Assignment No.

2

QUANTITATIVE TECHNIQUES (5564) Executive MBA/MPA (Col)

RELEVANCY OF PROBABILITY THEORY IN DECISION MAKING

ZAHID NAZIR
Roll.No. AB523655 Semester:Autumn 2008
Zahid Nazir – 1st Semester (MBA Col) Page 1

INTRODUCTION TO TOPIC THE MEANING OF PROBABILITY
Most of the managerial decisions are decisions related to uncertainty. Tomorrow is not well defined. Managers are required to make some appropriate assumptions for the ‘would be tomorrow’ and base their decisions on such assumptions. The notion of uncertainty or chance is so common in everybody’s life that it becomes difficult to define it. We talk about chances of one’s winning the election, chances of one’s getting a handsome job and a beautiful wife. Infact almost everything happening in our day to day life is a matter of chance. Some people would prefer to call it “Luck” others would say that under uncertainty man is forced to gamble. i.e. under uncertainty decision maker is forced to take risk. Statistically speaking, we attach probability with the occurrence or non occurrence of an event.

RELEVANCE OF PROBABILITY THEORY IN DECISION MAKING
Let us have a look at some of the business situations characterized by uncertainty. i). INVESTMENT PROBLEM A business man having a choice of investing in two different projects, each having different initial investment. The decision has to be taken on the choice, the outcome of which is contingent upon the level of demand. ii). INTRODUCING A NEW PRODUCT When a new product is developed, the problem is to decide whether or not to introduce the product in addition to the existing product-mix. The decision maker may not be sure about the acceptability of the product. He conducts a test marketing in three regions and gets contradictory results. Should he drop the idea of introducing a new product? It is necessary to answer the question: What is the probability that the new product introduced will be successful?
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iv). The price behavior of securities is subjected to uncertainties. the mangers and businessmen.7. Thus when we say that chances of winning an election are seventy per cent. first. those situations where an experiment can be conducted repeatedly. not necessarily optimal. is sometimes referred to as ‘ business acumen’. Let us now define the probability in a Zahid Nazir – 1st Semester (MBA Col) Page 3 .iii). have at the back of their mind the concept of probability. In the situations discussed above. managers take decisions on the basis of their forecast of the probable future. The commodity gets spoiled if it is not sold by end of the day. He is not sure about the demand pattern. Managers base their decisions either on the basis of their past experience (the repeated experiment) or on the basis of informed guess. we are in fact saying that the probability of winning is 0. The ability to make better decisions. The uncertainty situations can be classified into two categories. a better term for which will be the subjective probability. which in turn depend upon numerous factors. secondly. DEFINITION OF PROBABILITY The word probability refers to the chances of happening of an event. those situations where it is not possible to conduct the experiment either because the cost is prohibitive or because it is physically impossible to conduct the experiment. THE INDIVIDUAL INVESTOR An investor who is engaged in buying and selling of equities is trying to optimize his return. While working on the basis of intuition. yet he must decide in advance how many units to stock. They use their “intuition” which may or may not be based on their past experience. in fact. STOCKING DECISIONS A dealer of a perishable commodity does not know the demand in advance.

2. THE CLASSICAL APPROACH i) Equally Likely: Under the classical approach.5.the Classical Approach and the Bayesian Approach. Find the probability of drawing “a dice” in a single draw from a well shuffled deck of cards. the probability of an event A is equal to the number of possible outcomes favorable to A divided by the total number of possible outcomes of the experiment. hence equal probability is assigned to each outcome. assuming all the outcomes as equally likely. So far we have discussed the concept of probability of an outcome (simple event).e. Thus the probability that the face with dots ‘i’ turns up will be P(i)= 1/6 for all values of i. in tossing a coin.5. For example. Thus. Consider the following numerical examples: a).3.5. there are six possible outcomes corresponding to the six sides of the die and each outcome is equally likely. where by an event we mean a combination of simple events. We can use this concept to define the probability of an event. 1. In a deck of 52 cards.e.3 and 5 of the total six possible equally likely outcomes.more rigorous way. For example. 52 possible outcomes. in a throw of a single die. then the probability of each outcome will be 0. the probability of getting a head up is the same as the probability of getting a tail up and is equal to 0.5. Therefore in a single toss of a fair coin. it is assumed that each outcome of an experiment is “equally likely”. If we roll a six sided die.6. Hence the probability of getting an odd number is 3/6 or 0. i. Thus if there are only two outcomes in a random experiment. the probability of drawing a dice is Zahid Nazir – 1st Semester (MBA Col) Page 4 . We will define it under two approaches . 1. the head up or tail up. of which 13 are dice.4. there are only two outcomes i. the event “odd number” can occur in three (favorable) ways i.e.

In a production run of 500 items. Trials are independent of one another. If the total number of trials is ‘n’ and ‘m’ denotes the number of times the outcome ‘A’ occurs. i.P (Dice) = = Number of dice cards / Total number of cards 13/52 = 0. The fraction m/n of the outcome is referred to as the “relative frequency” of the event in ‘n’ trials. If one item is drawn from the production run at random.e.03 Relative Frequency Approach ( Empirical Definition): Let us assume that an experiment can be repeated a large number of times under the same conditions and each trial has no influence on subsequent repetitions. If 1000 tosses of a coin result in 519 heads.25 b). then the probability of obtaining the event ‘A’ is defined as P (A) = Limn-x m/n = p Thus the probability of ‘A’ is a unique number ‘p’ to which the outcome ultimately settles down.505 If another 1000 tosses results in 496 heads. then the probability of head is = 519 + 491 + 496 / 3000 = 0. 15 items are found to be defective. the probability of head is = 519 + 491/2000 = 0.519 If another 1000 tosses result in 491 heads. the probability of head is = 519/1000 = 0. 15/500 = 0.502 Zahid Nazir – 1st Semester (MBA Col) Page 5 . what is the probability that it will be found defective ? P (Defective)= Number of defective items / Total number of items = ii).

and so on. the probability must lie between 0 and 1 i. Thus the limit is tending to 0. if the decision maker is making an attempt to quantify the possibility of happening of an event. its probability is 0 and if its occurrence is certain its probability is 1. The subjective probability provides a quantitative way to express one’s beliefs and conviction about each outcome. Under such circumstances. as per their own degree of beliefs. Thus. If the event cannot occur. and thus they may assign different probabilities.e. Such quantification in terms of a number between 0 and 1 is often referred to as personal or subjective probability. Choosing a number ‘0’ means the decision maker believes that the event is impossible to occur and choosing a number ‘1’ means that he believes that the event is ‘dead sure’ to happen.5. conviction.5 and therefore the probability of getting a head is 0. the probability of an event is a number between 0 and 1. Any other number between 0 and 1 indicates the decisions maker’s judgment as to the likelihood of occurrence. Zahid Nazir – 1st Semester (MBA Col) Page 6 . he is expressing his opinion on the basis of his feelings about the situation and his “degree of rational belief”. and the extreme values it can take is ‘0’ and ‘n’. Since the ‘m’ cannot take a negative value. A complete set of all such numbers for each possible outcome will represent the subjective probability assessment distribution of the way the uncertainty enters the situation under consideration. 0 ≤ p ≤ 1. However the decision maker’s final action will depend upon his own assessment and judgment of the situation. BAYESIAN APPROACH (Subjective Probability) Managers quite often face problems that have never occurred in the past and will never occur in the future in precisely the same form. experience and background. Different decision makers may view the same situation differently.

iii). in the real situation. The simplest illustration of a random experiment is tossing a coin or a die. A random experiment can be defined as an experiment having the property that i). one may assess the probability of happening of an event using one of the above mentioned approaches or a combination of approaches depending upon the availability of historical data and decision maker’s personal judgment. it is necessary to understand certain terms very precisely and the most important is randomness or random experiment. Another example is the sex of the first two children born. The term experiment or trial is used to refer to any type of situation that can be Zahid Nazir – 1st Semester (MBA Col) Page 7 . All possible outcomes can be specified in advances. Experiments can be repeated a large number of times. The outcome does not necessarily be the same on different trials so that the actual outcome of the experiment is not known in advance. The number of possible outcomes is either finite or infinite. ii). Approach Classical Approach Context The pattern of outcomes is countable. It can be repeated any number of times.So. Bayesian Approach Experiments can be performed only once and can not be repeated. SAMPLE SPACE AND EVENTS In order to understand the concept of probability more clearly.

An event is said to occur if the outcome of a random experiment. TH. an elementary outcome or an element of the sample space. Consider the simple example of tossing an unbiased coin twice. it is necessary to understand the following terms.experienced on a repeated basis. or by making a descriptive statement characterizing the set of possible outcomes. HT. the outcome is not predictable in advance. once performed. TT } Each possible distinct outcome. HH indicates that two heads obtained in a row. one can define the sample space as follows: all industries declaring the dividends during the last two consecutive financial years Zahid Nazir – 1st Semester (MBA Col) Page 8 . This is also called a set of outcomes. A collection of all possible distinct outcomes of an experiment is called the sample space of outcomes. Each distinct outcome of an experiment is called a simple event. A sample space is presented either by listing all possible outcomes of an experiment or trial by using convenient symbols to identify the outcomes. The basic feature of random experiment is. However through the use of probability. is contained within a given event. To develop the concepts of probability. In studying the performance of industries. TH. HT. something can be said about the frequency of the occurrence in a large number of repeated experiments or trials. HT indicates a head in the first toss and a tail in the second and so on. The sample space can be represented as follows: { HH. such as HH. or TT is considered as an event of this experiment. This means that there is an uncertainty in the outcome of an experiment.

5. 4. i) ii) iii) iv) i).e. Zahid Nazir – 1st Semester (MBA Col) Page 9 . 5. It should be understood that a properly defined sample space considers or exhausts all possible outcomes and that there is no overlap among the elements within the space i. BASIC RULES OF PROBABILITY Before discussing rules of probability. U An. 3. the events are mutually exclusive. 2. Each time an experiment is conducted. Therefore the event of throwing 1.The elements of this sample space are those industries which have declared dividends during the last two years. Mutually exclusive and collectively exhaustive events Compound events Conditional probability Independent events MUTUALLY EXCLUSIVE & COLLECTIVELY EXHAUSTIVE EVENTS By mutually exclusive events (figure) we mean that the happening of one of them prevents or precludes the happening of the other. Thus a set of events A1. following concepts must be clarified. 2. one and only one outcome or event can occur. If any industry has not declared the dividend during either of the last two years will not belong to this sample space. then the event of getting 4 precludes the event of throwing 1. They are also collectively exhaustive as they together constitute the set of possible events (also called a sample space).. An is mutually exclusive if Ai ∩ Aj = Ø (for any i ≠ j) and collectively exhaustive if E (the entire set) = A1 U A2 U A3 U ……. So if we toss a die and it shows 4. 3. 6 on tossing a die are mutually exclusive. A2. 6. ……….

The joint probability of two events is denoted as P(AB). iii). INDEPENDENT EVENTS Zahid Nazir – 1st Semester (MBA Col) Page 10 .A B ii). CONDITIONAL PROBABILITY The probability that is assigned to an event A when it is known that another event B has already occurred or that would be assigned to A if it were known that B had occurred is called the conditional probability of A given B and is denoted by P(A|B) (figure) and is given by P(A|B) = P(A ∩B) / P(B) if P(B) ≠ 0. their simultaneous occurrence is called a compound event and the probability that the two or more events will all occur is called the “joint probability” of these events. COMPOUND EVENTS When two or more events occur in connection with each other. A∩B A B iv).

A2. An will occur is the sum of the probability of the occurrences of the individual events. but find the total in such a way that no outcome is counted more than once. A1. Thus P(A1 U A2 U……… U An) = P(A1) + P(A2) + ……… + P(An) If an event A consists of n mutually exclusive and collectively exhaustive events. A2. Thus if A and B are independent P (A|B) P (B|A) AADITIVE LAW OF PROBABILITY The probability that at least one of the several mutually exclusive events A1. the probability that either event A occurs or event B occurs (or they both occur) as the single outcome of the procedure. ………. GENERAL RULE FOR COMPOUND EVENT When finding the probability that event A occurs or event B occurs. find the total number of ways A can occur and the number of ways B can occur. then A = A1 U A2 U……… U An So P(A) = P(A1) + P(A2) + ……… + P(An) = = P (A) P (B) ADDITION RULE Addition rule is used as a device for finding probabilities that can be expressed as P(A or B). they are said to be independent.If there are two or more events such that the occurrence of any one does not depend on the occurrence of any other. ………. An so that A occurs whenever any of these occur and vice versa. Zahid Nazir – 1st Semester (MBA Col) Page 11 .

Formal Addition Rule P(A or B) = P(A) + P(B) – P(A and B) where P(A and B) denotes the probability that A and B both occur at the same time as an outcome in a trial or procedure. P(A or B) is equal to that sum. divided by the total number of outcomes in the sample space. find the sum of the number of ways event A can occur and the number of ways event B can occur. Intuitive Addition Rule To find P(A or B).) Diagram for events that are not disjoint Diagram for disjoint events Zahid Nazir – 1st Semester (MBA Col) Page 12 . adding in such a way that every outcome is counted only once. disjoint events do not overlap. Definition Events A and B are disjoint (or mutually exclusive) if they cannot occur at the same time. (That is.

it is important to adjust the probability of B to reflect the occurrence of event A. P(A and B) = P(event A occurs in a first trial and event B occurs in a second trial) Tree Diagrams A tree diagram is a picture of the possible outcomes of a procedure. These diagrams are helpful if the number of possibilities is not too large. The rule for finding P(A and B) is called the multiplication rule.RULES FOR COMPLEMENTARY EVENT P(A) and P(Ā) are disjoint. shown as line segments emanating from one starting point. It is impossible for an event and its complement to occur at the same time. Zahid Nazir – 1st Semester (MBA Col) Page 13 . Rules for the complementary events are: P(A) + P(Ā) = 1 P(Ā) = 1 – P(A) P(A) = 1 – P(Ā) Diagram for the complement of event A MULTIPLICATION RULE If the outcome of the first event A somehow affects the probability of the second event B.

P(B|A) is really the same as P(B). Intuitive Multiplication Rule When finding the probability that event A occurs in one trial and event B occurs in the next trial. but be sure that the probability of event B takes into account the previous occurrence of event A. multiply the probability of event A by the probability of event B.”) Formal Multiplication Rule P(A and B) = P(A) * P(B|A) Note that if A and B are independent events. Note that there are 10 possible combinations. Zahid Nazir – 1st Semester (MBA Col) Page 14 . P(B|A) represents the probability of event B occurring after it is assumed that event A has already occurred (read B|A as “B given A. Conditional Probability The probability for the second event B should take into account the fact that the first event A has already occurred.This figure summarizes the possible outcomes for a true/false followed by a multiple choice question.

Applying the Multiplication Rule Zahid Nazir – 1st Semester (MBA Col) Page 15 .

Zahid Nazir – 1st Semester (MBA Col) Page 16 . Original documents could not be part of assignment due to their confidentiality. the Risk Management System is used as proactive approach to eliminate / reduce the potential risks associated with their business.PRACTICAL STUDY OF THE ORGANISATION WITH RESPECT TO THE TOPIC ORGANISATION: SYSTEM STUDIED: GLAXOSMITHKLINE Pakistan Limited RISK MANAGEMENT SYSTEM In GSK. Note : This is only the overview of Risk Management System. Probability theory is used extensively in Risk Management System for scoring the risks on the basis of likelihood and consequences.

medicines. Betnovate. profits and growth. Seretide. Zahid Nazir – 1st Semester (MBA Col) Page 17 . Company proud of thier consistency and stability in sales. supporting welfare organizations and donating to/sponsoring various developmental concerns and hospitals. GSK Pakistan operates mainly in two industry segments: Pharmaceuticals (prescription drugs and vaccines) and consumer healthcare (over-the-counter. Beecham Pakistan (Private) Limited and Glaxo Wellcome (Pakistan) Limited. volume and prescription market shares. In addition. Aquafresh. GSK participates in year round charitable activities which include organizing medical camps. implementation and replication of models for the sustainable development of children with specific emphasis on primary healthcare and education. GSK leads the industry in value. which is also extremely involved in the design. oral care and nutritional care).COMPANY INTRODUCTION: GlaxoSmithKline Pakistan Limited was created on January 1st 2002 through the merger of SmithKline and French of Pakistan Limited. GSK consider it their responsibility to nurture the environment we operate in and persevere to extend their support to our community in every possible way. Some of their key brands include Augmentin. Panadol. Furthermore. companyis also deeply involved with our communities and undertake various Corporate Social Responsibility initiatives including working with the National Commission for Human Development (NCHD) for whom GSK was one of the largest corporate donors. Companies that respond sensitively and with commitment by changing their business practices to address such challenges will be the leaders of the future. Company believe this is both an ethical imperative and key to business success. Zantac and Calpol in medicine and renowned consumer healthcare brands include Horlicks. Macleans and ENO.standing today as the largest pharmaceutical company in Pakistan. As a leading international pharmaceutical company they make a real difference to global healthcare and specifically to the developing world. GSK maintains strong partnerships with non-government organizations such as Concern for Children.

Quality is at the heart of everything we do.GSK’s MISSION STATEMENT Excited by the constant search for innovation. We value performance achieved with integrity. we at GSK undertake our quest with the enthusiasm of entrepreneurs. Our mission is to improve the quality of human life by enabling people to do more.from the discovery of a molecule to the development of a medicine. feel better and live longer. We will attain success as a world class global leader with each and every one of our people contributing with passion and an unmatched sense of urgency. Zahid Nazir – 1st Semester (MBA Col) Page 18 .

• Establish appropriate mechanisms for communication. understood and accepted. A systematic. SCOPE OF RISK MANAGEMENT PROCESS Zahid Nazir – 1st Semester (MBA Col) Page 19 .RISK MANAGEMENT SYSTEM Risk management is an essential component of the system of internal control and governance and is regarded as good management practice throughout GSK. standardized and effective approach to risk management is required in order to: • Establish a common language and protocols for communicating risks. • Ensure that business objectives are achieved. reporting and escalation of risks. • Ensure that responsibilities for managing risks are clearly stated.

• Identify. • Confirm and Approve Risk Mitigation plans. Record and Priorities Scored Risks. • Governance and Maintenance.PROCESS STEP ACTIVITIES Following are the different steps involved in the risk management system: • Establish the Risk Management Organisation for the risk assessment area. • Implementation. Figure: Risk Management Process Zahid Nazir – 1st Semester (MBA Col) Page 20 . monitoring and of risk mitigation plans.

Risks are scored on the basis of likelihood and consequences. Risk Risk Mitigation Risk Mitigation Risk Mitigation Plan(s) Plan(s) Plan(s) Action Plans Action Plan(s) Approval Approval RISK SCORING • Risk scoring is subjective – there is no right or wrong answer it is based on personal judgement or consensus.Probability theory comes into play when a risk is going to be scored (Analyse the risks). Zahid Nazir – 1st Semester (MBA Col) Page 21 . A Risk must have at least one Risk Mitigation Plan. • Review the consequence of a risk first and only when this is agreed – review the associated likelihood of the scored consequence. A number of Risk Mitigation Plans may be attached to a Risk. A Risk Mitigation Plan must have at least one Action Plan. Risk requirements now split into three components. Mandated requirements to progress risks through workflow. • The diagram below depicts the structure of a Risk Record. • A number of Action Plans may be attached to each a Risk Mitigation Plan. INFORMATION STRUCTURE IN RMS • • • • A Risk is the basic record.

• Differences in number and ratings of risks across risk assessment areas should be explored in terms of processes. • Similar risks on different plants may have different scores because: The impact to each plant is different from the same risk. and local objectives . judgement is required where several risks all have the same score and decisions are required in terms of resource allocation. • It is essential that risks within a risk assessment area are consistently scored and prioritised and a group view is required by the Quality management Process to avoid personal bias in scoring. The risks are written in different ways / aggregated at different levels. even then. • The scoring supports the prioritisation of risks but.a team based approach is always used to reach consensus on likelihood. Zahid Nazir – 1st Semester (MBA Col) Page 22 . • The key requirement for the risk management process is that the significant risks are identified managed appropriately – the precise scoring is a secondary consideration. • As with risk description. background. • Comparisons of numbers of risks on aggregation of risk assessment areas is of little value – any analysis and trending should focus on topics and not scores. resources and approach to generate them. scoring is based on the current environment taking into account all controls.• The subjectivity on assessment of likelihood is inherently higher than that for consequence and influenced by individual perception.

the consequence and likelihood Matrix (Appendix i) has been changed. Hence. rather than focus on the impact of the Regulators detecting risks e. Note: Likelihood does not relate to how often a process is conducted but how often the risk associated with it is likely to occur. then it may be necessary to separate these into separate risks on the register and score them individually. Zahid Nazir – 1st Semester (MBA Col) Page 23 . • Risks must be considered against the criteria in each of the 3 consequence areas in turn and scored against the area with the highest consequence. A control should be considered as something which impacts how severe a risk can become and not be limited to physical controls. • If there are several potential consequences with different root causes.g. The likelihood captured in the risk management process is the likelihood of an event happening NOT the likelihood of detection e.g. • The timing of potential future audits relative to the risk being detected will not impact the score. but current controls would not stop the effect occurring then the likelihood is at least “possible” (3). • The frequency of manufacture using a particular process may impact the likelihood score. observations. to focus on the actions required by GSK with respect to the Regulators. • If there is no historical example of a risk scenario being considered. • Risks should be assessed and scored from a GSK perspective. by the regulators or internal auditors. written procedures or failsafe controls.• A control can impact the consequence or likelihood.

*********************** Zahid Nazir – 1st Semester (MBA Col) Page 24 .• The record of the consequence against which the risk is scored is in the “Area of Impact” column in the risk register. (Appendix ii) • The capture of the rationale for scoring should be encouraged and can be added in a column in the risk register or within the risk description.

Red = >10 Amber 5 – 9 Green <5 Zahid Nazir – 1st Semester (MBA Col) Page 25 . Amber. There is a pre-determined Red. Green (RAG) analysis aligned to the Consequence and Likelihood Matrix (see above Appendix) which can be used to give initial guidance on banding of risks to support focus of activities i.e.Appendix i CONSEQUENCE AND LIKELIHOOD MATRIX CONSEQUENCES Insignificant 1 Minor 2 Moderate 3 Major 4 Catastrophic 5 LIKELIHOOD Almost certain 5 Likely 4 Possible 3 Unlikely 2 Rare 1 5 10 15 20 25 4 3 2 1 8 6 4 2 12 9 6 3 16 12 8 4 20 15 10 5 The outcome of the risk assessment process is a list of scored risks which can be prioritised based on scoring allowing decisions to be made on where resource and effort should be focused.

Appendix ii RISK MANAGEMENT SYSTEM (HOME PAGE) Zahid Nazir – 1st Semester (MBA Col) Page 26 .

Appendix iii RISK MANAGEMENT SYSTEM WORKFLOW Zahid Nazir – 1st Semester (MBA Col) Page 27 .

Economic.Appendix iv RISK IDENTIFICATION TOOLS 5 -Whys Brainstorming Surveys Interviews FMEA (Failure Mode Effect Analysis) SWOT (Strengths. Weaknesses. Socio-Cultural. Opportunities & Threats) analysis PEST (Political. Technological) analysis Kaisen (Continuous Improvement) GEMBA (Go and See) Affinity & Fishbone diagrams Reality Trees (Undesirable Effects (UDEs) for complex root cause analysis Process flowcharts Potential Problem Analysis (Kepnor Tregoe) Benchmarking Mind maps IPO ************************ Zahid Nazir – 1st Semester (MBA Col) Page 28 .