1. Decision Making A General Overview 10th ed.
(Continue under the topic: Operations
Management as a Functional Area of Business)
Decision Making
A General Overview

2. Why study decision making?
-It is the most fundamental task performed by managers.
-It is the underlying theme of the course. The techniques and tools employed in the text are intended to improve our decision making skills as managers.
-It is assumed that a better understanding of decision making will lead to better decision by managers.

3. The Decision Process (Descriptive Model)
Identify the Problem
Specify objectives and the criteria for choosing a solution
Develop alternatives
Analyze and compare alternatives
Select the best alternative
Implement the chosen alternative
Monitor the results
The decision making process above is derived from work by H. A. Simon, a Nobel Laureate in Economic Sciences. Simon’s work led to the creation of the fields of Information Systems, Decision Support Systems, and Expert Systems. Note that you have to make a decision in order to “Identify the Problem,” or do any of the above steps. How do you think Simon could have described each of these steps? (Your answers will not be collected.)

4. Some Key Elements which Managers Must
Cope with in Their Decision Environment
Uncertainty/Risk (and even
luck)
Complexity
Change (including technological
change)
Behavioral/Political Considerations
This is the environment that you will face as a manager. Any of the tools or techniques from operations managements, or from other areas of business (e.g., accounting , marketing , finance, etc.), help you, as a manager, address the challenges in the decision environment.

5. How do we identify the vital few?
Pareto Phenomenon •
A vital few things are important for reaching
an objective or solving a problem. •
80/20 Rule - 80% of problems are caused by
20% of the activities.
The Pareto Phenomenon is an example of where nature is kind to managers. We don’t have to know everything to make a good decision, but we must identify the vital few that really count!
How do we identify the vital few?

6. A model is an abstraction of reality.
Models •
A model is an abstraction of reality. –
Physical
Schematic –
Mathematical
Models help simplify the analysis, since we can experiment on models before trying something in the real world that could be very costly if not done with a model. For example, we can use y = mx + b, a mathematical model, to predict the forecast of demand for cars (y) knowing disposable family incomes (x). Without the model, a manager would have to make a guess as to the forecast. Note that since the model is simpler than the real-world phenomenon that it represents, it might be an oversimplification, leading to wrong conclusions.
What are the pros and cons of models?

7. These are examples of physical models.

8. This is an example of a schematic model.

9. This is a mathematical and schematic model in the context of an Excel payoff table. (E=mc2 is a mathematical model in the context of an equation.)

10. “The whole is greater than the sum of the parts.”
Systems Approach
“The whole is greater than the sum of the parts.”
Suboptimization
A systems approach is desirable in business. It forces managers to take a “Big Picture” (abstract right) view of the business environment.

11. Causes of Poor Decisions (Cont’d)
Suboptimization
The result of different departments each attempting to reach a solution that is optimum for that department
Note that manufacturing wants low work-in-progress inventories to lower costs. However, marketing wants high finished-goods inventories to avoid lost sales from stock-outs. These departments must operate as a system in meeting their opposing inventory needs. Coordination is the responsibility of managerial levels above the directors of both departments.

12. Causes of Poor Decisions
Bounded Rationality
The limitations on decision making caused by costs, human abilities, time, technology, and availability of information
Of course, part of the answer to this problem is computer decision support and the Pareto Phenomenon.

13. Some Very Basic Approaches to Decision Making Based on Decision Theory

14. product and service design
Decision Theory
Decision Theory represents a general approach to decision making which is suitable for a wide range of operations management decisions, including:
capacity planning
product and service design
equipment
selection
location
planning

15. Decision Making Conditions
Certainty – Condition in which relevant parameters have known values
Uncertainty – Condition in which it is impossible to assess the likelihood of various future events
Risk – Condition in which certain future events have probable outcomes
Of course, most big decisions are usually in the categories of “uncertainty and risk.”

16. Decision Making Under Certainty
Examples of a criterion:
In basic break even analysis, all parameters (i.e., cost, profits, margins, etc.) are known, and do not include any probabilities.
Break Even Analysis:
Decide to produce items if they lead to a profit

17. Example BE analysis
Example of graphic break even analysis. Below the BEP (break even point), we lose money (Revenue –cost is negative), and above the BEP, we make money (Revenue –cost is positive).

18. Decision Making under Uncertainty
Examples of three criteria:
Maximin - Choose the alternative with the best of the worst possible payoffs
Maximax - Choose the alternative with the best possible payoff
Laplace - Choose the alternative with the best average payoff of any of the alternatives

19. Try to do homework problem 1(a,b,c)
on page 229 in the textbook

20. Decision Making under Risk
Examples of two criteria:
Expected monetary value: calculate the expected value (average or mean) of each alternative, choosing the alternative with the best expected value
Expected value of perfect information: calculate the difference between the expected payoff under certainty and the expected payoff under risk

21. Format of a Decision Tree
State of nature 1 B
Payoff 1
State of nature 2
Payoff 2
Payoff 3 2
Choose A’1
Choose A’2
Payoff 6
Payoff 4
Payoff 5
Choose A’3
Choose A’4
Choose A’ 1
Decision Point
Chance Event
This is a general model for a small decision tree. Note that branches emanating from squares are decision points, where the manager/decision maker chooses the branch. However, branches emanating from circles are chance events (i.e., such as states of nature similar to demand being high, or demand being low). Here the manager cannot pick a branch. Note that all branches emanating from the chance event are assigned probabilities which add to one. Hence, we have a probability distribution. Using the Expected Value Monetary criteria, we replace the probability distribution with its mean (or average, or expected value). The mean replaces the entire distribution, and becomes a payoff branch with the payoff equal to the mean.

22. Try to do homework problems 2(b,a,c),
10, and 11 on pp

23. Solutions to Homework Partial solutions are on the slides that
follow. Be sure to try the problems before
you look at the solutions.

24. 1. 1. a. Maximax: Expand [$80 is the highest payoff] b. Maximin:
Solutions 1. 1. a.
Maximax:
Expand [$80 is the highest payoff] b.
Maximin:
Worst payoffs:
Do Nothing: 50
[best of the worst payoffs]
Expand: 20
Subcontract: 40 c.
Laplace:
Average Payoff
Do Nothing 55
[Indifferent between Do Nothing
Expand
And Subcontract]
Subcontract
If the text in the above slide is too small, you can increase the size of the letters by increasing the percentage in the zoom box on the tool bar above the slide.
Comments on the above: Part (a) is simply the highest return of all possibilities in the table. Part (b) shows 50, 20, and 40 as the worst return for each of the three alternatives. Hence,
the best of the worst is 50, and the answer is “Do Nothing.” Note that Part (c) simply finds the
average for each alternative, l. Leading to a tie between Do Nothing and Subcontract. In a sentence or
two, could you find a method to break the tie?

25. 2.
2 b.
The problem should have had you do part b before doing part a. Why?
Also, how were the numbers in part a found?
Note that the tree in part b is incomplete. What do you need to do to complete it?

26. Expected Value under conditions of certainty = .30(50) + .70(80) = $71
Expected Value under conditions of risk =
EVPI (Expected Value of Perfect Information) = $9
Can you explain the logic behind the calculation for Expected Value under conditions of certainty? If so, you would be thinking “analytically,” or “abstract left” (and with a little bit of “abstract right”).

27. 10.
.70 high
For the states of nature (i.e., “low” and “high”), could you improve their position on the above tree? If so, where would you put these words on the above tree?

28. 11.
Note that the Expected Value calculations refer to the chance node numbers.
While you can solve this problem with the above tree, is there something about this tree that is a “little odd” or unusual?
=EV5

29. In-Class Assignment (You will be asked in class how this problem could be
solved. However, you need NOT solve this problem for class. We will do it
together during the lecture. All you should do, at the minimum, is to read this
problem carefully, and go to the next slide.)
It is suggested that you make a hardcopy of this slide and the next slide, and
bring the hardcopy to the next class.

30. (a) This is the structure of the decision
tree for the problem above. Try to
complete this tree (i.e., print out this slide
and add the payoffs and the probabilities). (b) For a greater challenge, try to solve this tree using the monetary expected value criterion, and write a brief statement on what Joe should do. (c) Based on your answer in part (b),
What is the probability that Joe could go bankrupt if bankruptcy occurs from a loss of $75,000? What is the probability of bankruptcy for a loss of $150,000?
For even a greater challenge, and assuming that you were able to answer the above questions, write a sentence or two on how Joe could do something unethical in order to get a better return, if he later found the market test to be unfavorable.
This is a difficult problem for most students, but it uses the concepts which you read in the textbook. The complete solution to the problem requires a combination of “abstract left” and “abstract right” thinking.

31. Discussion Problem: Do not try to solve this problem
Discussion Problem: Do not try to solve this problem. Simply read through it a few times. This problem will be solved in class as a computer application. Please make a hardcopy of this slide, and bring it to class. .

32. End of Session. See you during our next class meeting.