©Chelst & Canbolat Value-Added Decision Making Chapter 2 – Influence Diagrams Learn by example Learn vocabulary and grammar 9/19/2011 1

©Chelst & Canbolat Value-Added Decision Making 9/19/ Two key elements of decision framing- often not considered  Multiple Objectives  Tradeoffs  If NOT upfront then when?  Multiple stretch goals  tradeoffs too late  Uncertainty  Risk  If you do NOT ADMIT the existence of uncertainty, you cannot manage it  If you do not QUANTIFY uncertainty, you cannot decide how much to invest to address its impact

©Chelst & Canbolat Value-Added Decision Making 9/19/ Elements of a Decision Frame Elements of a Decision Frame  Decision(s): Single, Multiple (Simultaneous or Sequential)  Alternatives within each decision  Uncertainty  Criteria--Goals--Values--Objectives = Context Specific  Scope – Time horizon and organizational breadth  Decision Makers & Stakeholders  Constraints  Implicit - restrict range of alternatives  Explicit – mathematical representation (not included here)

©Chelst & Canbolat Value-Added Decision Making 9/19/ Influence Diagram - Communication  Explicitly note the existence of randomness and uncertainty  Clarify the “main” values or objectives of decision  Emphasize the influence of uncertainty on values  Specify the sequence of decisions

©Chelst & Canbolat Value-Added Decision Making 9/19/2011 Categories of common objectives. Table 2.1  Min-Costs (variable and investment)  Min-Time to complete  Max-Profit—NPV, TARR, ROI  Min- Risk of not meeting targets  Min- Human resources required  Min (Max) -Management issues  Max-Long-term value  Min-Operational issues  Max-Performance Sales and/or market share  Min-Training requirements 5

©Chelst & Canbolat Value-Added Decision Making 9/19/2011 Common uncertainties. Table 2.2  Time needed to complete task or reach goal  Performance to specifications  Warranty claims and quality control  Resources required  Competitive actions  Cost  Is task doable?  Market demand  Revenue  Throughput–productivity  Will some specific event occur  who will be elected president  pandemic occurs 6

©Chelst & Canbolat Value-Added Decision Making 7 Framing decision with randomness influence diagrams: Vocabulary = Rectangles/Boxes = Circles/Ovals = Rounded rectangle = Diamond = Text box with list =Arrow Random Events Decisions Values/Goals Calculation Ultimate goal Influence Input/Data 9/19/2011

©Chelst & Canbolat Value-Added Decision Making 9/19/ Automation Investment Boss Controls  Manufacture an option to be made  Available to one million purchasers of cars  Uncertain take-rate (percent who buy option)  Deliver the option to (OEMs) at a price of $60.  Two alternatives: differ significantly in investment level automation and variable cost of production

©Chelst & Canbolat Value-Added Decision Making 9/19/ Automation Investment Take rate Automation Investment Profits Volume Variable Cost Investment

©Chelst & Canbolat Value-Added Decision Making 9/19/ Automation Investment: Expanded Take rate Automation Investment Profits Investment Volumes Variable Cost

©Chelst & Canbolat Value-Added Decision Making 9/19/2011 Figure 2.5: Theater Party Invitations % Yes Responses Percent No Shows Attendees Number Sent Invitations Maximize Goodwill Invitees Not Attending 11

©Chelst & Canbolat Value-Added Decision Making 9/19/2011 Figure 2.6: Divide and delay decision - Theater party invitations % Round 1 Yes Percent of No Shows Attendees Round 1 Invitations Maximize Goodwill Invitees Not Attending % Round 2 Yes Round 2 Invitations 12

©Chelst & Canbolat Value-Added Decision Making 13 Influence Diagram Symbols Microsoft PowerPoint  Pick appropriate shape: rectangle, oval, rounded rectangle, and diamond.  You may want to have specific fill color for each type of box  Right click on shape: “Add text” Can specify size of text and place on more than one line.  Move shapes to appropriate location.  Connect shapes with arrows  Be sure to link to a red dot on each shape  enables redesign  Shapes can be copied and text modified. 9/19/2011

©Chelst & Canbolat Value-Added Decision Making 9/19/ Influence Diagram Construction  Specify primary decision  Define values and ultimate goal  Identify relevant random variables or events  Specify downstream decisions that need to be analyzed to make primary decision  Add arrows to define relationships  Review layout  List data inputs

©Chelst & Canbolat Value-Added Decision Making 15 Example : Late to Market with New Product Case: A company is considering developing a product that will be ready 3 months after its competitor introduces a similar product. Random Event to Random Event – Conditional probability Random Event to Value – Random event directly influences the VALUE. The value will be uncertain. Competitive Action Sales Volumes Total Revenue Influence Diagram Arrows from Random Events: Connectors in PowerPoint 9/19/2011

©Chelst & Canbolat Value-Added Decision Making 9/19/ Influence Diagram Arrows from Random Events  Example : Late to Market with New Product  Random event to decision: Random event’s outcome is KNOWN before decision is to be made.  NEVER use an arrow from a circle to a decision to represent the fact that the decision is affected by the random event. This is the most common ERROR.  The arrow shows that the outcome of the chance node is known before the decision is made  Absence of an arrow from the chance node to the decision node does NOT mean that the uncertainty does not influence the decision.  Everything in the diagram affects the decision Competitor’s Price Launch Price

©Chelst & Canbolat Value-Added Decision Making 17 Decision to Decision - decision sequence (possibly influence) Decision to Random Event Price influences sales volume PriceProduct Features Price Sales Volume Influence Diagram Arrows from decisions 9/19/2011

©Chelst & Canbolat Value-Added Decision Making 18 Decision to Value – Decision directly influences value Pricing decision influences total revenue  Indirectly: by affecting sales volume and  Directly: since price  sales = Total Revenue Influence Diagram Arrows from Random Events Price Sales Volume Total Revenue 9/19/2011

©Chelst & Canbolat Value-Added Decision Making 19 If Total Revenue and/or Total Cost are influenced by random events then the Net Profit will be an uncertain value. However, once the other two values are known, Net Profit is no longer uncertain. Influence Diagram: value to value Net profit Total Revenue Total Cost 9/19/2011

©Chelst & Canbolat Value-Added Decision Making 9/19/ Competitor’s Price Launch Price Product Features Develop product Total Revenue Total Cost Net Profit Sales Volume All elements influence the decisions: to develop the product, its features & price Late to market with new product: 1 st lay out elements without arrows Engg. rates Labor rates Throughput

©Chelst & Canbolat Value-Added Decision Making 9/19/ Competitor’s Price Launch Price Product Features Develop product Total Revenue Total Cost Net Profit Sales Volume All elements influence the decisions: to develop the product, its features & price Late to market with new product – Add arrows Engg. rates Labor rates Throughput

©Chelst & Canbolat Value-Added Decision Making 22 Competitor’s features Modified Diagram? Competitor’s Price Launch Price Product Features Develop product Total Revenue Total Cost Net Profit Sales Volume Economy Manufacturing Cost PD Costs Actual Price Competitor’s product performance Engg. rates Labor rates Throughput 9/19/2011

©Chelst & Canbolat Value-Added Decision Making 9/19/ What New Objectives Might be Added  Maximize Market Share  Maximize Utilization of plant capacity  Minimize adding to labor workforce (Headcount)  Change overall goal – No longer just net profit – “value to corporation”

©Chelst & Canbolat Value-Added Decision Making 9/19/ Influence Diagram: Is not a Flow Diagram!  All elements of an Influence Diagram are analyzed and influence the decisions even if there are no nodes connected to the decisions  Forecasts of downstream uncertainties affect upstream decisions even without arrows linking the nodes.

©Chelst & Canbolat Value-Added Decision Making 9/19/ Limited Influence Diagram  Mainly uncertainties and only one or two objectives  Project management  complete project as planned (within time and budget)  Mainly multiple objectives and limited uncertainty  New car

©Chelst & Canbolat Value-Added Decision Making 9/19/2011 Figure 2.15: Buying a used car – value focused 26

©Chelst & Canbolat Value-Added Decision Making 9/19/2011 Figure 2.16: Used car revised – new information 27

©Chelst & Canbolat Value-Added Decision Making 9/19/2011 Figure 2.17: Oglethorpe diagram 28

©Chelst & Canbolat Value-Added Decision Making 9/19/ ALL Elements Represented in the Diagram Influence the Decisions Probabilistic forecasts of sales and the competitor’s price will affect forecasts of revenue and profit. These will influence the decisions:  Whether or not to introduce the product?  With what features?  And at what price?