In Example 11.1, the possible profits vary from negative to positive for each of the 10 possible bids examined.
a. For each of these, use @RISK’s RISKTARGET function to find the probability that Miller’s profit is positive. Do you believe these results should have any bearing on Miller’s choice of bid?
b. Use @RISK’s RISKPERCENTILE function to find the 10th percentile for each of these bids. Can you explain why the percentiles have the values you obtain?
EXAMPLE 11.1 BIDDING FOR A GOVERNMENT CONTRACT
The Miller Construction Company must decide whether to make a bid on a construction project. Miller believes it will cost the company $10,000 to complete the project (if it wins the contract), and it will cost $350 to prepare a bid. However, there is uncertainty about each of these. Upon further reflection, Miller assesses that the cost to complete the project has a triangular distribution with minimum, most likely, and maximum values $9000, $10,000, and $15,000. Similarly, Miller assesses that the cost to prepare a bid has a triangular distribution with parameters $300, $350, and $500. (Note the skewness in these distributions. Miller recognizes that cost overruns are much more likely than cost underruns.) Four potential competitors are going to bid against Miller. The lowest bid wins the contract, and the winner is then given the winning bid amount to complete the project. Based on past history, Miller believes that each potential competitor will bid, independently of the others, with probability 0.5. Miller also believes that each competitor’s bid will be a multiple of its (Miller’s) most likely cost to complete the project, where this multiple has a triangular distribution with minimum, most likely, and maximum values 0.9, 1.3, and 1.8, respectively. If Miller decides to prepare a bid, its bid amount will be a multiple of $500 in the range $10,500 to $15,000. The company wants to use simulation to determine which strategy to use to maximize its expected profit.
Objective To simulate the profit to Miller from any particular bid, and to see which bid amount is best.
WHERE DO THE NUMBERS COME FROM? We already discussed this type of bidding problem in Chapter 9. The new data required here are the parameters of the distributions of Miller’s costs, those of the competitors’ bids, and the probability that a given competitor will place a bid. Triangular distributions are chosen for simplicity, although Miller could try other types of distributions. The parameters of these distributions are probably educated guesses, possibly based on previous contracts and bidding experience against these same competitors. The probability that a given competitor will place a bid can be estimated from these same competitors’ bidding history.