EBS Decision Making Techniques

June 8, 2004
 1. Decision Analysis
• There are two common elements to every
decision problem:
 A choice has to be made.
 There must be a criterion by which to evaluate
the outcome of the choice.
• A pattern of decision/ chance event/
decision/ chance event… is the single most
important characteristic of problems that are
potentially solvable by the technique of
decision analysis.
 Problem Characteristics
• The decision maker seeks a technique that
matches the problem’s special characteristics. The
two principal characteristics of a problem for
which decision analysis will be an effective
technique:
 The problem comprises a series of sequential decisions
spread over time. These decisions are interwoven with
chance elements, with decisions taken in stages as new
information emerges.
 The decisions within the sequence are not
quantitatively complex.
 Decision Tree
• The logical sequence of decisions and chance
events are represented diagrammatically in a
decision tree, with decision nodes represented by a
square () and chance nodes by a circle (O),
connected by branches representing the logical
sequence between nodes.
• At the end of each branch is a payoff. Although
the payoff can be non-monetary, Expected
Monetary Value (EMV) is the usual criterion for
decision making in decision analysis.
 Carrying Out Decision Analysis
• Stage 1:Draw
1 the Tree
• Stage 2:
2 Insert Payoffs
 This might include a “gate”, or the cost of
proceeding down a particular path: the symbol
 straddles the branch.
• Stage 3:
3 Insert Probabilities
 Carrying Out Decision Analysis, 2
• Stage 4:4 Roll-back Procedure
 Starts with the payoffs and works backwards to

the commencement of the tree.

 Abandon branches with inferior pay-offs. The

elimination of a branch is denoted by ‖.

 All but the most favorable branch is eliminated.

This is the Optimal Path.

Path
• Stage 5:5 Summarize the Optimal Path and
Draw up the Risk Profile.
Profile
 Risk Profile
• …is a table summarizing the possible outcomes on
the optimal path, along with their payoffs and
probabilities.
 This is not the same thing as listing all outcomes since
the act of choosing the optimal path will have
eliminated some possibilities.
 A decision maker may favor a course with a lower
EMV but a more attractive risk profile.
 This will reveal whether the EMV incorporates a high-
impact, low probability (HILP) event.
 Where differences are small, a report might contain
multiple profiles.
 Value of Additional Information
• The Expected Value of Sample Information
(EVSI) relates to some specific extra
information.
 It is measured as the amount by which the
EMV of the decision will increase if this
information is available at zero cost.
cost
 This is a guide to the maximum amount that
should be paid for a particular piece of
information.
 Value of Additional Information, 2
• The Expected Value of Perfect Information
(EVPI) relates to any piece of information.
 It is measured as the amount by which the
EMV of the decision will increase if perfect
information were available.
 Perfect information means that the decision
maker is told what will be the outcome at every
chance event node.
 Perfect information does not guarantee a
particular outcome: it only tells what the
outcome will be.
 Validity of the EMV Criterion
• It frequently makes sense to do as well as possible
‘on average’: the foundation of EMV. However,
when there are very large payoffs or losses (even
with low probability), another criterion may be
selected by the decision maker.
 Maximin:
Maximin At each decision node, the option is selected
whose worst possible outcome is better than the worst
possible outcome of other options.
 Expected Opportunity Loss (EOL) incorporates the
value of the excluded alternative, calculated by
multiplying lost profit payoffs by the corresponding
probabilities.
 Proceeding to Decision
• Recommendations should be tested against
other criteria:
 Is the decision tree an accurate model of the
decision faced?
 How much faith can be put in the probability
estimates?
 Is EMV an appropriate criterion for the
situation?
 How robust (sensitive to small variations in
assumptions) is the optimal decision?
 2. Advanced Decision Analysis
• The most difficult aspect of decision
analysis is the derivation of the probabilities
of chance events.
• The fact that an optimal decision was so
highly dependent upon one probability is
valuable information:
 It suggests that the decision problem has no
clear-cut answer.
 It also indicates the area to which attention
should be given and further work done.
Continuous Probability Distributions
• Rather than being comprised of discrete values, a
chance node outcome may be a continuous
distribution, depicted in a decision tree by a fan.
• Probability in a distribution is notionally
determined by measuring areas under the curve.
 Alternatively, one can produce a cumulative
distribution – one that indicates on the vertical scale the
probability of a variable taking a value more than, or
less than, the value indicated on the horizontal scale.
 EMV is calculated upon a selected number of
representative values, often bracket medians.
 Bracket Medians
1. Decide how many representative values
are required.
• Rule of thumb: at least five but not more than
ten.
• If calculations are computerized, a large
number of values can be used for intricate or
sensitive distributions.
2. Divide the whole range of values into
equi-probable ranges (usual although not
strictly necessary).
 Bracket Medians, 2
3. Select one representative value from each
of the ranges by taking the median of the
range. This value is the bracket median.
median
4. Let the bracket median stand for all of the
values in the range and assign to it the
probability of all the values in the range.
• In a normal distribution, the mean is the
bracket median for the entire range.
Assessment of Subjective Probability
• The inability to objectively measure the
probability does not relegate it to
guesswork.
• An estimate might be produced by
interviewing experienced personnel to:
 Determine the endpoints, shape and relative
probability of outcomes.
 Subdivide ranges so far as it is useful to do so.
 Test for consistency.
 Revising Probability
• Bayes’ theorem is used whenever
probabilities are revised in light of some
new information (e.g., a sample).
 It combines experience (prior probabilities)
probabilities
with sample information (numbers) to derive
posterior probabilities.
probabilities
 P(A and B) = P(A) x P(B|A)
 P(A and B) = P(B) x P(A|B)
• The theorem could apply to payoffs as well
as to probabilities.
 A diagrammatic approach
• A Venn diagram – in this case, a square – can be
used to represent prior and posterior probabilities:
 Divide the square vertically to represent prior
probabilities. Thus, rectangles are created those areas
are proportional to their prior probabilities.
 Divide the rectangles horizontally to represent the
‘sample accuracy’ probabilities. These smaller areas
are proportional to the conditional probabilities.
 Areas inside the square can be combined or divided to
represent the posterior probabilities. A conditional
probability is given not by the area representing the
event, but by this area as a proportion of the area that
represents the condition.
 Bayesian Revision
• Results are conventionally summarized in
a table, showing how the calculations are
built up.
• The posterior probability is calculated by
dividing the term P(V) x P(T|V) in the
fifth column by P(T).
Prior Test
Test probability accuracy Posterior
outcome Variable of variable P(T|V) probability
(T) (V) P(V) P(T|V) P(V) x P(T|V) P(V|T)
 Utility
• The EMV criterion can mask large payoffs by
averaging them out. A utility function represents
monetary payoffs by utilities and allows EMVs to
be used universally.
 A utility is a measurement that reflects the (subjective?)
value of the monetary outcome to the decision maker.
 These are not necessarily scaled proportionately. If a $2
million loss meant bankruptcy where a $1 million loss
meant difficulty, the “disutility” of the former may be
more than twice the latter.
 The rollback then deals with utility rather than EMV.
 3. Linear Programming
• Linear programming (“LP”) is a technique for
solving certain types of decision problems. It is
applied to those that require the optimization of
some criterion (e.g., maximizing profit or
minimizing cost), but where the actions that can
be taken are restricted (i.e., constrained).
• Its formulation requires three factors: decision
variables, a linear objective function and linear
constraints.
 “Linear” means that there are no logarithmic nor
exponential functions.
 Application
• The Simplex method (developed by
Dantzig) or variations of it are used to solve
even problems with thousands of decision
variables and thousands of constraints.
• These are typically the product of computer
applications, although simple problems
might be resolved algebraically
(simultaneous equations) or graphically.
 The Solution
• The optimal point (if there is one) will be one of
the “corners” of the feasible region: the northeast
(maximization) or southwest (minimization),
unless:
1. The objective line is parallel to a constraint, in which
case the two corner points and all of the points on the
line are optimal.
2. The problem is infeasible (there are no solutions to
satisfy all constraints).
3. The solution is unbounded (usually an error?) and
there is an infinite number of solutions.
 Redundancy and Slack
• One way to save time is to scan the formulation
for redundancy in the constraints. Redundancy
occurs when one constraint is always weaker than
another. This term can be omitted.
• In the optimal solution:
 A constraint is tight if all the resource to which the
constraint refers is used up. A tight constraint has zero
slack.
 A slack constraint will have an excess, usually
indicated in the form ‘available minus used’ (which, in
a minimization problem, may be a negative number).
 The slack is reported for each constraint.
4. Extending Linear Programming
• Linear programming can be adapted to solve
problems for which the assumptions of LP, such
as linearity, are not met.
• The technique can also generate other information
that can be used to perform sensitivity analysis.
 It can solve problems in which some or all of the
variables can take only whole number values.
 It can be applied to problems where there is
uncertainty, as where decision variables have a
statistical distribution.
 Dual Values
• Each constraint has a dual value that is a measure
of the increase in the objective function if one
extra unit of the constrained resource were
available, everything else being unchanged.
 Dual values are sometimes called shadow prices.
prices
 They refer only to constraints, not to variables.
• These measure the true worth of the resources to
the decision maker and there is no reason why
they should be the same as the price paid for the
resource or its market value.
 Dual Values, 2
• When the slack is non-zero, then the dual
value is zero.
 If this were not so, then incremental use of the
resource could have been made, with an
increment in the objective function.
• The dual value also works in the other
direction: indicating a reduction in the
objective function for a one unit reduction
in the constrained resource.
 Reduced Costs
• Dual values can also be found for the non-
negativity constraints, but they are then called
“reduced costs”.
costs
 If the optimal value of a variable is not zero, then its
non-negativity constraint is slack, and the dual value
(reduced cost) is zero.
 If the optimal value is zero, then the constraint is tight
and will have a non-zero reduced cost (a loss).
• Dual values are marginal values and may not hold
over large ranges. Most computer packages give
the range for which the dual value holds. This is
known as the right-hand side range.
range
 Coefficient Ranges
• A coefficient range shows by how much an
objective function coefficient can change before
the optimal values in the decision variable change.
 Changing the coefficient value is the same as varying
the slope of the line. If they change by small amounts,
the slope of the line will not be sufficiently different to
move away from the optimal point.
 The same small changes will, however, change the
value of the optimal objective function.
 These ranges apply to the variation of one coefficient at
a time, the others being kept at original values.
 Transportation Problem
• Some LP problems have special characteristics that
allow them to be solved with a simpler algorithm.
• The classic transportation problem is an allocation of
production to destinations with an objective of
minimizing costs.
 The special structure is that all of the variables in all of the
constraints have the coefficient ‘0’ or ‘1’. (This is what the
book says, but I don’t understand what it means.)
• An assignment problem is like the transportation
problem, with the additional feature that the
coefficients are all ‘1’. (Likewise.)
 Other Extensions
• LP assumes that the decision variables are continuous,
that is, they can take on any values subject to the
constraints, including decimals and fractions. When the
solution requires integer values (or blocks of integer
values), a more complex algorithm is required.
• Quadratic programming can contend with objective
functions have squared terms, as may arise with variable
costs, economies of scale or quantity discounts.
• Goal programming – an example of a method with
multiple objectives – will minimize the distance
between feasibility and an objective.
 Handling Uncertainty
• The coefficients and constants used in problem
formulation are fixed, even if they have been
derived from estimates with various degrees of
certainty (i.e., the model is deterministic).
 Parametric programming is a systematic form of
sensitivity analysis. A coefficient is varied continuously
over a range and the effect on the optimal solution
displayed.
 Stochastic programming deals specifically with
probability information.
 Chance-constrained programming deals with constraints
do not have to be met all of the time, but only a certain
percentage of the time.
 5. Simulation
• Simulation means imitating the operation of a
system.
• Although a model may take (scaled down)
physical form, it is more often comprised of a set
of mathematical equations.
• The purpose of a simulation is to test the effect of
different decisions and different assumptions.
 These can be tested quickly and without the expense or
danger of carrying out the decision in reality.
 Benefits and Shortcomings
Benefits Shortcomings
• Simulation is capable of • Significant time and expense is
many applications where required to develop and then use
the requirements of the model.
optimization techniques • The model may determine the
cannot be met, e.g., “best” of the formulations
linearity of variable tested, but it cannot make
inputs. decisions or test alternatives
other than those specified by the
• Management has an
operator.
intuitive comfort with
• Data may not be readily
simulation that other
available.
methodologies may not
• One must establish the validity
enjoy.
of the model.
 Types of Simulations
Deterministic
• … means that the inputs
and assumptions are fixed
and known: none is
subject to probability
distributions.
• It is used because of the
number and complexity of
the relationships involved.
• Corporate planning
models are an example of
this type.
Stochastic
• … means that the some of the
inputs, assumptions and
variables are subject to
probability distributions.
• The Monte Carlo technique
describes a simulation run
many times, with the input of
particular variables defined by
their probabilities in a
distribution. The output will
often form a distribution, thus
defining a range and
probability of outcomes.
 Flowchart
• A flowchart is an intermediate stage that
helps transform a verbal description of a
problem into a simulation.

Flow of Events Flow of Information

Action Question Start/ End Record File

 Controlling the Simulation
• Even if inputs are provided by random
number generation, they could still (also by
chance) be unrepresentative.
 To test (only) the effect of different policies, a
set of simulations should use the same starting
conditions and inputs for each.
 A larger number of simulations would support
an inference that an outcome was related to the
differing policies rather than the chance
selection of inputs.
 Interpreting the Output
• The dispersion of results is a proxy for their
risk: the probability that an outcome may be
higher or lower than outcomes for other
policies.
• Risk might also be regarded as the
frequency of a result outside certain
parameters, e.g., a stock out may also have
negative implications for customer service.
 Risk Analysis
• When a stochastic simulation uses the
Monte Carlo technique to model cash flows,
it is called a risk analysis.
analysis This differs from
other stochastic simulations only in terms of
its application to financial problems.
• A best practice is to plan a series of trial
policies structured so that the range of
options can be narrowed down until a
nearly optimal one can be obtained.
6. Network Planning Techniques
• The Critical Path Method (CPM) or Programme
Evaluation and Review Technique (PERT) may
benefit a project through:
 Coordination: getting resources deployed at the right
time
 Time management: exploiting the flexibility within the
plan
 Issue identification: discovering tasks or constraints
that may otherwise be hidden until too late
 Cost control: idle resources can be costly
 Technique Basics
1. A project is broken down into all of its individual
activities.
2. The predecessors of each activity are identified.
• Some must be completed before others can start; some
can take place at the same time as others.
• A common mistake is confuse the customary
sequence with their logical sequence.
3. The sequence of activities is represented
graphically, where the lines are activities and
circles (called nodes) mark the start and
completion of the activities.
 Technique Basics, 2
3. (cont.)
• The node at the beginning of a task should be the end
node of all activities that are immediate predecessors.
• The node at the end should be the beginning node of
all activities that are immediate successors.
• A dummy activity, represented by a dotted line,
overcomes the requirement that no task can have the
same beginning and end nodes, and avoids depicting
a ‘false dependency’ of one task upon another.
4. The critical tasks are studied with a view to
deploying resources to speed completion or
minimize the impacts of over-runs.
 Analyzing the Network
• The network is analyzed to determine
timings and schedules. There are five
stages:
 Estimate activity durations
 Forward Pass
 Backward Pass
 Calculating float
 Determining the Critical Path
 Activity Duration
• The expected duration of an activity may be based on
experience or on subjective estimation.
• Where there is some uncertainty, a sensitivity analysis
can be performed. Alternatively, one can obtain
optimistic, most likely and pessimistic durations, then
• Expected duration = (Optimistic + (4 x Most Likely) +
Pessimistic) / 6
• Variance (for activity) = ((Pessimistic – Optimistic)/6) 2
• Variance (for project) = Σ (variance of activities on the
critical path)
• Standard deviation = variance (With 95% confidence,
expected duration = mean ± 2 std dev)
 Methodological Assumptions
1. Activity times follow a beta distribution – a unimodal
and non-symmetrical distribution with a shape
commonly found in activities in large projects.
2. Activities are independent. This allows the application
of the central limit theorem,
theorem that would predict that, as
the number of variables in the sum increases, the
distribution of the sum becomes increasingly normal.
In fact, the activities are probably not independent:
• The cause of delay in one activity may be the same cause of
delay in other activities.
• The critical path can change. Reductions in durations may
make other activities critical.
 Forward Pass
• A forward pass means going through the network
activity by activity to calculate for each an ‘earliest
start’ and ‘earliest finish’, using the following
formulae:
 Earliest finish = Earliest start + Activity duration
 Earliest start = Earliest finish (of previous activity)
 If there are several previous activities, we use the latest
of their earliest finish times.
• The notation appears, for example, as (6, 10, 16),
indicating that the activity’s earliest start is at week
6, has a duration of 10 weeks, and has an earliest
finish at week 16.
 Backward Pass
• A backward pass means going through the
network activity by activity, starting with the last
and finishing with the first, to calculate for each an
‘latest finish’ and ‘latest start’.
 Latest finish = Latest start (of following activity)
 Latest start = Latest finish - Activity duration
 If there are several following activities, we use the
earliest of their latest start times.
• The notation for backward pass is similar to that
for forward pass, indicating Latest start, Float
(discussed next) and Latest finish.
 Calculating Float
• An activity’s float is the amount of time that
it can be delayed without delaying
completion of the entire project.
 The difference between its earliest and latest
start times
 The difference between its earliest and latest
finish times (the same thing)
 Determining the Critical Path
• Activities for which a delay in start or
completion will delay the entire project are
critical.
critical Others are slack.
slack The critical
activities define a critical path through the
network.
• A critical activity has a float of zero.
• If the total completion time of a project
must be shortened, then one or more
activities on the critical path have to be
shortened.
 Time – Cost Trade-offs
• Time and cost are usually, but not always,
interchangeable and the planner can probably
reduce project completion time by spending more
money.
• The analysis relating cost to time (cost of
shortening by one week, by two weeks, etc.) is
known as crashing the network. This is based on a
time-cost “curve” for each activity: indicating cost
and time for normal operations and the (crash)
time and (crash) cost associated with the absolute
minimum.
 Time – Cost Trade-offs, 2
• The ratio of (Cost increase/ Time saved) is, in effect,
the crashing cost per unit of time.
• Only critical activities are crashed, since they are the
only ones that can reduce overall project completion
time. An activity is crashed until the greatest possible
reduction has been made or until a another parallel
path is critical.
• If there are multiple critical paths, activities in each
must be crashed simultaneously, with the sum of
their costs calculated per unit time.
• The final result can be graphed in a time – cost trade-
off curve.
 Stages in Network Analysis
1. List all activities in the project.
2. Identify the predecessors of each activity.
3. Draw the network diagram.
4. Estimate activity durations as average times or, if
uncertainty is to be dealt with explicitly, as
optimistic/ most likely/ pessimistic times.
5. Produce an activity schedule by making a
forward and then a backward pass through the
network.
6. Determine the critical path by calculating
activity floats.
 Stages in Network Analysis, 2
7. Measure uncertainty by calculating
activity variances, the variance of the
whole project and finally confidence
limits for the duration of the project.
8. Draw cost/ time curves for each activity.
9. Crash the network and construct a cost/
time graph for the project.
Activities-Predecessors-Draw-Duration-Passes-
Path-Variance-Costs-Crashes = APDDPPVCC
= Acting pretty draws dirty passes, pathing very costly crashes.
crashes
 7. Decisions & Info Technology
• A decision support system (DSS) is a computer
system that produces information specially
prepared to support particular decisions.
• Six elements of IT:
 Computers
 Software
 Telecommunications
 Workstations
 Robotics
 Smart Products
 History of IT in Business
• 1960’s:
1960’s successful mainframe applications for
accounting, operations (inventory, customer accounts)
and technical operations. MIS was little more than a data
dump.
• 1970’s:
1970’s recognition of the MIS failure, with various
attempts made to convert data to information that
managers at different levels could use.
• 1980’s:
1980’s introduction of the micro-computer puts
computing power in the hands of the end user.
• 1990’s and beyond:
beyond downloading for local analysis,
internal linkages (internal resource and information
sharing) and external linkages (internet).
 Challenges for
Computerized Management
• Controlling information: more is not
necessarily better
• Keeping information consistent
• Developing analytical abilities
• Avoiding behavioral conflicts (a supportive
business culture?)
• Aligning business and IT strategy
 Benefits
• Communications:
Communications speed and penetration of internal
and external communications; interfaces for data
transfer
• Efficiency:
Efficiency direct time and cost savings, turnaround
• Functionality:
Functionality systems capabilities, usability and
quality
• Management:
Management reporting provides a form of
supervision; gives personnel greater control of their
resources
• Strategy:
Strategy greater market contact; support for
company growth; competitive advantage
 The Right Attitudes
• Commitment: adequate resources, especially
management time, are put into the project
• Realistic expectations
• Motivation: the need for a champion or super-
users
• Persistence: detailing the plan, following through
on the details and monitoring performance
• Fear: balancing respect for IT against fear of it
 The Right Approach
• Top-down:
Top-down how can IT help to meet corporate
objectives?
• Planning based:
based defining objectives and
technologies
• Substantial user involvement
• Flexibility:
Flexibility adapting to a new modus operandi;
contingency planning
• Monitoring:
Monitoring costs and benefits
• Commitment to continuing development:
development markets
and technology are not static
 Skills and Knowledge
• Planning:
Planning leads to improved communication,
resource management and control
• Project planning techniques:
techniques critical path
• IT project stages:
stages Feasibility study 
Requirements  Specification  Programming 
Testing  Running in parallel  Install  Review
• Managing transition:
transition setting objectives, defining
tasks, recognizing the impacts of change
(especially on personnel), communicating
objectives and progress, dealing with unexpected
developments
 The Future
• Technical progress
 Expert systems, e.g., a medical diagnostic system

 Artificial Intelligence (AI): can deal with less structured

issue
 Data mining: looking for patterns

 Decision mapping: discovering the structure of a

problem
 Knowledge management, especially as a competitive

advantage
• Greater internal and external integration (especially
within the value chain)
• IT will be a greater part of corporate strategy