DECISION MAKING

TOOLS

REPORTED BY: MARIA THERESE M. CONSUL

 LEARNING OBJECTIVES

• Create a simple decision tree

• Build a decision table
• Explain when to used of the three types of decision making environments
• Calculate an expected monetary value (EMV)
• Evaluate the nodes in decision tree
• Create a decision tree with a sequential decisions
 WHAT MAKES THE DIFFERENCE?
GOOD DECISION AND BAD DECISION?

• A good decision –one that uses analytic decision making –based on logic and
considers all available data and possible alternatives.
• It also follows these six step:
1. Clearly define the problem and the factors that influence it.
2. Develop specific and measurable objectives.
3. Develop a model –that is, a relationship between objectives and variables (which are
measurable quantities).
4. Evaluate each alternative solution based on its merits and drawbacks.
5. Select the best alternative.
6. Implement and evaluate the decision and then set a timetable completion.
 OBJECTIVE OF DECISION ANALYSIS

• A method for reducing UNCERTAINTY in the decision making process through DATA
ANALYSIS.
• Provides a RATIONAL PROCESS for making decisions that is usually far better than
random selection.
• Easy to update if conditions change
 ANALYTIC DECISION MAKING

• One that requires models, objective and quantifiable variables, often in form of
probabilities and payoffs.
Introduction to two decision making tools
These two tools are used in numerous OM situations ranging from new product
analysis to capacity planning, to location planning to supply chain disaster planning

• Decision Table
• Decision Tree
 DECISION TERMINOLOGY

• Alternatives – the options available to the decision maker. Oftentimes DO

NOTHING is a viable option.
• State of Nature –Random factors outside the control of the decision maker
that nonetheless influence the outcome of the decision.
• Probabilities –the relative likehood of each possible state of nature. Most
often expressed as estimates based on secondary information. Not always
available.
• Payoff –a quantitative result for each alternative / state of nature combination.
 GETZ PRODUCT DECISION PROBLEM

• Getz Product Company is investigating the possibility of producing and marketing backyard storage sheds. Undertaking
this project would require the construction of either a large o a small manufacturing plant. The market for the
product produced –storage sheds–could be either favorable or unfavorable. Getz, of course has the option of not
developing a new product line at all
States of Nature
“ Out of control”
Set up cost /
Possible
Loss
Alternative
Decisions
“what could
we do”

Probabilities
 DECISION TABLE

• Is an excellent tool to use in both testing and requirements management.

Essentially it is a structured exercise to formulate requirements when dealing
with complex business rules. Decision tables are used to model complicated
logic.

Types of Decision-Making Environments

• Decision making under uncertainty

• Decision making under risk
• Decision making under certainty
THE CRITERIA FOR DECISION MAKING
UNDER UNCERTAINTY

MAXIMAX
This decision criterion locates the alternative with the highest possible gain
The decision for hopeless OPTIMIST. What is the best that can happen?
No probabilities are involved.

The maximum payoff from any state of nature for each decision alternative
THE CRITERIA FOR DECISION MAKING
UNDER UNCERTAINTY

MAXIMIN
This decision criterion locates the alternative that has the least possible loss.
The decision for the hardened PESSIMIST or the very cautious.
What is the best of the worst that can happen? No probabilities are involved

The best minimum payoff from any state of nature for each decision alternative.
 THE CRITERIA FOR DECISION MAKING
UNDER UNCERTAINTY

EQUALLY LIKELY
This approach assumes that each state of nature is equally likely to occur.
200,000 + (-180,000)(.5) = 10,000

Probabilities 0.6 0.4 0.5 0.5

Given even state probabilities, and using a weighted average, what is the best payoff?
In equally likely criterion we set probabilities to be the same/even.
 DECISION MAKING UNDER RISK

• Several possible state of nature may occur, each with an assumed probability.
Given a decision table with conditional values and probability assessments for
all states of nature, EVM for each alternative can be determined.

EXPECTED MONETARY VALUE

• Given the state probabilities, and using a weighted average, what is the best
payoff?
• We do not have PERFECT information, just our best analysis
 COMPUTE FOR EXPECTED MONETARY
VALUE

FORMULA:
In this case Getz should
built a SMALL PLANT
having the highest EMV

SOLUTION:
EMV (A1) = (0.6)(200,000)+(0.4)(-180,000) = 48,000
EMV (A2) = (0.6)(100,000)+(0.4)(-20,000) = 52,000  The
EMV (A3) = (0.6)(0)+(0.4)(0) = 0 Maximum
EMV
 DECISION MAKING UNDER CERTAINTY

• Supposed that Getz operations manager has been approached by a marketing research firm that proposes to
help him make the decision about whether to build the plant to produce storage sheds.The marketing
researcher claim that their technical analysis will tell Getz with certainty whether market is favorable for the
proposed product.
• The marketing firm would charge Getz 65,000 for this information, that could prevent Getz from making a
very expensive mistake in the first place.
THE QUESTIONS ARE: Insights:
If manager able to determine which state of nature
• Should Getz hire the firm to make the study? would occur then he would KNOW which
• Is it worth 65,000? DECISION to make (KNOWLEDGE now has a
VALUE)
• What it might be worth?
becomes
Probability payoff + (with
knowledge)
 PERFECT INFORMATION

• Solid, quality reliable information can be hard to come by. Firms hire specialists,
consultants, academics, etc. to use their expertise in order to greatly improve
the quality of fundamental data.
- Geologists, Economist Assessment, Marketing Specialist, etc
The goal is to reduce RISK and increase CERTAINTY

What is the value of PERFECT information? What should a company be willing to

pay for such information?
This is called the
EVPI (Expected Value of Perfect Information)
EVPI = Expected Value with Perfect Information – Maximum EMV
 EXPECTED VALUE OF PERFECT
INFORMATION

EVwPI is the expected (average) return if perfect information is available

Steps to calculate for EVwPI

• Choose best alternative for each state of nature
• Multiply its payoff times the probability of occurrence of that state of nature
• Repeat for each state of nature

Solution:

EVwPI = (200,000)(0.6) + (0)(0.4)

EVwPI = 120,000
 COMPUTE FOR EVPI

EVwPI = 120,000
Maximum EMV = 52,000 (A2 small plant)
Insights:
Formula:
EVPI = Expected Value with Perfect Information – Maximum EMV As the conditional value
Solution: of “large plant/favorable
market” increases, the
EVPI = 120,000 - 52,000 = 68,000 EVM also increases and
• The most Getz should be willing to pay for the perfect information is 68,000. This will affect the value of
conclusion of course is based on the assumption that the probability of the first state EVwPI and EVPI, would
of nature is 0.6 and the second is 0.4. also increase
How does EVPI change if the “large plant/favorable market” conditional value is
250,000?
EVPI = 150,000 - 78,000
(Answer: the EMV (A1) = 78,000, AI is now the preferable decision) = 72,000
 DECISION TREE

• When there are TWO OR MORE SEQUENTIAL DECISIONS and later

decisions are based on the outcome of prior ones.
• A GRAPHICAL MEANS of analyzing decision alternatives and states of nature
(Starting at the right of the tree and working back).
• Is a decision support tool that uses a tree-like model of decisions and their
possible consequences, including chance event outcomes, resource costs, and
utility. It is one way to display an algorithm that only contains conditional
control statements.
SIMPLE DE CISION TRE E FOR GE TZ PRODUCTS

F ive s t e p s in a n a ly z in g
p rob le m s w it h d e c is ion t re e :

1 . D e f in e t h e p rob le m
2 . S t r u c t u re or d r aw t h e
d e c i s i on t re e .
3 . A s s ig n p rob a b ilit ie s t o t h e
s t a t e of n a t u re .
4 . E s t i m a t e p ayof f s for e a c h
NEED TO p os s ib le c om b in a t ion of
d e c is ion a lt e r n a t ive s a n d
KNOW s t a t e s of n a t u re .
5 . S olve t h e p rob le m by
c om p u t in g t h e E M V for
e a c h s t a t e s of n a t u re
n od e .
C O M P L E T E D D E C I S I O N T R E E F O R G E T Z P RO D U C T S

• Payoffs are p laced at th e

righ t – h an d side of each
of tree’s b ran ch es. th e
p rob ab ilities are p laced
in p aren th eses n ex t to
each

• Th e b ran ch leavin g th e
NEED TO decision n ode to th e
KNOW state -of -n atu re n ode
with th e h igh est E MV
will b e ch osen . in Getz’s
case , a small p lan t sh ou ld
b e b u ilt
 A MORE COMPLEX DECISION TREE

Let’s say that Getz Products has two decisions to make

With the second decision dependent on the outcome of the first
Before deciding about building a new plant – option is to conduct its own marketing survey, at a
cost 10,000
The information from this survey could help them to decide whether to build large plant, small
plant or to do nothing at all
Getz recognize that although such survey will not provide it with perfect information, it may be
extremely helpful.

• Note all possible outcomes and alternatives are included in their logical sequence and should be
examined carefully.
 LETS EXAMINE THE TREE

 1 s t d e c is ion p oin t =
c o n d u c t m a r ke t s u r vey
v s n ot t o c on d u c t
m a r ke t s u r vey
 2nd decision point = to
b u ilt la r g e p la n t , s m a ll
p la n t o r t o d o n o t h in g
 P ro b a b i l i t y o f f avo r a b l e
s u r vey re s u lt = 4 5 %
NEED TO  P ro b a b ilit y o f n e g a t ive
s u r vey re s u l t = 5 5 %
KNOW
U P P E R PA RT O F T R E E

• S t a t e - o f - n a t u re - n od e 2 &
3 f avor a b l e m a r ke t
p rob a b ilit y = 7 8 %
• S t a t e - o f - n a t u re - n od e 2 &
3 u n f avor a b l e m a r ke t
p rob a b ilit y = 2 2 %

A MORE COMPLEX DECISION TR1EE FOR GETZ PRODUCTS

 M I D D L E PA RT O F T H E
TREE

S t a t e - o f - n a t u re - n od e 4
& 5 f avor a b le m a r ke t
p rob a b ilit y = 2 7 %
S t a t e - o f - n a t u re - n od e 4
& 5 u n f avor a b le m a r ke t
p rob a b ilit y = 7 3 %

NEED TO
KNOW L OW E R PA RT O F T H E
TREE

S t a t e - o f - n a t u re - n od e 6
& 7 f avor a b l e m a r ke t
p rob a b ilit y = 6 0 %
S t a t e - o f - n a t u re - n od e 6
& 7 u n f avor a b l e m a r ke t
p rob a b ilit y = 4 0 %

A MORE COMPLEX DECISION TR1EE FOR GETZ PRODUCTS

 E VA L UAT E E AC H N O D E S
IN A DECISION TREE

The rest of probabilities are all

conditional probabilities e.g 78% is the
probability of a favorable market
(favorable result from a market survey),
of course you would expect a high
probability of a favorable market
indicated that the market is good.

The cost of study = 10, 000 –has been

subtracted from each top 10 tree
branches

a. Favorable of 200,000 – 10,000 =

190,000
b. Unfavorable of -180,000 – 10,000 =
190,000
Given favorable survey results:

EMV (node 2) = (.78)(190,000) +

(.22)(-190,000) = 106,400
EMV (node 3) = (.78)(90,000) +
(.22)(-30,000) = 63,600
EMV of no plant = -10,000

If the survey results are favorable, a

large plant should be built.

Given negative survey results:

EMV (node 4) = (.27)(190,000) +

(.73)(-190,000) = -87,400
EMV (node 5) = (.27)(90,000) +
(.73)(-30,000) = 2,400
EMV of no plant = -10,000

If the survey results are negative, a

small plant should be built.
EMV of conducting a market survey:

EMV (node 1) = (.45)(106,400) +

(.55)(2,400) = 49,200

If the market survey is not

conducted:

EMV (node 6) = (.6)(200,000) +

(.4)(180,000) = 48,000
EMV (node 7) = (.6)(100,000) +
(.4)(20,000) = 52,000
EMV of no plant = 0

Building a small plant is the best

choice, given the marketing
research is not performed.
 (EMV) EXPECTED MONETARY VALUE

Therefore:
As the EMV of not conducting survey is 52,000 vs an EMV of 49,200 for
conducting the study –the best choice is to NOT SEEK MARKETING
information. Getz should built the SMALL PLANT.
Getz estimates that if he conducts a market survey, there is really only a 35%
chance the results will indicate a favorable market for the sheds. How does the
tree change?

(Answer: the EMV of conducting a market survey = 38,800 so Getz should = (.35)(106,400) + (.65)(2,400)
still not do it.)
THANK YOU