Reference no: EM133615734

American Airlines Uses Should-Cost Modeling to Assess the Uncertainty of Bids for Shipment Routes

American Airlines, Inc. (AA) is one of the world's largest airlines. Its core business is passenger trans-portation, but it has other vital ancillary functions that include full-truckload (FTL) freight shipment of maintenance equipment and in-flight shipment of passenger service items that could add up to over $1 billion in inventory at any given time. AA receives numerous bids from suppliers in response to requests for quotes (RFQs) for inventories. AA's RFQs could total over 500 in any given year. Bid quotes vary significantly as a result of the large number of bids and resultant complex bidding process. Sometimes, a single contract bid could deviate by about 200%. As a result of the complex process, it is common to either overpay or underpay suppliers for their services. To this end, AA wanted a should-cost model that would streamline and assess bid quotes from suppliers to choose bid quotes that were fair to both them and their suppliers.

Methodology/Solution

To determine fair cost for supplier products and ser-vices, three steps were taken:

Question 

1. Primary (e.g., interviews) and secondary (e.g., Internet) sources were scouted for base-case and range data that would inform cost variables that affect an FTL bid.

2. Cost variables were chosen so that they were mutually exclusive and collectively exhaustive.

3. The DPL decision analysis software was used to model the uncertainty.

Furthermore, Extended Swanson-Megill approximation was used to model the probability distribution of the most sensitive cost variables used. This was done to account for the high variability in the bids in the initial model.

Results/Benefits

A pilot test was done on an RFQ that attracted bids from six FIL carriers. Out of the six bids presented, five were within three standard deviations from the mean, whereas one was considered an outlier.

Subsequently, A used the should-cost FTL model on more than 20 RFQs to determine what a fair and accurate cost of goods and services should be.
It is expected that this model will help in reducing the risk of either overpaying or underpaying its suppliers.

QUESTIONS FOR DISCUSSION

1. Besides reducing the risk of overpaying or underpaying suppliers, what are some other benefits AA would derive from its "should-be" model?

2. Can you think of other domains besides air transportation where such a model could be used?

3. Discuss other possible methods with which A could have solved its bid overpayment and underpayment problem.