MARKETING (UNR471)

Dr. Mohamed Sameh

DECISION ANALYSIS
DECISION ANALYSIS 3

• Provides a systematic approach to decision-making under conditions of uncertainty.

• Is employed across many diverse fields: healthcare, business, economics, law,
engineering…..
• Helps decision-makers think clearly about many elements of complex decisions.
• Is divided to “Decision making without experimentation” and “Decision making
with experimentation”.
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• In the early 1990s, Phillips Petroleum Company ( now Conoco Philips)

DECISION became an industry leader in the application of OR for decision analysis.
ANALYSIS • They developed a decision analysis software package called DISCOVERY.
• The user interface allows a geologist or engineer to model the uncertainties
associated with a project and then the software interprets the inputs and
constructs a decision tree that shows all the decision nodes and advises on
the best decision to:
(1) Evaluate petroleum exploration projects
(2) Rank projects in terms of preference
(3) Identify the firm’s appropriate level of participation in these projects
(4) Stay within budget.
• As a result, by 2013, they became the world’s largest independent
exploration and production company!
 • Decision-makers and nature can be viewed as the two 5
players.

ANALOGY • The alternatives and the possible states of nature can then be
viewed as the available strategies.
WITH GAME
THEORY • The framework for decision making:
1. The decision-maker chooses one of the alternatives.
2. Nature chooses one of the possible states of nature.
3. Each choice combination results in a payoff used to
build the payoff table.
4. The table is used to find an optimal alternative for the
decision-maker.
• Unlike game theory, nature is not Rationale. It is a passive
player that chooses its strategies(states of nature) in some
random fashion.
 DECISION MAKING WITHOUT EXPERIMENTATION

• Misr Textiles Co. (Ghazl Al-Mehalla) owns several factories. The management is
considering renewing the production line on one factory to introduce a new line of
clothing. The cost of developing is about 1,000,000 L.E. The planning director
believes from experience that there is 25% of success for any new product in today’s
market. If the new line is successful, the expected profit from sales within the next 5
years will be 8,000,000 L.E., so the company’s expected gross profit will be about
7,000,000 L.E. However, if the product is not successful, the company will lose the
cost of the renovation. As the company’s financial situation is unstable, the loss would
seriously affect it. Another textile company has offered to purchase the factory for
900,000 L.E. Should the company sell the factory, or renew it?
DECISION MAKING WITHOUT EXPERIMENTATION

Pay-off Matrix
Alternatives Payoff
Success Failure
Renew the Factory 7,000,000 -1,000,000
Ghazl Al-Mehalla Sell the Factory 900,000 900,000
Chance of status of nature 0.25 0.75

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Decision making without experimentation
MAX-MINI CRITERION
• For each possible decision alternative, find the minimum payoff over all possible
states of nature.
1. Find the maximum of these minimum payoffs.
2. Choose the alternative whose minimum payoff gives this maximum.
Alternatives Payoff
Success Failure minimum
Renew the Factory 70 -10 -10
Ghazl Al-
Sell the Factory 9 9 9
Mehalla
Chance of status of nature 0.25 0.75
Max-mini value
• Best Decision: Sell the factory.
• A pessimistic viewpoint.
• Provides the best guarantee of the payoff, regardless of the true state of nature.
Decision making without experimentation
MAXIMUM LIKELIHOOD CRITERION
1. Identify the most probable state of nature.
2. For this state, find the alternative with the maximum payoff.
3. Choose this alternative.

Alternatives Payoff
Success Failure
Renew the Factory 70 -10
Ghazl Al- Sell the Factory 9 9
Mehalla Chance of status of 0.25 0.75
nature Maximum
Maximum column value
• Best Decision: Sell the factory. probability
• Does not permit gambling on a low-probability big payoff.
Decision making without experimentation
BAYES’ DECISION RULE
1. Calculate the expected payoff (EP) for each alternative (EP = Σ Pi *Xi).
2. Choose the alternative with the maximum expected payoff.
Alternatives Payoff
Success Failure
Renew the Factory 70 -10
Ghazl Al-
Sell the Factory 9 9
Mehalla
Chance of status of nature 0.25 0.75

• EP (Renew the Factory) = 0.25 * 70 + 0.75 *-10 = 10 (1,000,000 L.E.)

• EP (Sell the Factory) = 0.25 * 9 + 0.75 * 9 = 9 (900,000 L.E.)
• Best Decision: Renew the factory.
• Incorporates all available information, including payoffs and probabilities.
• The reasonableness of the probability estimates should be assessed.
Decision making without experimentation
SENSITIVITY ANALYSIS (FOR TWO STATES OF NATURE)
• Studies the effect of probability change on the decision.
1. Let one state of nature outcome probability be P.
2. The other state probability would be 1-P.
3. The EP of any decision would be X1* P + X2 * (1-P).
4. EP for both alternatives should be equal at the crossover point.
Alternatives Payoff
Success Failure
Renew the Factory 70 -10
Ghazl Al-
Sell the Factory 9 9
Mehalla
Chance of status of nature 0.25 0.75
1-P
P
EP(Renew the factory) = 70 * P + (-10) * (1-P) = 80 P – 10.
EP(Sell the factory) = 9 * P + 9 * (1-P) = 9.
At the cross point; 80 P – 10 = 9 ➔ P = 23.75 % ( if P< 23.75 % sell the factory)
 • Experimentation can be done to improve the preliminary
estimates of the probabilities of the respective states of
nature.
DECISION
MAKING • These improved estimates are called posterior
WITH probabilities.
EXPERIMENT • If n = number of possible states of nature;
ATION • P(I) ➔ Prior probability for state I, for I = 1, 2, . . . , n;
(BAYE’S • Finding = finding from experimentation.
THEOREM)
• Finding J = one possible value of finding;
• P(I|J) ➔ posterior probability for state I, given J, for I = 1, 2,
. . . , n.
𝑃 𝐽 𝐼 ∗ 𝑃(𝐼)
• P(I|J) =
Σ𝑃 𝐽 𝐼 ∗ 𝑃(𝐼)
 • Misr Textiles Co. (Ghazl Al-Mehalla) owns several factories. The
management is considering renewing the production line on one
factory to introduce a new line of clothing. The cost of developing is
about 1,000,000 L.E. The planning director believes from
DECISION experience that there is 25% of success for any new product in
MAKING today’s market. If the new line is successful, the expected profit from
WITH sales within the next 5 will be 8,000,000 L.E., so the company’s
EXPERIMENT expected profit will be about 7,000,000 L.E. However, if the product
ATION is not successful, the company will lose the cost of the renovation.
As the company’s financial situation is unstable, the loss would
seriously affect it. Another textile company has offered to purchase
the factory for 900,000 L.E. The company could hire a marketing
consultant to make a marketing survey before launching the product
that would cost about 300,000 L.E. Based on past experience if the
product would be successful, the odds of favorable survey results
would be 60%. If the product is not, the odds of favorable survey
results would be 20%. Should the company sell the factory, or renew
it?
 • Prior probabilities: P(Success) = 0.25, P(Failure) = 0.75
• Postrior probabilities:
DECISION • P ( Fav. | Success) = 0.6 ➔ P ( Unfav. | Success) = 0.4
MAKING
• P ( Fav. | Failure) = 0.2 ➔ P ( Unfav. | Failure) = 0.8
WITH
EXPERIMENT • P( Fav.) = 0.6 * 0.25 + 0.2 * 0.75 = 0.3
ATION • P( Unfav.) = 0.4 * 0.25 + 0.8 * 0.75 = 0.7 (or = 1-P(Fav.))
0.6 ∗0.25
• Then; P ( Success | Fav.) = = 0.5 ➔
0.3
P (Failure | Fav. ) = 0.5
0.4 ∗0.25
• P ( Success | Unfav.) = = 0.143 ➔
0.7
P (Failure | Unfav. ) = 0.857
Decision making with experimentation

Fav. + Success P(Success|Fav.)

0..6*0.25=0.15 0.15/0.3 = 0.5

Renew the
Unfav. + Success P(Success|Unfav.
factory 0.4*0.25=0.1 )
Fav. + Failure 0.1/0.7 = 0.143
P(Failure|Fav.)
0.2*0.75=0.15 0.15/0.3 = 0.5

P(Fav. ) = 0.15+ 0.15 = 0.3 P(Failure|Unfav.)

Unfav. + Failure
0.8*0.75=0.6 0.6/0.7 = 0.857
P(Unfav. ) = 0.1+ 0.6 = 0.7
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