Robust optimization approach for long-term project pricing


Thesis Type: Postgraduate

Institution Of The Thesis: Middle East Technical University, Turkey

Approval Date: 2010

Thesis Language: English

Student: Kaan Balkan

Co-Supervisor: FATMA SEDEF MERAL, Fatma Meral

Abstract:

In this study, we address the long-term project pricing problem for a company that operates in the defense industry. The pricing problem is a bid project pricing problem which includes various technical and financial uncertainties, such as estimations of workhour content of the project and exchange & inflation rates. We propose a Robust Optimization (RO) approach that can deal with the uncertainties during the project lifecycle through the identification of several discrete scenarios. The bid project’s performance measures, other than the monetary measures, for R&D projects are identified and the problem is formulated as a multi-attribute utility project pricing problem. In our RO approach, the bid pricing problem is decomposed into two parts which are v solved sequentially: the Penalty-Model, and the RO model. In the Penalty-Model, penalty costs for the possible violations in the company’s workforce level due to the bid project’s workhour requirements are determined. Then the RO model searches for the optimum bid price by considering the penalty cost from the Penalty-Model, the bid project’s performance measures, the probability of winning the bid for a given bid price and the deviations in the bid project’s cost. Especially for the R&D type projects, the model tends to place lower bid prices in the expected value solutions in order to win the bid. Thus, due to the possible deviations in the project cost, R&D projects have a high probability of suffering from a financial loss in the expected value solutions. However, the robust solutions provide results which are more aware of the deviations in the bid project’s cost and thus eliminate the financial risks by making a tradeoff between the bid project’s benefits, probability of winning the bid and the financial loss risk. Results for the probability of winning in the robust solutions are observed to be lower than the expected value solutions, whereas expected value solutions have higher probabilities of suffering from a financial loss.