Cost‐Benefit Analysis for Optimization of Risk Protection Under Budget Constraints

Cost‐benefit analysis (CBA) is commonly applied as a tool for deciding on risk protection. With CBA, one can identify risk mitigation strategies that lead to an optimal tradeoff between the costs of the mitigation measures and the achieved risk reduction. In practical applications of CBA, the strategies are typically evaluated through efficiency indicators such as the benefit‐cost ratio (BCR) and the marginal cost (MC) criterion. In many of these applications, the BCR is not consistently defined, which, as we demonstrate in this article, can lead to the identification of suboptimal solutions. This is of particular relevance when the overall budget for risk reduction measures is limited and an optimal allocation of resources among different subsystems is necessary. We show that this problem can be formulated as a hierarchical decision problem, where the general rules and decisions on the available budget are made at a central level (e.g., central government agency, top management), whereas the decisions on the specific measures are made at the subsystem level (e.g., local communities, company division). It is shown that the MC criterion provides optimal solutions in such hierarchical optimization. Since most practical applications only include a discrete set of possible risk protection measures, the MC criterion is extended to this situation. The findings are illustrated through a hypothetical numerical example. This study was prepared as part of our work on the optimal management of natural hazard risks, but its conclusions also apply to other fields of risk management.     

Terrorism Risks and Cost‐Benefit Analysis of Aviation Security

We evaluate, for the U.S. case, the costs and benefits of three security measures designed to reduce the likelihood of a direct replication of the 9/11 terrorist attacks. To do so, we assess risk reduction, losses, and security costs in the context of the full set of security layers. The three measures evaluated are installed physical secondary barriers (IPSB) to restrict access to the hardened cockpit door during door transitions, the Federal Air Marshal Service (FAMS), and the Federal Flight Deck Officer (FFDO) Program. In the process, we examine an alternate policy measure: doubling the budget of the FFDO program to $44 million per year, installing IPSBs in all U.S. aircraft at a cost of $13.5 million per year, and reducing funding for FAMS by 75% to $300 million per year. A break‐even cost‐benefit analysis then finds the minimum probability of an otherwise successful attack required for the benefit of each security measures to equal its cost. We find that the IPSB is costeffective if the annual attack probability of an otherwise successful attack exceeds 0.5% or one attack every 200 years. The FFDO program is costeffective if the annual attack probability exceeds 2%. On the other hand, more than two otherwise successful attacks per year are required for FAMS to be costeffective. A policy that includes IPSBs, an increased budget for FFDOs, and a reduced budget for FAMS may be a viable policy alternative, potentially saving hundreds of millions of dollars per year with consequences for security that are, at most, negligible.     

Optimal Control of Selling Channels for an Online Retailer with Cost‐per‐Click Payments and Seasonal Products

The problem studied in this paper is a predigestion of the decision faced by online retailers (etailers) that advertise on publisher or comparison‐shopping websites. An etailer may sell its product not only through its online and bricks‐and‐mortar stores, but also through the websites of one or more third parties (e.g., Yahoo.com). However, the etailer has to pay a certain amount to such third parties in an action‐based payment scheme, such as a cost‐per‐click (CPC) scheme. Under the CPC scheme, payment is based solely on click‐throughs, which means that the etailer pays only when a shopper clicks through to the product page of its website. Only a fraction of such clicks lead to actual sales. The extra cost that is associated with shoppers who first click through to the third‐party websites makes them less attractive as customers than those who directly visit the etailer's online store. Moreover, the CPC rate for a prominent placement is normally set by competitive bidding, and thus varies over time. Therefore, the etailer needs to decide dynamically whether or not to list on a third‐party website. The structural properties of the optimal policy are discussed, and numerical examples are given to show the revenue impact of dynamic listing control.     

Cost‐Benefit Analysis of Passive Fire Protections in Road LPG Transportation

The cost‐benefit evaluation of passive fire protection adoption in the road transport of liquefied petroleum gas (LPG) was investigated. In a previous study, mathematical simulations of real scale fire scenarios proved the effectiveness of passive fire protections in preventing the “fired” boiling liquid expanding vapor explosion (BLEVE), thus providing a significant risk reduction. In the present study the economical aspects of the adoption of fire protections are analyzed and an approach to cost‐benefit analysis (CBA) is proposed. The CBA model is based on the comparison of the risk reduction due to fire protections (expressed in monetary terms by the value of a statistical life) and the cost of the application of fire protections to a fleet of tankers. Different types of fire protections were considered, as well as the possibility to apply protections to the entire fleet or only to a part of it. The application of the proposed model to a real‐life case study is presented and discussed. Results demonstrate that the adoption of passive fire protections on road tankers, though not compulsory in Europe, can be economically feasible, thus representing a concrete measure to achieve control of the “major hazard accidents” cited by the European legislation.     

Incremental and Average Cost‐Effectiveness Ratios: Will Physicians Make a Distinction?

Physicians are increasingly asked to use cost-effectiveness information when evaluating alternative health care interventions. Little is known about how the way such information is presented can influence medical decision making. We presented physicians with hypothetical screening scenarios with multiple options, varying the type of cost-effectiveness ratios provided as well as whether the scenarios described cancer screening settings that were familiar or unfamiliar. Half the scenarios used average cost-effectiveness ratios, as commonly reported, calculating benefits and costs relative to a no-screening option. The other half used the preferred incremental cost-effectiveness ratios, with each option's benefits and costs calculated relative to the next best alternative. Relative to average cost-effectiveness ratios, incremental cost-effectiveness information significantly reduced preference for the most expensive screening strategies in two of three unfamiliar scenarios. No such difference was found for familiar scenarios, for which physicians likely have established practice patterns. These results suggest that, in unfamiliar settings, average cost-effectiveness ratios as reported in many analyses reported in the literature can hide the often high price for achieving incremental health care goals, potentially causing physicians to choose interventions with poor cost effectiveness.     

The Unintended Effects of Risk‐Refuting Information on Anxiety

Researchers in the field of risk perception have been asking why people are more worried about risk today than in years past. This article explores one possible answer to this question, associative anxiety. The affect heuristic and the mental network models suggest that anxiety triggered by information regarding a particular risk can spread to other risks of the same category. Research to date, however, has not examined how information refuting the particular risk can also be generalized across other risks. The article presents two experimental studies addressing this issue. Study 1 showed that when participants were presented with information based on a real train collision, they experienced increased anxiety not only about train collisions but also about public transportation in general. In contrast, those who were informed about the train collision case as well as the preventative measures implemented after the accident experienced decreased anxiety about train collisions but not about public transportation more generally. Study 2 measured the changes in participant anxiety about a genetically modified organism (GMO) and compared the influence of information about either the existence or nonexistence of its risk. Similar to Study 1, associative anxiety rippled through the risk category. The results also suggest that the follow‐up information refuting the GMO risk reduced the anxiety toward the hazard drastically, but did not fully alleviate the anxiety toward other hazards in the category. The implications and the limitations of these studies are also discussed.     

Cost‐Effective Application of Thermal Protection on LPG Road Transport Tanks for Risk Reduction Due to Hot BLEVE Incidents

A simplified risk and cost‐benefit analysis is presented for the application of thermal protection (TP) on propane and LPG highway tanker trucks operating in North America. A risk analysis is performed to determine the benefits of risk reduction by TP, relative to the costs of applying and maintaining TP on a tanker truck. The results show that TP is cost effective if the tanker truck spends enough time (or travels enough distance) in areas of moderate or high population density. The analysis is very sensitive to a number of inputs, including: (i) value of life, (ii) hot boiling liquid expanding vapor explosion frequency, (iii) public exposure to severe hazards, and (iv) life cost of TP. With this simplified analysis, it is possible to generate tanker truck exposure times to the public that justify the application of TP based on cost and benefit considerations.     

The Effects of Strategic and Structural Supply Chain Orientation on Operational and Customer‐Focused Performance

Supply chain orientation (SCO), or the implementation of a supply chain management philosophy, consists of two distinct, yet interdependent elements, namely strategic SCO and structural SCO. Strategic SCO involves integrating an SCM philosophy into the firm's strategy development, while structural SCO encompasses operational‐level behaviors and actions that reflect such a philosophy. This study extends the research on SCO by developing hypotheses on the contingent effects of strategic SCO and structural SCO on a firm's operational and customer‐focused performance. Drawing on the strategy‐structure‐performance framework, the study proposes that strategic SCO and structural SCO positively affect different dimensions of performance and that structural SCO plays a mediating role in the relationship between strategic SCO and performance. These relationships are tested using primary survey data and archival data from 183 manufacturers in the Midwestern US. Results confirm that strategic SCO is associated with both operational performance and customer‐focused performance, but structural SCO is only related to operational performance. Structural SCO acts as a mediator in linking strategic SCO with operational performance and customer‐focused performance and mediation effects are strengthened at higher levels of environmental dynamism.     

An Approach for Optimal Allocation of Safety Resources: Using the Knapsack Problem to Take Aggregated Cost‐Efficient Preventive Measures

On the basis of the combination of the well‐known knapsack problem and a widely used risk management technique in organizations (that is, the risk matrix), an approach was developed to carry out a cost‐benefits analysis to efficiently take prevention investment decisions. Using the knapsack problem as a model and combining it with a well‐known technique to solve this problem, bundles of prevention measures are prioritized based on their costs and benefits within a predefined prevention budget. Those bundles showing the highest efficiencies, and within a given budget, are identified from a wide variety of possible alternatives. Hence, the approach allows for an optimal allocation of safety resources, does not require any highly specialized information, and can therefore easily be applied by any organization using the risk matrix as a risk ranking tool.     

Ex Post Problems in Buyer–Supplier Transactions: Effects of Transaction Characteristics, Social Embeddedness, and Contractual Governance

This paper focuses on ex post governance of inter-firm transactions. We develop and test hypotheses on the occurrence of ex post problems like delivery delays, inferior quality, and insufficient service in buyer–supplier transactions. Our hypotheses address effects of transaction characteristics, of social embeddedness, and of contractual governance on the occurrence of problems. Other than earlier research on embeddedness effects in this field, we consider not only effects of dyadic embeddedness but also effects of network embeddedness. We test hypotheses using rich survey data on more than 1200 purchases of information technology (IT) products: hardware and software, both standard and complex. We find evidence for effects of transaction characteristics on the occurrence of problems, while our data do not support hypotheses on effects of contractual governance. Our data provide rather consistent support for hypotheses on the effects of embeddedness. Specifically, we find evidence that network embeddedness reduces problems.     

Outsourcing to a Powerful Contract Manufacturer: The Effect of Learning‐by‐Doing

The contract manufacturing industry has grown rapidly in recent years as firms have increasingly outsourced production to reduce costs. This growth has created powerful contract manufacturers (CMs) in several industries. Achieving a competitive cost position is often a primary motive for outsourcing. Outsourcing influences both the original equipment manufacturer's (OEM) and the CM's production levels, and, therefore, through learning‐by‐doing renders future costs dependent on past outsourcing decisions. As such, outsourcing should not be viewed as a static decision that, once made, is not revisited. We address these considerations by analyzing a two‐period game between an OEM and a powerful CM wherein both firms can reduce their production costs through learning‐by‐doing. We find that partial outsourcing, wherein the OEM simultaneously outsources and produces in‐house, can be an optimal strategy. Also, we find that the OEM's outsourcing strategy may be dynamic—i.e., change from period to period. In addition, we find both that the OEM may engage in production for leverage (i.e., produce internally when at a cost disadvantage) and that the CM may engage in low balling. These and other findings in this paper demonstrate the importance of considering learning, the power of the CM, and future periods when making outsourcing decisions.     

Self‐Service Operations at Retail Stores: The Role of Inter‐Customer Interactions

Inter‐customer interactions are important to the operation of self‐services in retail settings. More specifically, when self‐service terminals are used as part of customers’ checkout processes in retail operations without the explicit involvement of retailers as the direct service providers, inter‐customer interactions become a significant managerial issue. In this article, we examine the impact of inter‐customer interactions at retail self‐service terminals on customers’ service quality perceptions and repeat purchase intentions at retail stores. We conduct a scenario‐based experimental design (N = 674) using a 2 × 2 factorial design in which inter‐customer interactions are divided into “positive” vs. “negative” and occur during the “waiting” or during the actual “transaction” stages of self‐services at a retail store. We use attribution theory to develop the hypotheses. The results demonstrate that, through their interactions, fellow customers can exert influences on a focal customer's quality perceptions and repeat purchasing intentions toward a retail store. Furthermore, these influences were impacted by how customers attribute blame or assign responsibility toward the retail store. Service operations managers should leverage these interactions by designing into self‐service settings the capacities and interfaces that are best suited for customers’ co‐production of their self‐service experiences.     

The Impact of E‐Replenishment Strategy on Make‐to‐Order Supply Chain Performance

This research investigates the impact of electronic replenishment strategy on the operational activities and performance of a two‐stage make‐to‐order supply chain. We develop simulation‐based rolling schedule procedures that link the replenishment processes of the channel members and apply them in an experimental analysis to study manual, semi‐automated, and fully automated e‐replenishment strategies in decentralized and coordinated decision‐making supply chain structures. The average operational cost reductions for moving from a manual‐based system to a fully automated system are 19.6, 29.5, and 12.5%, respectively, for traditional decentralized, decentralized with information sharing, and coordinated supply chain structures. The savings are neither equally distributed among participants, nor consistent across supply chain structures. As expected, for the fully coordinated system, total costs monotonically decrease with higher levels of automation. However, for the two decentralized structures, under which most firms operate today, counter‐intuitive findings reveal that the unilateral application of e‐procurement technology by the buyer may lower his purchasing costs, but increase the seller's and system's costs. The exact nature of the relationship is determined by the channel's operational flexibility. Broader results indicate that while the potential economic benefit of e‐replenishment in a decentralized system is substantial, greater operational improvements maybe possible through supply chain coordination.     

Endogenous Adaptation: The Effects of Technology Position and Planning Mode on IT‐Enabled Change*

The redesign of information technology (IT)‐enabled work processes often necessitates fundamental design changes to the intended work process, the IT platform hosting the work process, or both. Research suggests that such design changes often can be traced to earlier decisions involving endogenous adaptation or internal organizational change. Two such decisions are a firm's technology position and planning mode. This study examines the relationship between technology position and planning mode in predicting the magnitude of design change in process redesign projects. The conceptual frame applied in examining these relationships involves a synthesis of Miles and Snow's adaptive cycle with elements central to concurrent engineering. Our results indicate that the magnitude of design change is related to differences in technology position and planning mode. To effectively implement organizational change, firms must leverage their IT platform by carefully timing IT investments in accordance with their adopted technology position. Directing the trajectory of a firm's IT platform and deploying it so as to complement the firm's technology position reduces design uncertainty, promoting reengineering success.     

The Effects of Random and Discrete Sampling when Estimating Continuous–Time Diffusions

High–frequency financial data are not only discretely sampled in time but the time separating successive observations is often random. We analyze the consequences of this dual feature of the data when estimating a continuous–time model. In particular, we measure the additional effects of the randomness of the sampling intervals over and beyond those due to the discreteness of the data. We also examine the effect of simply ignoring the sampling randomness. We find that in many situations the randomness of the sampling has a larger impact than the discreteness of the data.     

Impact of Information Technology Integration and Lean/Just‐In‐Time Practices on Lead‐Time Performance*

Managers seeking to improve lead‐time performance are challenged by how to balance resources and investments between process improvement achieved through lean/just‐in‐time (JIT) practices and information technology (IT) deployment. However, extant literature provides little guidance on this question. Motivated by both practical importance and lack of academic research, this article examines empirically the relationships among interfirm IT integration, intrafirm IT integration, lean/JIT practices, and lead‐time performance using data from IndustryWeek's Census of Manufacturers ( IndustryWeek, 2006 ). The results provide several new insights on the relationship between IT integration and lean/JIT practices. First, the study confirms that implementing lean/JIT practices significantly reduces lead time. Second, lean/JIT practices mediate the influence of IT integration on lead‐time performance. This suggests that process improvements that result from lean/JIT practices are important contributors to the success of IT integration. Even companies that have experienced success in reducing lead time through lean/JIT practices may benefit from IT integration practices such as those embodied in enterprise resource planning systems. The findings provide managers with empirical evidence and a theoretical framework on the balance between lean/JIT and IT for effecting improvement in lead‐time performance, thus offering practical guidance on this important question. Future research is needed to extend the lean/JIT practices in this study to supply chain practices and explore the relationship between supply chain practices and IT integration.     

Competing on Time: An Integrated Framework to Optimize Dynamic Time‐to‐Market and Production Decisions

This study develops a comprehensive framework to optimize new product introduction timing and subsequent production decisions faced by a component supplier. Prior to market entry, the supplier performs process design activities, which improve manufacturing yield and the chances of getting qualified for the customer's product. However, a long delay in market entry allows competitors to enter the market and pass the customer's qualification process before the supplier, reducing the supplier's share of the customer's business. After entering the market and if qualified, the supplier also needs to decide how much to produce for a finite planning horizon by considering several factors such as manufacturing yield and stochastic demand, both of which depend on the earlier time‐to‐market decision. To capture this dependency, we develop a sequential, nested, two‐stage decision framework to optimize the time‐to‐market and production decisions in relation to each other. We show that the supplier's optimal market entry and qualification timing decision need to be revised in real time based on the number of qualified competitors at the time of market‐entry decision. We establish the optimality of a threshold policy. Following this policy, at the beginning of each decision epoch, the supplier should optimally stop preparing for qualification and decide whether to enter the market if her order among qualified competitors exceeds a predetermined threshold. We also prove that the supplier's optimal production policy is a state‐dependent, base‐stock policy, which depends on the time‐to‐market and qualification decisions. The proposed framework also enables a firm to quantify how market conditions (such as price and competitor entry behavior) and operating conditions (such as the rate of learning and inventory/production‐related costs) affect time‐to‐market strategy and post‐entry production decisions.     

Analysis of Travel Times and CO2 Emissions in Time‐Dependent Vehicle Routing

Due to the growing concern over environmental issues, regardless of whether companies are going to voluntarily incorporate green policies in practice, or will be forced to do so in the context of new legislation, change is foreseen in the future of transportation management. Assigning and scheduling vehicles to service a pre‐determined set of clients is a common distribution problem. Accounting for time‐dependent travel times between customers, we present a model that considers travel time, fuel, and CO₂ emissions costs. Specifically, we propose a framework for modeling CO₂ emissions in a time‐dependent vehicle routing context. The model is solved via a tabu search procedure. As the amount of CO₂ emissions is correlated with vehicle speed, our model considers limiting vehicle speed as part of the optimization. The emissions per kilometer as a function of speed are minimized at a unique speed. However, we show that in a time‐dependent environment this speed is sub‐optimal in terms of total emissions. This occurs if vehicles are able to avoid running into congestion periods where they incur high emissions. Clearly, considering this trade‐off in the vehicle routing problem has great practical potential. In the same line, we construct bounds on the total amount of emissions to be saved by making use of the standard VRP solutions. As fuel consumption is correlated with CO₂ emissions, we show that reducing emissions leads to reducing costs. For a number of experimental settings, we show that limiting vehicle speeds is desired from a total cost perspective. This namely stems from the trade‐off between fuel and travel time costs.     

The Effect of Single Rater Bias in Multi‐Stakeholder Research: A Methodological Evaluation of Buyer‐Supplier Relationships

As the global competitive landscape intensifies, firms have looked to their supply chain organizations to improve cost, visibility, and cycle time performance across functions, products, and markets. As a result, the scope of supply chain related operations have increasingly cut across organizational boundaries. To understand and capture such cross‐organizational activities, researchers have broadened the focus of their studies and included multiple stakeholders in their analysis (e.g., integration, sustainability, and buyer‐supplier relationships). However, multi‐stakeholder research has also increased the complexity and effort required to conduct studies across organizational boundaries. Unfortunately, many studies that use multi‐stakeholder constructs fail to fully address their multi‐sided nature during both construct conceptualization and data collection. Several studies suggest that neglecting the multi‐sided nature of certain constructs can affect the research validity and reliability and may invalidate research inferences and results, although such concerns have not been empirically demonstrated. The current study addresses this gap by performing a series of tests using data from 105 matched pairs of buyers and their suppliers to illustrate key methodological considerations for conducting multi‐stakeholder research. This study also offers practical guidance regarding assumptions routinely made in single rater research and proposes when single rater data may be appropriate for multi‐stakeholder research.     

Selling with Money‐Back Guarantees: The Impact on Prices,Quantities, and Retail Profitability

In this paper, we consider a retailer adopting a “money‐back‐guaranteed” (MBG) sales policy, which allows customers to return products that do not meet their expectations to the retailer for a full or partial refund. The retailer either salvages returned products or resells them as open‐box items at a discount. We develop a model in which the retailer decides on the quantity to procure, the price for new products, the refund amount, as well as the price of returned products when they are sold as open‐box. Our model captures important features of MBG sales including demand uncertainty, consumer valuation uncertainty, consumer returns, the sale of returned products as open‐box items, and consumer choice between new and returned products and possibility of exchanges when restocking is considered. We show that selling with MBGs increases retail sales and profit. Furthermore, the second‐sale opportunity created by restocking returned products enables the retailer to generate additional revenues. Our analysis identifies the ideal conditions under which this practice is most beneficial to the retailer. Offering an MBG without restocking increases the new product price. We show that if the retailer decides to resell the returned items as open‐box, the price of the new product further increases, while open‐box items are sold at a discount. On the other hand, customers enjoy more generous refunds along with lower restocking fees. The opportunity to resell returned products also generally decreases the initial stocking levels of the retailer. Our extensive numerical study substantiates the analytical results and sharpens our insights into the drivers of performance of MBG policies and their impact on retail decisions.