© Prof. Dr. Ulrich W. Thonemann

Behavioral Operations

Prof. Ulrich W. Thonemann, Ph.D.DirectorUniversity of Cologne

1

CONTENTS

� Supply Chain Management at the University of Cologne

� Motivating Examples

� A Supply Chain Decision

� System 1 vs. System 2

� Thoughts on the Decision Process

� Whom to go out with tonight?

SCM AT THE UNIVERSITY OF COLOGNE

Business

School

Accounting & Taxation

Corporate Development

Supply Chain Management

Finance Marketing

LogisticsProductionManagement

Science

Network & Inventory

OptimizationEmpirical &Behavioral

� Success factors� Benchmarking� Human behavior� …

� Crew scheduling� Robustness� Optimization� …

� Strategy� Footprint design� Inventory optimization� …

2

PARTNER

3

4

CONTENTS

� Supply Chain Management at the University of Cologne

� Motivating Examples

� A Supply Chain Decision

� System 1 vs. System 2

� Thoughts on the Decision Process

� Whom to go out with tonight?

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DO A AND B HAVE DIFFERENT COLORS/BRIGHTNESS?

6Source: http://de.wikipedia.org/wiki/Optische_T%C3%A4uschung

Does the small bar have a uniform gray?

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DO THE BLUE OBJECTS HAVE THE SAME SIZE?

8Source: http://de.wikipedia.org/wiki/Optische_T%C3%A4uschung

DO THE BLUE OBJECTS HAVE THE SAME SIZE?

9Source: http://de.wikipedia.org/wiki/Optische_T%C3%A4uschung

Note: The only difference is that an option is missing that nobody chooses!

WHICH OPTION WOULD YOU CHOOSE?

10Source: Dan Arial, Predictably Irrational

16 %

0 %

84 %

32 %

68 %

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CONTENTS

� Supply Chain Management at the University of Cologne

� Motivating Examples

� A Supply Chain Decision

� System 1 vs. System 2

� Thoughts on the Decision Process

� Whom to go out with tonight?

PROBLEM

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� Task: Determine order quantity for Newspapers

� Unit cost: w (e.g., 80 cents)

� Unit selling price: r (e.g., 100 cents)

� Delivery: Tomorrow 6 am

� Sales: Tomorrow 6 am – 8 pm

� Unit buyback price: b (e.g., 60 cents)

� Demand: All demands between 1 and 100 are equally likely

- 1 % probability of demand = 1

- 1 % = 2

….

- 1 % = 100

Source: Becker-Peth, Katok, Thonemann, Designing Contracts for Irrational but Predictable Newsvendors (2011)

QUESTION

Contract 1

Unit revenue = 100

Wholesale price = 50

Buyback price = 0

Contract 2

Unit revenue = 100

Wholesale price = 80

Buyback price = 60

Your order?

Which contract would you prefer?

41 59

~ 20 % ~ 80 %

Expected profit under average order quantity:

Loss probability under average order quantity:

1190 434

20 % 30 %

Source: Becker-Peth, Katok, Thonemann, Designing Contracts for Irrational but Predictable Newsvendors (2011)

You are in charge of a warehouse and you have discovered room for inventory optimization for products A, B and C. Unfortunately, your budget restrictions allow just one product optimization. You know the current days in inventory (inventory turns) and how they will change after investing in inventory optimization.

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Product A B C

Sales volume per year (units) 10,000 10,000 10,000Unit cost (€) 500 500 500

Days in inventory (days)- Current situation 120 36 15- After optimization 90 18 9

Inventory turns (1/days)- Current situation 3 10 24- After optimization 4 20 40

Inventory value (million €)- Current situation 1.667 500 208- After optimization 1.250 250 125

57 % 36 % 7 %

33 % 56 % 11 %

15

CONTENTS

� Supply Chain Management at the University of Cologne

� Motivating Examples

� A Supply Chain Decision

� System 1 vs. System 2

� Thoughts on the Decision Process

� Whom to go out with tonight?

SYSTEM 1 AND SYSTEM 2

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A coffee in a paper cup costs € 1,10.

The coffee costs € 1,00 more than the cup.

How much does the cup cost?

Coffee = + € 1,00 = € 1,10

Total = € 1,20

Cup = € 0,10!

System 1: “Intuition”

Cup = € 0,05!

Coffee = + € 1,00 = € 1,05

Total = € 1,10

System 2: “Reflection”

� Fast

� Unconscious

� Often right, sometimes not

� Example: Car driving

� Slow

� Requires effort

� Controls activities

� Example: see above Source: http://g3associates.wordpress.com/2009/09/02/when-it-

comes-to-decision-making-how-reliable-is-your-instinct/, 16.9.11

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CONTENTS

� Supply Chain Management at the University of Cologne

� Motivating Examples

� A Supply Chain Decision

� System 1 vs. System 2

� Thoughts on the Decision Process

� Whom to go out with tonight?

CHECKLIST

18Source: Kahneman, Lovallo, and Sibony, Checkliste für Entscheider, Harvard Business Managers, 9/2011, pp. 19

�

General questions

1. Has the team fallen in love with the proposal?

2. What are the individual interests of the team members?

3. Are there diverting opinions in the team?

Questions to team members

1. Do we use wrong analogies?

2. Have we considered all alternatives?

3. Would we make the same decision one year ahead?

4. Do we know where the numbers come from?

5. Is there a Halo-effect (one attribute over-evaluated)?

6. Do we anchor too much on previous decisions?

Final questions

1. Is the base scenario too optimistic?

2. Is the negative scenario bad enough?

3. Is the team too risk-averse?

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CONTENTS

� Supply Chain Management at the University of Cologne

� Motivating Examples

� A Supply Chain Decision

� System 1 vs. System 2

� Thoughts on the Decision Process

� Whom to go out with tonight?

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© Prof. Dr. Ulrich W. Thonemann

Behavioral Operations

Prof. Ulrich W. Thonemann, Ph.D.DirectorUniversity of Cologne

24

Backup

25

… when directors are hearing from an

advisor, it appears to me that there is only

one way to get a rational and balanced

discussion:

Directors should hire a second advisor to

make the case against

Warren Buffet

CEO, Berkshire

Hathaway

the proposed acquisition,

with its fee contingent on

the deal not going

through.

Don’t ask the barberwhether you need a haircut!