = \alpha (\text{Best outcome}) + (1-\alpha) (\text{Worst
outcome})Expected payoff=α(Best outcome)+(1−α)(Worst outcome)
o Where α\alphaα represents the level of optimism.
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For Smith Industry, let’s assume α=0.7\alpha = 0.7α=0.7 (optimistic) and 1−α=0.31 - \alpha =
0.31−α=0.3 (pessimistic):
o Manufacture: Expected payoff = 0.7(500) +0.3(200) =350+60=4100.7(500) +
0.3(200) = 350 + 60 = 4100.7(500) +0.3(200) =350+60=410
o Buy: Expected payoff = 0.7(300) +0.3(300) =210+90=3000.7(300) + 0.3(300) =
210 + 90 = 3000.7(300) +0.3(300) =210+90=300
Decision: Manufacture because the expected payoff (410) is higher than buying (300).
4. Equal Likelihood
In this approach, you assume that each outcome (high demand and low demand) is
equally likely (probability = 0.5) and choose the decision with the highest average payoff.
For Smith Industry:
o Manufacture: Expected payoff = 0.5(500) +0.5(200) =250+100=3500.5(500) +
0.5(200) = 250 + 100 = 3500.5(500) +0.5(200) =250+100=350
o Buy: Expected payoff = 0.5(300) +0.5(300) =150+150=3000.5(300) + 0.5(300) =
150 + 150 = 3000.5(300) +0.5(300) +0.5(300) =150+150=300
Decision: Manufacture because the expected payoff (350) is higher than buying (300).
Step 4: Conclusion
Based on the different decision-making strategies:
Maximax: Suggests Manufacture.
Maximin: Suggests Buy.
Hurwicz: Suggests Manufacture (with a reasonable level of optimism).
Equal Likelihood: Suggests Manufacture.
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Recommendation:
If Smith Industry is optimistic about the market and believes the likelihood of high
demand is significant, they should manufacture the component.
If the company is more risk-averse and prefers securing a consistent return (even if it’s
lower), they should buy the component, as it guarantees a stable profit (300) regardless of
demand.
In most cases, based on the payoff table and assuming a balanced approach, manufacturing the
component appears to be the most profitable decision, especially if Smith Industry can manage
the production efficiently.
