MODULE 2

STRATEGIC BUSINESS ANALYSIS

SESSION TOPIC 1: Option and Alternative Formulation and Evaluations Techniques

LEARNING OUTCOMES:
The following specific learning objectives are expected to be realized at the end of the session:
1. Enable to understand the necessity of a business to formulate strategies for its survival

KEY POINTS

Organization Structure Organizational Strategy

CORE CONTENT
Introduction:
This module covers the discussion organizational structure and strategy.

IN-TEXT ACTIVITY

Steps in Decision Making: 

Every day you are deciding, even if you do nothing you are deciding.  

All your decisions made or to be done, whether personal or professional matter, basically follows
the similar steps. These steps will be your character and the sign of your decision-making skills.  

Under Decision Theory, decisions can be done using an analytical and systematic approach. And
using this approach we based our actions on logic. Decision Theory generally include these steps:  

 
 
Let us apply the mentioned steps: 

 
 

Module 2: Strategic Business Analysis 1

Following the Decision Theory (decision analysis) steps 

Step 1. What is the problem or issue?  

You want to spend the excess money that you will received the highest return. 
Step 2: What are the alternative available? 
You can either invest to stocks, mutual funds, or bonds. In which, each alternative is differ-
ent from one another. Therefore, you have three alternatives. 
Step 3: What are the possible outcomes? 
The possible outcome may, assuming, the economy will grow, or the
economy will decline. Under the decision theory, outcomes that is beyond the control of
decision maker is called state-of-nature. For example, the growing or declining of the
economy, you cannot control it therefore state-of-nature. In this case, we have two state-
of-nature the growing and declining of the economy.  
Step 4: What are the payoffs? 
The payoff, in this case, is the return you expect from selecting one of the
alternatives- and because there are two state-of-nature, we expect six payoffs. One return
if you choose to invest in the stock and if the economy will grow, and another if the econ -
omy declines. These payoffs, as well as the other factors, can be easier understand using
the decision table or payoff table. 
Step 5: What model or approach you will use? 
Will you use the optimistic approach, pessimistic approach, or other?
Which will be discussed on the later part. 
Step 6: Decide. 

Decision Table (Payoff Table)

Decision table is the presentation of lists the alternatives, states of nature, and payoffs in a decision-
making situation. Given our example case above, below is the decision table, payoff table-

Investment Instrument Growing Economy Declining Economy

Stocks 70 -13
Mutual Funds 53 -5
Bonds 20 20

These are the parts of the Decision Table:

These are state-of-nature

Investment Instrument Growing Economy Declining Economy
Stocks 70 -13
Mutual Funds 53 -5
Bonds 20 20

These are the alternatives These are the payoffs

Module 2: Strategic Business Analysis 2

The decision makers decide in the following environments:

Type of Environment Description

Decision Making Under Certainty
Decision Making Under Uncertainty
Decision Making Under Risk
In this kind of environment, the decision makers
know with accuracy and certainty the
consequences of every alternative or decision.
Example: Treasury Bills with an 8% annual
interest and a Loan with 12% interest rate per
annum
Ratio:
The decision maker knows the interest rates of
both instrument at 8% and 12% on Treasury bills
and Loan, respectively. Thus, the decision maker
is certain and will not assume other rates.
In this kind of environment, each alternative has
several possible outcomes and the decision
maker does not know the probabilities if each
outcome.
Example: The decision to invest or not to your
own business
Ratio:
The decision to be made is one of two- If you do
not invest in the business the result ranges losing
your money or retaining it, while if you did invest
your money may grow to more than 100% or
worse incurred business losses. But the amount,
percentages, winnings or losses cannot be
ascertained with certainty.
In this kind of environment, each alternative have
several outcomes and the decision maker knows
the probability of occurrence.
Example: Color game (A single cube with color in
each side)
Ratio:
In color game, there are limited outcome. And
each throw of the cube will result to any of the 6
colors in each side or 1/6.

There are limited occasions, in personal or professional areas, that the decision maker deals with
certainty.

Now the question is ‘how we deal with uncertainty?’ – we assume, we hypothesis, we find
solutions to contingencies. Taking into consideration that making decision is mandatory, that even we do
nothing – it is a decision itself- therefore it has repercussions and effects. Accordingly, several criteria
exist to help decision maker decide under uncertain environment and it include the

 Optimistic Criterion or Maximax Approach

o The best payoff for each alternative is considered and the alternative with the best of
these is selected.

Example:

Investment Instrument Growing Economy Declining Economy Maximum in a Row

Stocks 70 -13 70Maximax
Mutual Funds 53 -5 53

Module 2: Strategic Business Analysis 3

 Bonds 20 20 20

Using the optimistic criterion for maximization of the return, Stocks will be the best option.

 Pessimistic Criterion or Maximin Approach

o The worst or minimum payoff for each alternative is considered and the alternative with
the best (maximum) payoff of these is selected.

Example:

Investment Instrument Growing Economy Declining Economy Worse in a Row

Stocks 70 -13 -13
Mutual Funds 53 -5 -5
Bonds 20 20 20 Maximin

Using the pessimistic criterion for maximization of the return, Bonds will be the best option.

 Criterion of Realism or the Hurwicz Criterion

o This is also commonly termed as the weighted average, each states of nature is to be as -
signed of their weight (or coefficient of realism), the best payoff for an alternative would
be the lowest payoff in the row and the worst would be the highest payoff in the row.

Example

Investment Instrument Growing Economy Declining Economy Average of the Row

Stocks 70 -13 20.2 Best Option
Mutual Funds 53 -5 18.2
Bonds 20 20 20
Probability 0.40 0.60

Coefficient
Using of Realism
the criterion or Weight
of realism, of Each
the decision State-of-Nature
maker should determine or assign the coefficient of
realism (or weight of each state-of-nature), in the above example the coefficient is assigned at
0.40 for growing economy and 0.60 for declining economy. Then the average mean is computed
for each alternative. The highest average will be the best option.

 Equally Likely or Laplace

o Under this criterion, each alternative is equally likely. This approach assumes that all
probabilities of occurrence for the states of nature are equal, and thus each state of na -
ture is equally likely.

Example

Investment Instrument Growing Economy Declining Economy Average of the Row

Stocks 70 -13 28.5
Best Option
Mutual Funds 53 -5 24
Bonds 20 20 20
Probability 0.50 0.50
Under the Laplace, each state-of-nature has equal chances of
occurrence
Under Laplace, each state-of-nature has equal chances of occurrence, at the case, 50-50, then

Module 2: Strategic Business Analysis 4

 each alternative’s average is computed. Depending on the objectives of the decision maker,
whether maximize or minimize, the average of the row is taken into consideration. At the case, we
want to maximize the return, then Stocks is the best alternative having higher average of the row.

 Minimax Regret
o Under this approach, the difference between the optimal option or payoff given a state of
nature and the actual payoff received for a particular decision.

Example:

Investment Instrument Growing Economy Declining Economy

Stocks 70 -13
Mutual Funds 53 -5
Bonds 20 20

Each alternative will be compared to the highest value of in each state-of-nature, growing
economy and declining economy. In the growing economy the highest return is the stocks with 70
expected return, it is the highest value of regret if not selected- (70-70, 70-53, and 70 – 20).
Same will be done in the Declining Economy, where the highest return is 20 under the bonds (20
– (-13), 20 – (-5), and 20 – (20)). The highest value after the comparison will be selected per row.
The minimax, the lowest of the maximum regret, in the case, is the Mutual Funds.

Investment Instrument Growing Economy Declining Economy Maximum of a Row

Stocks 0 33 33
Mutual Funds 17 25 25
Bonds 50 0 50 Minimax
Decision Making Under Risk

Managers the probabilities of the state of nature are known and the decision makers usually use the
Expected Monetary Value approach.

The Expected Monetary Value (EMV) refers to the mean value of each alternative. In formula:

EMV = ∑ Xi P( Xi)
Where:

Xi = payoff for the alternative in state of nature i

P( Xi ) = probability of achieving payoff Xi
∑ = summation (sum of all)

For expanded formula:

EMV = (Payoff in first state of nature * Probability of first state of nature)

+ (payoff in second state of nature * probability of second state of nature)
+ …. + (payoff in last state of nature * probability of last state of nature)

Decision Tree

Decision Tree is a graphical illustration of decision analysis, that contain decision point or decision node,
state-of-nature points or state-of-nature nodes, and payoffs.

The use of decision table (payoff table) is of great tool in performing these criteria.

Module 2: Strategic Business Analysis 5

 The image on the right, presents a decision
tree.

The (square at the start) represents the

decision node, which is one of several
alternatives may be chosen.

The (circle in each alternative) represents

the state-of-nature node, which one of the
state-of-nature will occur.

Module 2: Strategic Business Analysis 6

Finding the EMV for the alternatives of the
above presented case of decision:
EMV 20.8
EMV of Stocks = (70 * 0.4) + (-13 * 0.60)
= 20.8

EMV of Mutual Funds = (53 *.04) + ( -5 *.06) EMV 18.2

= 18.2

EMV of Bonds = 20
in both state of nature 20 is the expected
payoff EMV 20

Expected Monetary Value with Perfect

Information:

Assuming, that you can acquire the perfect information, which means that the result can be forecasted
with accuracy. Row for with perfect information is added- with the average of the 28. Therefore, you may
have addition return of 7.8 (from with perfect information less stocks row or 28 minus 20.2) and such
amount is the value of the perfect information.

Investment Instrument Growing Economy Declining Economy Average of the Row

Stocks 70 -13 20.2
Mutual Funds 53 -5 18.2
Bonds 20 20 20
With Perfect Information 70 0 28
Probability 0.4 0.6  

Prescriptive analytics

Prescriptive analytics is a process that analyzes data and provides instant recommendations on how to
optimize business practices to suit multiple predicted outcomes. In essence, prescriptive analytics takes
the “what we know” (data), comprehensively understands that data to predict what could happen, and
suggests the best steps forward based on informed simulations.

Prescriptive analytics is the third and final tier in modern, computerized data processing. These three tiers
include:

Descriptive analytics: Descriptive analytics acts as an initial catalyst to clear and concise data analysis. It
is the “what we know” (current user data, real-time data, previous engagement data, and big data).
Predictive analytics: Predictive analytics applies mathematical models to the current data to inform
(predict) future behavior. It is the “what could happen."

Prescriptive analytics: Prescriptive analytics utilizes similar modeling structures to predict outcomes and
then utilizes a combination of machine learning, business rules, artificial intelligence, and algorithms to
simulate various approaches to these numerous outcomes. It then suggests the best possible actions to
optimize business practices. It is the “what should happen.”

Prescriptive analytics is the natural progression from descriptive and predictive analytics procedures. It
goes a step further to remove the guesswork out of data analytics. It also saves data scientists and
marketers time in trying to understand what their data means and what dots can be connected to deliver a
highly personalized and propitious user experience to their audiences.

Module 2: Strategic Business Analysis 7

SELF-ASSESSMENT
Activity 1

Identify an existing company and provide for Organizational Structure.

REFERENCES
Refer to the references listed in the syllabus of the subject.

Module 2: Strategic Business Analysis 8