Application Portfolio ESD.71 Anna Massie 1 Introducing Flexibility into an Aircraft Assembly Plant Abstract: This application portfolio analyzes the impact of uncertainty on the profits obtained in aircraft assembly. The primary source of uncertainty is the demand of aircraft in any given year due to the current state of the economy, and political influences. A simplified model has been created to relate these parameters to the overall demand of aircraft, which then translates into the profits obtained by an aircraft manufacturing company. The aircraft manufacturing company has the option to build and operate a facility of fixed size, or a facility that has the option to grow larger if necessary. This paper outlines the uncertainties and flexibility options for the aircraft manufacturer. Then the two designs are analyzed using both a decision tree and binomial lattice to establish a value of the flexibility. Finally a hybrid decision tree with lattice is outlined and analyzed. From all three analyses, the flexible facility is more profitable than the fixed facility, allowing the aircraft manufacturer to realize higher potential gains even though he has a possibility of experiencing lower minimums.Application Portfolio ESD.71 Anna Massie 2 Table of Contents 1 System Description ......................................................................................................... 3 1.2 Design Levels.................................................................................................. 3 2 Uncertainties ............................................................................................................... 4 2.1 Uncertainty Number One: The Economy ............................................................ 4 2.2 Uncertainty number Two: Wartime production spikes........................................ 6 3 Two-stage decision analysis ............................................................................................ 8 4 Lattice Development of Economic Uncertainty ............................................................ 10 5 Decision Analysis using Lattice..................................................................................... 14 6 Simplified Hybrid Decision Analysis – Lattice............................................................. 17 7 Discussion...................................................................................................................... 20Application Portfolio ESD.71 Anna Massie 3 1 System Description Each year the United States government approves procurement funds available for each of the Department of Defense branches in the National Defense Authorization Act. In fiscal year 2008, the authorized funds for procurement purposes totaled $18.5 billion for the Army, $35.7 billion for the Navy and Marine Corps, $33.8 billion for the Air Force, and $3.9 billion for joint activities or rapid acquisitions. This gives the United States up to $91.9 billion on procurements out of a total budget of $623 billion for military expenditures [1]. Contractors to DoD organizations therefore have much to gain from a relationship with these organizations, yet there is also uncertainty in the total number of planes that will be demanded each year due to uncertainties primarily in the economy and the current political state. The question therefore, is how is flexibility able to help a contractor plan for these uncertainties. In particular I will be looking at the tanker acquisition as it is a current topic of interest. 50 years ago, Boeing began producing the KC-135 tanker. In total it delivered 600 aircraft. The Air Force first purchased 29 of the fleet in 1954, with the first aircraft flying in 1956 and the last in 19651. 732 KC-135 tankers have been produced, with 57 additional airframes being cancelled2. 6001 of which have been delivered to the US Air Force, with 505 still being flown today3. The other tankers are being operated by France, Singapore, Pakistan and Turkey3. For the purposes of this exercise I will focus of the number of aircraft required by the US as the majority of previous tankers have been delivered here. 1.2 Design Levels The aircraft manufacturer will therefore produce a baseline of 10 aircraft per year over the next 10 years (the tanker contract calls for 100 aircraft, versus the 600 previously desired). Because this is a highly specialized aircraft, a new assembly facility has to be built and staffed. This facility can either be built to support the size of the contract of 10 aircraft per year, or can be built with additional flexibility to allow for future expansion. The aircraft manufacturer may want this additional capability if demand rises, yet demand can also fall as will be illustrated. In addition the flexibility will cost the aircraft manufacturer both initially and for each aircraft produced as additional space, equipment and personnel will need to be purchased. This type of flexibility is an American call option “in-project” where if the outcome looks favorable at the end of any given year, the aircraft manufacturer can decide to exercise the option to expand. For simplicity in the decision lattice example, I used the European model where the aircraft manufacturer could only use this flexibility at the end of year 5. Fixed: The fixed facility has a capacity to produce 10 aircraft per year. It utilizes 50 acres of land and 10 assembly lines. Each acre of land costs $2 million over a 5 year period and each assembly line costs $10 million over a 5 year period. Per year this is equivalent toApplication Portfolio ESD.71 Anna Massie 4 $40 million in fixed costs. There is a marginal cost per aircraft of $2.5 million for personnel, equipment, raw materials, and any pre-fabricated parts. Flexible: The flexible facility has an initial capacity of 10 aircraft per year, which can be increased to 12 aircraft per year yielding 60 aircraft in a 5 year period. The facility can also be decreased to 8 aircraft per year yielding 40 aircraft in a 5 year period. There is an initial $30 million to purchase extra land, and building space. If the aircraft manufacturer decides to expand there is an additional $5 million to purchase the assembly line machinery necessary giving a fixed cost of $45 million. There is a marginal cost per aircraft of $3 million for personnel equipment raw materials and any pre-fabricated parts. If the aircraft