Operations Research: Introduction, Historical Background

Operations research (OR) is an analytical method of problem-solving and decision-making that is useful in the management of
organizations. In operations research, problems are broken down into basic components and then solved in defined steps by
mathematical analysis.

Analytical methods used in OR include mathematical logic, simulation, network analysis, queuing theory, and game theory. The
process can be broadly broken down into three steps.

1. A set of potential solutions to a problem is developed. (This set may be large.)

2. The alternatives derived in the first step are analyzed and reduced to a small set of solutions most likely to prove workable.
3. The alternatives derived in the second step are subjected to simulated implementation and, if possible, tested out in real-
world situations. In this final step, psychology and management science often play important roles.

Phases in Operation Research Study:

Since, the main objective of operation research is to provide better quantitative information’s for making decision. Now our aim is to
learn how we can have better decisions.

(i) Judgment Phase:

1. Determination of operation.
2. Determination of objectives.
3. Determination of effectiveness of measures.
4. Determination of type of problem, its origin and causes.

(ii) Research Phase:

1. Observation and data collection for better understanding of the problem.

2. Formulation of relevant hypothesis and models.
 3. Analysis of available information and verification of hypothesis.
4. Production and generation of results and consideration of alternatives.

(iii) Action Phase:

1. Recommendations for remedial action to those who first posed the problem, this includes the assumptions made, scope and
limitations, alternative courses of action and their effect.
2. Putting the solution to work: implementation.

Without OR, in many cases, we follow these phases in full, but in other cases, we leave important steps out. Judgment and subjective
decision-making are not good enough. Thus industries look to operation research for more objective way to make decisions. It is
found that method used should consider the emotional and subjective factors also.

For example, the skill and creative labour are important factors in our business and if management wants to have a new location,
the management has to consider the personal feeling of the employees for the location which he chooses.

Characteristics (Features) of Operation Research:

(i) Inter-Disciplinary Team Approach:

This requires an inter-disciplinary team including individuals with skills in mathematics, statistics, economics, engineering, material
sciences, computer etc.

(ii) Wholistic Approach to the System:

While evaluating any decision, the important interactions and their impact on the whole organisation against the functions originally
involved are reviewed.

(iii) Methodological Approach:

O.R. utilises the scientific method to solve the problem

(iv) Objective Approach:

O.R. attempts to find the best or optimal solution to the problem under consideration, taking into account the goals of the
organisation.

Methodology of Operation Research:

1. Formulating the Problem:

The problem must be first clearly defined. It is common to start the O.R. study with tentative formulation of the problem, which is
reformulated over and again during the study. The study must also consider economical aspects.

While formulating the O.R. study, analyists must analyse following major components:

(i) The environment:

Environment involves physical, social and economical factors which are likely to affect the problem under consideration. O.R. team
or analysts must study the organisation contents including men, materials, machines, suppliers, consumers, competitors, the
government and the public.

(ii) Decision-makers:

Operation analyst must study the decision-maker and his relationship to the problem at hand.

(iii) Objectives:
Considering the problem as whole, objectives should be defined.

(iv) Alternatives:

The O.R. study determines as to which alternative course of action is most effective to achieve the desired objectives. Expected
reactions of the competitors to the alternative must also be considered.

2. Deriving Solution:

Models are used to determine the solution either by simulation or by mathematical analysis. Mathematical analysis for deriving
optimum solution includes analytical or numerical procedure, and uses various branches of mathematics.

3. Testing the Model and Solution:

A properly formulated and correctly manipulated model is useful in predicting the effect of changes in control variables on the overall
system effectiveness. The validity of the solution is checked by comparing the results with those obtained without using the model.

4. Establishing Controls over the Solution:

The solution derived from a model remains effective so long as the uncontrolled variables retain their values and the relationship.
The solution goes out of control, if the values of one or more variables vary or relationship between them undergoes a change. In
such circumstances the models need to be modified to take the changes into account.

5. Implementing the Solution:

Solution so obtained should be translated into operating procedure to make it easily understandable and applied by the concerned
persons. After applying the solution to the system, O.R. group must study the response of the system to the changes made.
Historically, the term Operations Research originated during Second World War when U.S.A. and Great Britain’s Armed Forces sought
the assistance of Scientists to solve complex and very difficult strategical and tactical problems of warfare, like making mines harmless
or increasing the efficiency of antisubmarine aerial warfare, etc.

Operations research employs mathematical logic to complex problems requiring managerial decisions.

Operations research aids, in solving diverse business problems and in planning and investigation of major operational decisions.

Operations Research (Operational Research, O.R., or Management science) includes a great deal of problem-solving
techniques like Mathematical models, Statistics and algorithms to aid in decision-making. O.R. is employed to analyze complex real-
world systems, generally with the objective of improving or optimizing performance.

In other words, Operations Research is an interdisciplinary branch of applied mathematics and formal science which makes use of
methods like mathematical modeling, algorithms statistics and statistics to reach optimal or near optimal solutions to complex
situations.

SCOPE OF OPERATIONS RESEARCH

In its recent years of organized development, O.R. has solved successfully many cases of research for military, the government and
industry. The basic problem in most of the develop-ing countries in Asia and Africa is to remove poverty and hunger as quickly as
possible. So there is a great scope for economist, statisticians, administrators, politicians and technicians working in a team to solve
this problem by an O.R. approach.
On the other hand, with the explosion of population and consequent shortage of food, every country is facing the problem of optimum
allocation of land for various crops in accordance with climatic conditions and available facilities. The problem of optimal distribution
of water from a resource like a canal for irrigation purposes is faced by developing country. Hence a good amount of scientific work
can be done in this direction.

In the field of Industrial Engineering, there is a claim of problems, starting from the pro-curement of material to the despatch of
finished products. Management is always interested in optimizing profits.

Hence in order to provide decision on scientific basis, O.R. study team con-siders various alternative methods and their effects on
existing system. The O.R. approach is equally useful for the economists, administrators, planners, irrigation or agricultural experts
and statisticians etc.

Operation research approach helps in operation management. Operation management can be defined as the management of systems
for providing goods or services, and is concerned with the design and operation of systems for the manufacture, transport, supply
or service. The operating systems convert the inputs to the satisfaction of customers need.

Thus the operation management is concerned with the optimum utilisation of resources i.e. effective utilisation of resources with
minimum loss, under utilisation or waste. In other words, it is concerned with the satisfactory customer service and optimum resource
utilisation. Inputs for an operating system may be material, machine and human resource.
O.R. study is complete only when we also consider human factors to the alternatives made available. Operation Research is done by
a team of scientists or experts from different related disciplines.

For example, for solving a problem related to the inventory management, O.R. team must include an engineer who knows about
stores and material management, a cost ac-countant a mathematician-cum-statistician. For large and complicated problems, the
team must include a mathematician, a statistician, one or two engineers, an economist, computer program-mer, psychologist etc.

Some of the problems which can be analysed by operations research are given hereunder:

(I) Finance, Budgeting and Investment:

Cash flow analysis, long range capital requirement, investment portfolios, divi-dend policies,
Claim procedure, and
Credit policies.
(II) Marketing:

Product selection, competitive actions,

Number of salesmen, frequencies of calling on, and
Advertising strategies with respect to cost and time.
(III) Purchasing:
Buying policies, varying prices,
Determination of quantities and timing of purchases,
Bidding policies,
Replacement policies, and
Exploitation of new material resources.
(IV) Production Management:

Physical distribution: Location and size of warehouses, distribution centres and retail outlets, distribution policies.
Facilities Planning: Number and location of factories, warehouses etc. Loading and unloading facilities.
Manufacturing: Production scheduling and sequencing stabilisation of produc-tion, employment, layoffs, and optimum product mix.
Maintenance policies, crew size.
Project scheduling and allocation of resources.
(V) Personnel Management:

Mixes of age and skills,

Recruiting policies, and
Job assignments.
(VI) Research and Development:

Areas of concentration for R&D.

Reliability and alternate decisions.
Determination of time-cost trade off and control of development projects.

LIMITATIONS OF OPERATIONS RESEARCH

These do not take into account qualitative and emotional factors.
These are applicable to only specific categories of decision-making problems.
These are required to be interpreted correctly.
Due to conventional thinking, changes face lot of resistance from workers and some-times even from employer.
Models are only idealised representation of reality and not be regarded as absolute.
Costly: Operations Research (OR) is very costly. This is because OR makes mathematical models for taking decisions and solving
problems. The company has to make various models for solving different problems. All this increments the cost.

Not Realistic: OR experts make very complex models for solving problems. These models may not be realistic. Hence, they may not
be useful for real-life situations.

Complex: OR is very complex concept. It is very difficult for an average manager to understand it. Therefore, most managers do not
use OR techniques.

DECISION UNDER CERTAINTY, UNCERTAINTY, AND RISK

Decision-making under Certainty
A condition of certainty exists when the decision-maker knows with reasonable certainty what the alternatives are, what conditions
are associated with each alternative, and the outcome of each alternative. Under conditions of certainty, accurate, measurable, and
reliable information on which to base decisions is available.

The cause and effect relationships are known and the future is highly predictable under conditions of certainty. Such conditions exist
in case of routine and repetitive decisions concerning the day-to-day operations of the business.

DECISION-MAKING UNDER RISK:

When a manager lacks perfect information or whenever an information asymmetry exists, risk arises. Under a state of risk, the
decision maker has incomplete information about available alternatives but has a good idea of the probability of outcomes for each
alternative.

While making decisions under a state of risk, managers must determine the probability associated with each alternative on the basis
of the available information and his experience.

Decision-making under Uncertainty:

Most significant decisions made in today’s complex environment are formulated under a state of uncertainty. Conditions of uncertainty
exist when the future environment is unpredictable and everything is in a state of flux. The decision-maker is not aware of all available
alternatives, the risks associated with each, and the consequences of each alternative or their probabilities.
The manager does not possess complete information about the alternatives and whatever information is available, may not be
completely reliable. In the face of such uncertainty, managers need to make certain assumptions about the situation in order to
provide a reasonable framework for decision-making. They have to depend upon their judgment and experience for making decisions.

Modern Approaches to Decision-making under Uncertainty:

There are several modern techniques to improve the quality of decision-making under conditions of uncertainty.

The most important among these are:

(1) Risk analysis,

(2) Decision trees and
(3) Preference theory.

Risk Analysis:
Managers who follow this approach analyze the size and nature of the risk involved in choosing a particular course of action.
For instance, while launching a new product, a manager has to carefully analyze each of the following variables the cost of launching
the product, its production cost, the capital investment required, the price that can be set for the product, the potential market size
and what percent of the total market it will represent.

Risk analysis involves quantitative and qualitative risk assessment, risk management and risk communication and provides managers
with a better understanding of the risk and the benefits associated with a proposed course of action. The decision represents a trade-
off between the risks and the benefits associated with a particular course of action under conditions of uncertainty.

DECISION TREES:

These are considered to be one of the best ways to analyze a decision. A decision-tree approach involves a graphic representation
of alternative courses of action and the possible outcomes and risks associated with each action.

By means of a “tree” diagram depicting the decision points, chance events and probabilities involved in various courses of action,
this technique of decision-making allows the decision-maker to trace the optimum path or course of action.

Preference or Utility Theory:

This is another approach to decision-making under conditions of uncertainty. This approach is based on the notion that individual
attitudes towards risk vary. Some individuals are willing to take only smaller risks (“risk averters”), while others are willing to take
greater risks (“gamblers”). Statistical probabilities associated with the various courses of action are based on the assumption that
decision-makers will follow them.
3For instance, if there were a 60 percent chance of a decision being right, it might seem reasonable that a person would take the
risk. This may not be necessarily true as the individual might not wish to take the risk, since the chances of the decision being wrong
are 40 percent. The attitudes towards risk vary with events, with people and positions.

Top-level managers usually take the largest amount of risk. However, the same managers who make a decision that risks millions of
rupees of the company in a given program with a 75 percent chance of success are not likely to do the same with their own money.

Moreover, a manager willing to take a 75 percent risk in one situation may not be willing to do so in another. Similarly, a top executive
might launch an advertising campaign having a 70 percent chance of success but might decide against investing in plant and
machinery unless it involves a higher probability of success.

Though personal attitudes towards risk vary, two things are certain.

Firstly, attitudes towards risk vary with situations, i.e. some people are risk averters in some situations and gamblers in others.

Secondly, some people have a high aversion to risk, while others have a low aversion.

Most managers prefer to be risk averters to a certain extent, and may thus also forego opportunities. When the stakes are high,
most managers tend to be risk averters; when the stakes are small, they tend to be gambler.
Decision Tree Analysis
Decision Tree may be understood as the logical tree, is a range of conditions (premises) and actions (conclusions), which are depicted as nodes
and the branches of the tree which link the premises with conclusions. It is a decision support tool, having a tree-like representation of decisions
and the consequences thereof. It uses ‘AND’ and ‘OR’ operators, to recreate the structure of if-then rules.

A decision tree is helpful in reaching the ideal decision for intricate processes, especially when the decision problems are interconnected and
chronological in nature.

A decision tree does not constitute a decision but assists in making one, by graphically representing the material information related to the
given problem, in the form of a tree. It diagrammatically depicts various courses of action, likely outcomes, states of nature, etc, as nodes, branches
or sub-branches of a horizontal tree.

Nodes
There are two types of Nodes:

 Decision Node: Represented as square, wherein different courses of action arise from decision node in main branches.
 Chance Node: Symbolised as a circle, at the terminal point of decision node, the chance node is present, where they emerge as sub-branches. These
depict probabilities and outcomes.

For instance: Think of a situation where a firm introduces a new product. The decision tree presented below gives a clear idea of managerial
problems.
  Key A is a decision node, wherein the decision is taken, i.e. to test the product or drop the same.
 Key B is an outcome node, which shows all possible outcomes, that can be taken. As per the given situation, there are only two outcomes, i.e. favorable
or not.
 Key C is again a decision node, that describes the market test is positive, so the firm’s management will decide whether to go further with complete
marketing or drop the product.
 Key D is one more decision node, but does not shows any choice, which depicts that if the market test is unfavorable then the decision is to drop the
product.
 Key E is again an outcome node.

The decision tree can be applied to various areas, where decisions are pending such as make or buy decision, investment decision, marketing
strategy, the introduction of a new project. The decision maker will go for the alternative that increases the anticipated profit or the one which
reduces the overall expected cost at each decision point.
Types of Decision Tree

In a single stage decision tree, the decision maker can find only one solution, which is the best course of action, on the basis of the information
gathered. On the other hand, multi-stage decision tree involves a series of the decision to be taken.

Decision Tree Analysis

The Decision Tree Analysis is a schematic representation of several decisions followed by different chances of the occurrence. Simply, a tree-
shaped graphical representation of decisions related to the investments and the chance points that help to investigate the possible outcomes is called
as a decision tree analysis.
The decision tree shows Decision Points, represented by squares, are the alternative actions along with the investment outlays, that can be
undertaken for the experimentation. These decisions are followed by the chance points, represented by circles, are the uncertain points, where the
outcomes are dependent on the chance process. Thus, the probability of occurrence is assigned to each chance point.

Once the decision tree is described precisely, and the data about outcomes along with their probabilities is gathered, the decision alternatives can
be evaluated as follows:

1. Start from the extreme right-hand end of the tree and start calculating NPV for each chance points as you proceed leftward.
2. Once the NPVs are calculated for each chance point, evaluate the alternatives at the final stage decision points in terms of their NPV.
3. Select the alternative which has the highest NPV and cut the branch of inferior decision alternative. Assign value to each decision point equivalent to
the NPV of the alternative selected.
4. Again, repeat the process, proceed leftward, recalculate NPV for each chance point, select the decision alternative which has the highest NPV value
and then cut the branch of the inferior decision alternative. Assign the value to each point equivalent to the NPV of selected alternative and repeat this
process again and again until a final decision point is reached.
Thus, decision tree analysis helps the decision maker to take all the possible outcomes into the consideration before reaching a final investment
decision.

A decision tree 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.