FLEXIBILITY IN DESIGN - Title Page - MIT

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de Neufville + Scholtes D R A F T September 30, 2009Box 1.2_____________________________________________________________________________Standard design based on fixed assumptions: oil platformsDeep-water platforms for extracting oil and gas from sub-sea reservoirs, as in the Gulf of Mexicoor offshore of Angola, commonly cost about $1 billion each.Usual practice is to design the size and location of these platforms based upon anassumed price of oil, $40 per barrel for example. 3 (The price assumed is a closely guardedcorporate secret, because of its importance in contract negotiations. It represents assumptionsabout longer-term prices and thus differs from immediate spot prices. It also varies by companyand over time.) The norm is to mandate designers to design for a fixed price of oil, even though itvaries widely and events have proven trends to be unreliable, as Figures 1.1 and 1.2 show.[Figures 1.1 and 1.2 here]The effect of assuming a fixed price is to ignore oil fields that would be profitable athigher prices. This means that when prices are in fact higher and secondary fields might havebeen worthwhile, the platforms do not have easy access to these valuable reservoirs. Theirexploitation would require a completely new project, which might not be economically feasible.The owners thus miss opportunities that a flexible, easily adjustable design would have exploited._____________________________________________________________________________Part 1: Chapters 1 to 3 <strong>Page</strong> 12 of 69
de Neufville + Scholtes D R A F T September 30, 2009Box 1.3_____________________________________________________________________________Flaw of averages: capacity constrained facilityA simple example illustrates the “Flaw of Averages”. 4 Consider a constrained facility, such as a 5level parking garage with a total capacity of 500 spaces.Suppose that the• annual revenue per space used is $ 10,000;• annualized cost of the facility is $ 3,000,000; and• demand for spaces depends on whether or not developers open a new office building,and is equally likely to be either 350 spaces -- or 550 spaces.Table 1.1 shows the possible revenues:[Table 1.1 here]The average profit is then (1000 – 200) / 2 = 400. However, the profit calculated by using theaverage demand of 450 spaces is ($3600 – $3000) = $600 !The reason for the difference between the true expected value ($400), calculated using the actualoutcomes and the false value ($600), estimated using average outcomes, is that the gains on theupside are limited by capacity constraints and do not compensate for the losses on the downside.You cannot park 550 cars if you only have 500 spaces!_____________________________________________________________________________Part 1: Chapters 1 to 3 <strong>Page</strong> 13 of 69
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