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Decision Trees
Analytic Hierarchy Process (AHP)

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Mary is a director of Movie X. Two
companies A and B both want exclusive
rights to her movie. If she signs with the
company B, she will receive a single lump
sum, but if she signs with the company A,
the amount she will receive depends on the
market response to her movie. What should
she do?
 Company A Payouts
Small Box Office - $200,000
Medium Box Office - $1,000,000
Large Box Office - $3,000,000
Company B Payout
Flat rate - $900,000
Probabilities
P(Small Box Office) = 0.3
P(Medium Box Office) = 0.6
P(Large Box Office) = 0.1

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 A Visual Representation of Choices, Consequences,
Probabilities, and Opportunities.

A Way of Breaking Down Complicated Situations

Down to Easier-to-Understand Scenarios

Can be used as visual aids to structure and solve

sequential decision problems

Especially beneficial when the complexity of the

problem grows

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 Types of nodes
Decision nodes - represented by squares ()
Chance nodes - represented by circles ()

Solving the tree involves pruning all but the

best decisions at decision nodes, and finding
expected values of all possible states of nature
at chance nodes

Create the tree from left to right

Solve the tree from right to left
 Chance
Event 1
node
Decision Event 2
node Event 3
 Small Box Office
$200,000

Sign with Company A. Medium Box Office

$1,000,000

Large Box Office

$3,000,000

Small Box Office

$900,000

Sign with company B Medium Box Office

$900,000

Large Box Office

$900,000
 Small Box Office
ER .3 $200,000
?
Sign with Company A .6 Medium Box Office
$1,000,000
ER .1
? Large Box Office
$3,000,000

Small Box Office

ER .3 $900,000
?
Sign with Company B Medium Box Office
.6 $900,000
.1
Large Box Office
$900,000
 Small Box Office
ER .3 $200,000
960,000
Sign with Company A .6 Medium Box Office
$1,000,000
ER .1
960,000 Large Box Office
$3,000,000

Small Box Office

ER .3 $900,000
900,000
Sign with Company B .6 Medium Box Office
$900,000
.1
Large Box Office
$900,000
A glass factory specializing in crystal is experiencing a
substantial backlog, and the firm's management is
considering three courses of action:
A) Arrange for subcontracting
B) Construct new facilities
C) Do nothing (no change)

The correct choice depends largely upon demand, which

may be low, medium, or high. By consensus, management
estimates the respective demand probabilities as 0.1, 0.5,
and 0.4.

Given the payoffs on the next page, manually create and

solve this problem using a decision tree.
The management estimates the profits when
choosing from the three alternatives (A, B, and
C) under the differing probable levels of
demand. These profits, in thousands of dollars
are presented in the table below:
0.1 0.5 0.4
Low Medium High
A 10 50 90
B -120 25 200
C 20 40 60
 Analytic Hierarchy Process (AHP) is one of Multi Criteria
decision making methods that was originally developed
by Prof. Thomas L. Saaty

It is a method to derive ratio scales from paired

comparisons.
 Information is decomposed into a hierarchy
of alternatives and criteria

Information is then synthesized to determine

relative ranking of alternatives

Both qualitative and quantitative information

can be compared using informed judgements
to derive weights and priorities
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Weight Definition

1 Equal importance

3 Weak importance of one over another

5 Essential or strong importance

7 Very strong importance

9 Absolute importance

2,4,6,8 Intermediate values between the two

adjacent judgments

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17
Montreal Co. is selecting a new location to expand its
operations. The company want to use AHP to help it
decide which location to build its new plant. It has four
criteria they will base their decision on, these are the
following: property price, distance from suppliers, the
availability of qualified labor, and the cost of labor. They
have three locations to decide from.
 PRICE DISTANCE LABOR
A B C A B C A B C
A 1 1/3 5 A 1 6 1/3 A 1 1/3 1
B 3 1 7 B 1/6 1 1/9 B 3 1 7
C 1/5 1/7 1 C 3 9 1 C 1 1/7 1

WAGES
To fill the lower triangular matrix, we use the
A B C
reciprocal values of the upper diagonal.
A 1 1/3 1/2
B 3 1 4
C 2 1/4 1
 PRICE
A B C
A 1 1/3 5
B 3 1 7
C 1/5 1/7 1 First sum (add up) all
the values in each column.
21/5 31/21 13
 PRICE
A B C
A 121/5 =5/21 1/331/21 = 7/31 513 = 5/13 Next the values in
+ + + each column are divided
by the corresponding
B 321/5 = 15/21 131/21 = 21/31 713=7/13
column sums.
+ + +
C 1/521/5 = 1/21 1/731/21 = 3/31 113 = 1/13
= 1 1 1

NOTICE: the values in each column sum to 1.

 Next find the average of each row.

PRICE
A B C Row Average
A ( 5/21 + 7/31 + 5/13 )/3 = 0.2828
B ( 15/21 + 21/31 + 7/13 )/3 = 0.6434
C ( 1/21 + 3/31 + 1/13 )/3 = 0.0738
1.000


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 Saaty proved that for consistent reciprocal matrix, max= n

Consistency Index as deviation or degree of consistency is

obtained using the following formula:

m n
CI
n 1

In our case:
CI=(3.0967-3)/2=0.0484

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 Next compare this with Random Consistency Index (R.I)

Average Random consistency

Size of matrix ( n) 1 2 3 4 5 6 7 8 9

R.I 0 0 0.58 0.90 1.12 1.24 1.32 1.41 1.45

As proposed by Saaty, the level of inconsistency in the judgement

matrix is considered acceptable if the consistency ratio is small enough
such that:
CI
CR 10%
RI
In our case:
CR=0.0484/0.58=8.3%<10%

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 Find the average for all the criterion by doing steps 1-3 on all the
criteria. Arriving at the following

Location Price Distance Labor Wages

A .2828 .2819 .1790 .1561
B .6434 .0598 .6850 .6196
C .0738 .6583 .1360 .2243
Rank the criteria in order of importance ~use the same method used in ranking
each criterion.

Criteria Price Distance Labor Wages

Price 1 1/5 3 4
Distance 5 1 9 7
Labor 1/3 1/9 1 2
Wages 1/4 1/7 1/2 1
 Repeat steps 1-4 with the new matrices. You should arrive at the following :

Criteria Price Distance Labor Wage Row

Average
Price .1519 .1375 .2222 .2857 .1933
Distance .7595 .6878 .6667 .5000 .6535
Labor .0506 .0764 .0741 .1429 .0860
Wage .0380 .0983 .0370 .0714 .0612
1.000
 CRITERIA
Price .1993 Clearly the price of
the land is #1, followed
Distance .6535 by distance to suppliers,
Labor .0860 labor pool quality, and
last cost of wages.
Wage .0612
Take the criteria matrix and multiple it by the preference vector

Location Price Distance Labor Wages CRITERIA

A .2828 .2819 .1790 .1561 Price .1993

B .6434 .0598 .6850 .6196 X Distance .6535

C .0738 .6583 .1360 .2243 Labor .0860

Wage .0612

Location A score = .1993(.2828) + .6535(.2819) + .0860(.1790) +.0612(.1561) = .2656

Location B score = .1993(.6434) + .6535(.0598) + .0860(.6850) + .0612(.6196) = .2641
Location C score = .1993(.0738) + .6535(.6583) + .0860(.1360) + .0612(.2243) = .4703
LOCATION Score

A .2656
B .2641
C .4703

1.0000

Based on the scored Location C should be chosen for Montreal Co. to

built a plant.
 Systems Engineering: Principles and Practice, 2nd edition, 2011. A. Kossiakoff et al., Wiley.
Chapter 9

Saaty, T.L. (2000). Fundamentals of Decision Making and Priority Theory with the Analytic Hierarchy Process,
RWS Publishers, Pittsburgh, PA, USA.