© 2006 Prentice Hall, Inc. A – 1

Operations ManagementOperations ManagementModule A – Decision-Making ToolsModule A – Decision-Making Tools

© 2006 Prentice Hall, Inc.

PowerPoint presentation for PowerPoint presentation for Operations Management ClassOperations Management ClassUpdated and extended by Prof. DedekeUpdated and extended by Prof. Dedeke

© 2006 Prentice Hall, Inc. A – 2

OutlineOutline

Fundamentals of Decision MakingFundamentals of Decision Making

Decision TablesDecision Tables

Types of Decision-Making Types of Decision-Making EnvironmentsEnvironments Decision Making Under UncertaintyDecision Making Under Uncertainty

Decision Making Under RiskDecision Making Under Risk

Decision Making Under CertaintyDecision Making Under Certainty

Expected Value of Perfect Expected Value of Perfect Information (EVPI)Information (EVPI)

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IntroductionIntroduction

Decision Making ApproachesDecision Making Approaches StructuredStructured

UnstructuredUnstructured

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Structured Decision Making Structured Decision Making ProcessProcess

1.1. Clearly define the problem and the factors that Clearly define the problem and the factors that influence itinfluence it

2.2. Develop the specific goals to be achievedDevelop the specific goals to be achieved

3.3. Develop quantitative measures that relate the Develop quantitative measures that relate the goals to the problemgoals to the problem

4.4. Develop alternate solutions to problemDevelop alternate solutions to problem

5.5. Compare the alternate solutions using a model or Compare the alternate solutions using a model or structured methodology and the quantitative structured methodology and the quantitative measures from step 3measures from step 3

6.6. Select the best alternativeSelect the best alternative

7.7. Implement the decision and set a timetable for Implement the decision and set a timetable for completioncompletion

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Decision Making EnvironmentDecision Making Environment

DecisionsDecisionsunderunder

uncertaintyuncertainty

DecisionsDecisionsunderunderriskrisk

DecisionsDecisionsunderunderriskrisk

DecisionsDecisionsunderunder

certaintycertainty

Estimate-ableEstimate-able KnownKnown

PartialPartial

TotalTotal

Value or Size ofValue or Size ofoutcomes and outcomes and consequencesconsequences

Level of confidenceLevel of confidenceabout occurrenceabout occurrenceof outcomes and consequencesof outcomes and consequences

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Decision-Making Decision-Making EnvironmentsEnvironments

Decision making under uncertaintyDecision making under uncertainty Complete uncertainty as to which Complete uncertainty as to which

state of nature may occurstate of nature may occur

Decision making under riskDecision making under risk Several states of nature may occurSeveral states of nature may occur

Each has a probability of occurringEach has a probability of occurring

Decision making under certaintyDecision making under certainty State of nature is knownState of nature is known

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Decision Making Under CertaintyDecision Making Under Certainty

1.1. EMV(EMV(AA11) = (1)($200,000) + (0)(-$180,000) = $200,000) = (1)($200,000) + (0)(-$180,000) = $200,000

2.2. EMV(EMV(AA22) = (1)($100,000) + (0)(-$90,000) = $100,000) = (1)($100,000) + (0)(-$90,000) = $100,000

States of NatureStates of Nature

FavorableFavorable UnfavorableUnfavorable Alternatives Alternatives Market Market MarketMarket

Construct large plant (A1)Construct large plant (A1) $200,000$200,000 -$180,000-$180,000

Construct small plant (A2)Construct small plant (A2) $100,000$100,000 -$90,000-$90,000

Do nothing (A3)Do nothing (A3) $0$0 $0$0

ProbabilitiesProbabilities 11 00

From Table A.3From Table A.3

The preferable option is A1The preferable option is A1

© 2006 Prentice Hall, Inc. A – 8

Decision Making Under RiskDecision Making Under Risk

1.1. EMV(EMV(AA11) = (0.3)($200,000) + (0.7)(-$180,000) = -$66,000) = (0.3)($200,000) + (0.7)(-$180,000) = -$66,000

2.2. EMV(EMV(AA22) = (0.3)($100,000) + (0.7)(-$90,000) = -$33,000) = (0.3)($100,000) + (0.7)(-$90,000) = -$33,000

3.3. EMV(EMV(AA33) = (0.3)($0) + (0.7)($0) = $0) = (0.3)($0) + (0.7)($0) = $0

States of NatureStates of Nature

FavorableFavorable UnfavorableUnfavorable Alternatives Alternatives Market Market MarketMarket

Construct large plant (A1)Construct large plant (A1) $200,000$200,000 -$180,000-$180,000

Construct small plant (A2)Construct small plant (A2) $100,000$100,000 -$90,000-$90,000

Do nothing (A3)Do nothing (A3) $0$0 $0$0

ProbabilitiesProbabilities 0.30.3 0.70.7

From Table A.3From Table A.3

A3 is the option to choose.A3 is the option to choose.

If A3 is excluded, The preferable option is If A3 is excluded, The preferable option is A2A2

© 2006 Prentice Hall, Inc. A – 9

Decision Making Under Risk (2)Decision Making Under Risk (2)

In some cases the states of nature expected are certain, however the In some cases the states of nature expected are certain, however the values of each states are uncertain. values of each states are uncertain.

States of DemandStates of Demand

Seasonal TicketSeasonal Ticket Occasional Occasional Alternatives Prob. Market Alternatives Prob. Market Prob. Market Prob. Market

Sell 100 tickets now (A1) 0.7 Sell 100 tickets now (A1) 0.7 $200,000 0.3$200,000 0.3 $50,000 $50,000

Sell 100 tickets later (A2) 0.3 Sell 100 tickets later (A2) 0.3 $150,000 0.7$150,000 0.7 $300,000 $300,000

Do nothing (A3) Do nothing (A3) $0$0 $0 $0

1.1. EMV(EMV(AA11) = (0.7)($200,000) + (0.3)($50,000) = $155,000) = (0.7)($200,000) + (0.3)($50,000) = $155,000

2.2. EMV(EMV(AA22) = (0.3)($150,000) + (0.7)($300,000) = $255,000) = (0.3)($150,000) + (0.7)($300,000) = $255,000

3.3. EMV(EMV(AA33) = (0)($0) + (0)($0) = $0) = (0)($0) + (0)($0) = $0 The preferable option is A2The preferable option is A2

© 2006 Prentice Hall, Inc. A – 10

RiskRisk

Each possible state of nature has an Each possible state of nature has an assumed probabilityassumed probability

States of nature are mutually exclusiveStates of nature are mutually exclusive

Probabilities must sum to 1Probabilities must sum to 1

Determine the expected monetary value Determine the expected monetary value (EMV) for each alternative(EMV) for each alternative

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Expected Monetary ValueExpected Monetary Value

EMV (Alternative i) =EMV (Alternative i) = (Payoff of 1(Payoff of 1stst state of nature) x state of nature) x (Probability of 1(Probability of 1stst state of nature) state of nature)

++ (Payoff of 2(Payoff of 2ndnd state of nature) x state of nature) x (Probability of 2(Probability of 2ndnd state of nature) state of nature)

+…++…+ (Payoff of last state of nature) x (Payoff of last state of nature) x (Probability of last state of (Probability of last state of nature)nature)

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Decision Making Under Decision Making Under UncertaintyUncertainty

States of NatureStates of Nature

FavorableFavorable UnfavorableUnfavorable MaximumMaximum MinimumMinimum RowRowAlternativesAlternatives MarketMarket MarketMarket in Rowin Row in Rowin Row AverageAverage

ConstructConstruct large plantlarge plant $200,000$200,000 -$180,000-$180,000 $200,000$200,000 -$180,000-$180,000 $10,000$10,000

ConstructConstructsmall plantsmall plant $100,000$100,000 -$20,000 -$20,000 $100,000$100,000 -$20,000 -$20,000 $40,000$40,000

Do nothingDo nothing $0$0 $0$0 $0$0 $0$0 $0$0

1.1. Maximax choice is to construct a large plantMaximax choice is to construct a large plant2.2. Maximin choice is to do nothingMaximin choice is to do nothing3.3. Equally likely choice is to construct a small plantEqually likely choice is to construct a small plant

MaximaxMaximax MaximinMaximin Equally Equally likelylikely

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Using Decision Trees to Solve Using Decision Trees to Solve Decision Making Under RiskDecision Making Under Risk

2.2. Symbols used in a decision tree:Symbols used in a decision tree:

.a.a ——decision node from which one decision node from which one of several alternatives may be of several alternatives may be selectedselected

.b.b ——a state-of-nature node out of a state-of-nature node out of which one state of nature will occurwhich one state of nature will occur

© 2006 Prentice Hall, Inc. A – 14

Decision Tree ExampleDecision Tree Example

Favorable marketFavorable market

Unfavorable marketUnfavorable market

Favorable marketFavorable market

Unfavorable marketUnfavorable market

Construct Construct small plantsmall plant

Do nothing

Do nothing

A decision nodeA decision node A state of nature nodeA state of nature node

Construct

Construct

large plant

large plant

Figure A.1Figure A.1

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Decision Table ExampleDecision Table Example

State of NatureState of Nature

AlternativesAlternatives Favorable MarketFavorable Market Unfavorable MarketUnfavorable Market

Construct large plantConstruct large plant $200,000$200,000 –$180,000–$180,000

Construct small plantConstruct small plant $100,000$100,000 –$ 20,000–$ 20,000

Do nothingDo nothing $ 0$ 0 $ 0 $ 0

Table A.1Table A.1

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Decision Tree ExampleDecision Tree Example

= (.5)($200,000) + (.5)(-$180,000)= (.5)($200,000) + (.5)(-$180,000)EMV for node 1= $10,000

EMV for node 2= $40,000 = (.5)($100,000) + (.5)(-$20,000)= (.5)($100,000) + (.5)(-$20,000)

PayoffsPayoffs

$200,000$200,000

-$180,000-$180,000

$100,000$100,000

-$20,000-$20,000

$0$0

Construct la

rge plant

Construct la

rge plant

Construct Construct

small plantsmall plantDo nothing

Do nothing

Favorable market Favorable market (.5)(.5)

Unfavorable market Unfavorable market (.5)(.5)1

Favorable market Favorable market (.5)(.5)

Unfavorable market Unfavorable market (.5)(.5)2

Figure A.2Figure A.2

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Complex Complex Decision Decision

Tree Tree ExampleExample

Figure A.3Figure A.3

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Decision Trees in Ethical Decision Trees in Ethical Decision MakingDecision Making

Maximize shareholder value and Maximize shareholder value and behave ethicallybehave ethically

Technique can be applied to any Technique can be applied to any action a company contemplatesaction a company contemplates

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YesYes

NoNo

YesYes

NoNo

Decision Trees in Ethical Decision Trees in Ethical Decision MakingDecision Making

YesYes

Is it ethical? (Weigh the affect on employees, customers, suppliers,

community against shareholder benefit)

NoNoIs it ethical not to take

action? (Weigh the harm to shareholders

vs. the benefits to other stakeholders)

Do itDo it

Don’t Don’t do itdo it

Don’t Don’t do itdo it

Do it, Do it, but notify but notify appropriate appropriate partiesparties

Don’t Don’t do itdo it

NoNo

YesYes

Does action maximize company returns?

Is action legal?

Figure A.4Figure A.4

© 2006 Prentice Hall, Inc. A – 20

• Operations decisions often involve selection of Operations decisions often involve selection of suppliers, vendors, markets, products and so on. suppliers, vendors, markets, products and so on. In most of these cases, one has to define In most of these cases, one has to define priorities.priorities.

• StepsSteps– Identify attributes to rank or compare, skill, ageIdentify attributes to rank or compare, skill, age

– Have a scale to use for ranking, e.g. 1, 2, 3, 4, 5Have a scale to use for ranking, e.g. 1, 2, 3, 4, 5

– Choose a scale for priorities, e.g. 0.1, 0.3, 0.9…Choose a scale for priorities, e.g. 0.1, 0.3, 0.9…

– Use system to compare alternativesUse system to compare alternatives

Qualitative Decision Making: Qualitative Decision Making: Factoring PrioritiesFactoring Priorities

© 2006 Prentice Hall, Inc. A – 21

Example: Priorities and Example: Priorities and Decision MakingDecision Making

Employee Employee AA

Employee Employee AA

Employee Employee BB

Employee Employee BB

WeightWeight(W)(W)

ScoreScore(S(S1 1 ))

W x SW x S11ScoreScore(S(S2 2 ))

W x SW x S22

LanguageLanguage 0.10.1 1010 66

AnalyticalAnalytical 0.250.25 66 88

TechnicalTechnical 0.300.30 77 99

Salary Salary Expect.Expect.

0.200.20 55 66

DegreeDegree 0.150.15 1010 55

TOTALTOTAL

© 2006 Prentice Hall, Inc. A – 22

Example: Priorities and Example: Priorities and Decision MakingDecision Making

Employee Employee AA

Employee Employee AA

Employee Employee BB

Employee Employee BB

WeightWeight(W)(W)

ScoreScore(S(S1 1 ))

W x SW x S11ScoreScore(S(S2 2 ))

W x SW x S22

LanguageLanguage 0.10.1 1010 11 66 0.60.6

AnalyticalAnalytical 0.250.25 66 1.51.5 88 22

TechnicalTechnical 0.300.30 77 2.12.1 99 2.72.7

Salary Salary Expect.Expect.

0.200.20 55 11 66 1.21.2

DegreeDegree 0.150.15 1010 1.51.5 55 0.750.75

TOTALTOTAL 1.01.0 7.17.1 7.257.25

© 2006 Prentice Hall, Inc. A – 23

• Review Chapter 8, Example 1, page Review Chapter 8, Example 1, page 253-254 & 258 253-254 & 258

Solved problem 8.1, page 263Solved problem 8.1, page 263

See problem 8.1 in Excel See problem 8.1 in Excel spreadsheetspreadsheet

Qualitative Decision Making: Qualitative Decision Making: Location StrategiesLocation Strategies