Efficiency Bounds for Two-Stage Production Systems

Traditional data envelopment analysis (DEA) models find the most desirable weights for each decision-making unit (DMU) in order to estimate the highest efficiency score as possible. These efficiency scores are then used for ranking the DMUs. The main drawback is that the efficiency scores based on weights obtained from the standard DEA models ignore other feasible weights; this is due to the fact that DEA may have multiple solutions for each DMU. To overcome this problem, Salo and Punkka (2011) deemed each DMU as a “Black Box” and developed models to obtain the efficiency bounds for each DMU over sets of all its feasible weights. In many real world applications, there are DMUs that have a two-stage production system. In this paper, we extend the Salo and Punkka’s (2011) model to a more common and practical case considering the two-stage production structure. The proposed approach calculates each DMU’s efficiency bounds for the overall system as well as efficiency bounds for each subsystem/substage. An application for nonlife insurance companies has been discussed to illustrate the applicability of the proposed approach and show the usefulness of this method.