A Three-Year Catalog Contract From an Unknown Customer: Expected Value, Downside Risk and Two Biases in a Commercial Printer's Decision to Lease a Second Press
[Student Name]
University of Phoenix
MGT/521: Management
Week 3 Assignment
[Instructor Name]
[Date]
The company, customer and figures are a composite written for a model paper.
A composite commercial printing company with about $9 million in annual revenue and 55 employees prints brochures, direct mail and short-run catalogs for regional businesses. In the spring, a fast-growing online home goods retailer asked it to print four seasonal catalogs a year under a three-year contract. The work would fill the company's single web press beyond capacity, so accepting would require leasing a second press at about $380,000 a year for three years. The retailer's buyer projected high volumes, but the retailer is only four years old, the company has never worked with it and its financial statements are private. The owner had two weeks to decide, and every number that mattered was an estimate. This paper analyzes the decision.
Framing the Decision
The rational decision-making process moves from defining the problem to identifying criteria, generating alternatives, evaluating them and choosing (Robbins & Coulter, 2021). The problem is not simply whether to accept the contract but how to capture its profit without putting the company at unacceptable risk. The owner's criteria are expected profit over three years, the worst-case loss the company could survive, cash flow and the effect on existing customers.
Three alternatives were identified. Accept the three-year contract and lease a press. Decline. Or accept a one-year pilot, printing on the existing press where possible and sending overflow to a partner printer at a lower margin, before deciding whether to lease.
The Uncertainties
Two uncertainties dominate. The first is volume. Based on the retailer's projections, discounted by the company's sales manager, the analysis assumes a 50% chance of high volume, producing an annual contribution margin of about $900,000; a 30% chance of medium volume, about $500,000; and a 20% chance of low volume, about $150,000. Expected annual contribution is therefore 0.5 times $900,000 plus 0.3 times $500,000 plus 0.2 times $150,000, or $630,000.
The second is credit risk. A young retailer with rapid growth may run short of cash. Based on a trade credit report and discussions with two of the retailer's other suppliers, the analysis assumes a 15% chance that the retailer fails to pay and ends the relationship after the first year, leaving an unpaid receivable of about $250,000.
Expected Values
Accept the three-year contract
If the retailer pays, the company earns $630,000 minus the $380,000 lease each year, or $250,000, for three years: $750,000. If the retailer defaults after year one, the company earns $250,000 in year one, loses the $250,000 receivable and still owes two more years of lease payments, $760,000, partly offset by about $150,000 a year of other work it could run on the press. That path totals about negative $460,000. The expected value is 0.85 times $750,000 plus 0.15 times negative $460,000, or about $568,000.
Decline
The expected value is zero, though the company keeps its capacity for existing customers.
One-year pilot
Without a new press, the company would print what it can and send overflow to a partner printer, earning about 60% of the in-house contribution, or about $378,000 in expected value for the year. Requiring a deposit would limit credit losses to about $100,000 in the default case, reducing the expected value slightly to about $363,000. The pilot also produces information: after one year, the company would know the real volumes and the retailer's payment behavior.
Expected Value Versus Risk
By expected value, the three-year contract is best. But expected value describes the average across many similar decisions, and this company would make this decision only once. The default path produces a loss of about $460,000, which for a company of this size, with thin cash reserves, could threaten its ability to pay its own suppliers and staff. The low-volume case adds a second bad outcome: with only $150,000 of annual contribution against a $380,000 lease, the company would lose about $230,000 a year.
Bounded Rationality and Bias
Simon (1955) argued that decision makers have limited information and computational capacity and therefore seek satisfactory rather than optimal choices. The owner's two-week deadline and the retailer's private finances limit what can be known, which makes the quality of the estimates, and the biases shaping them, especially important.
Tversky and Kahneman (1974) showed that people rely on heuristics that produce systematic biases. Two were visible here. Anchoring: the owner's first estimate of annual contribution, $1.1 million, came straight from the retailer's buyer's projection; the sales manager's discounted figures produced a lower expected value. Availability: the owner's concern about credit risk was shaped by a vivid loss two years earlier, when a customer went bankrupt; the credit report suggested this retailer's risk was real but moderate. Recognizing both biases helped the owner move toward the evidence-based estimates used here.
Improving the Options
The analysis suggests that the best choice may be a better version of the three-year contract. The owner negotiated two protections. The press leasing company offered a 12-month break clause for an additional $30,000 a year, with a $100,000 termination fee. And the retailer agreed to pay a deposit equal to one catalog's printing cost and to accept 30-day terms.
With these protections, the three-year contract earns about $220,000 a year if the retailer pays, or $660,000 over three years. In the default case, the deposit covers most of the receivable, and the company can exit the lease after year one, limiting the default path to a small gain of about $40,000. The expected value is about $567,000, almost unchanged, but the worst case improves from a loss of about $460,000 to roughly break-even. The break clause also caps the loss if volumes prove low.
The protections matter more if the credit estimate is too optimistic. If the chance of default were 30% rather than 15%, the unprotected contract's expected value would fall to about $387,000, while the protected version would still be worth about $474,000. Because the retailer's finances are private, the default probability is the least reliable number in the analysis, and the protected contract is the better choice across the range of plausible values.
Recommendation
The company should accept the three-year contract with the lease break clause, the deposit and 30-day terms. This keeps nearly all the expected value of the original offer while removing the outcome that could threaten the company. The owner should also set a review point at nine months: if volumes are running below the medium scenario or payments are late, the company should prepare to exercise the break clause.
Conclusion
Faced with incomplete information, the printer's owner framed the decision, stated the uncertainties as explicit estimates, computed expected values and compared them with the worst cases. Recognizing anchoring and availability bias improved the estimates. The analysis showed that the option with the highest expected value was also the riskiest, and that negotiating protections could keep the value while limiting the downside, which is often the most useful result of decision analysis.
References
Robbins, S. P., & Coulter, M. (2021). Management (15th ed.). Pearson.
Simon, H. A. (1955). A behavioral model of rational choice. Quarterly Journal of Economics, 69(1), 99-118. https://doi.org/10.2307/1884852
Tversky, A., & Kahneman, D. (1974). Judgment under uncertainty: Heuristics and biases. Science, 185(4157), 1124-1131. https://doi.org/10.1126/science.185.4157.1124
How this MGT 521 Week 3 example is structured
The MGT/521 shelf page describes Week 3 as decision making on a case with incomplete information. The paper follows the rational decision process but shows where it must bend: probabilities are estimates, the manager's time and information are limited and judgment is exposed to predictable biases. Every number in the analysis is shown so the reader can test how the recommendation would change if an estimate were wrong. Students search this week as MGT 521 Week 3, MGT521 Wk 3 or MGT/521 Wk 3; all three are the same assignment.
MGT/521 Week 3 questions, answered
What does MGT/521 Week 3 usually ask for?
The MGT/521 shelf describes Week 3 as decision making on a case with incomplete information. Many sections ask students to analyze a business decision using a decision-making model, identify uncertainties and biases and recommend a course of action.
What is expected value in decision making?
The probability-weighted average of the outcomes of an option. It shows which option is best on average across many similar decisions but does not show the range of outcomes, so it should be considered alongside the worst case when a bad outcome could seriously harm the organization.
What is bounded rationality?
Herbert Simon's idea that decision makers cannot consider every option or know every outcome because of limited information, time and mental capacity. Instead they search until they find a satisfactory option, which he called satisficing.
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