1. Operations Management For Competitive Advantage © The McGraw-Hill Companies, Inc., 2001 C HASE A QUILANO J ACOBS ninth edition 1 Decision Trees  Used for complex decision problems  characterized by uncertainities  Two main symbols:  Box = Decision  Circle = Random event  Expected profit values calculated  Select decision with highest exp. profit

2. Operations Management For Competitive Advantage © The McGraw-Hill Companies, Inc., 2001 C HASE A QUILANO J ACOBS ninth edition 2 An Example A glass factory specializing in crystal is experiencing a substantial backlog, and the firm's management is considering three courses of action: A) Arrange for subcontracting, B) Construct new facilities. C) Do nothing (no change) The correct choice depends largely upon demand, which may be low, medium, or high. By consensus, management estimates the respective demand probabilities as.10,.50, and.40.

3. Operations Management For Competitive Advantage © The McGraw-Hill Companies, Inc., 2001 C HASE A QUILANO J ACOBS ninth edition 3 The Payoff Table The management also estimates the profits when choosing from the three alternatives (A, B, and C) under the differing probable levels of demand. These costs, in thousands of dollars are presented in the table below:

4. Operations Management For Competitive Advantage © The McGraw-Hill Companies, Inc., 2001 C HASE A QUILANO J ACOBS ninth edition 4 Step 1: Draw the decisions A B C

5. Operations Management For Competitive Advantage © The McGraw-Hill Companies, Inc., 2001 C HASE A QUILANO J ACOBS ninth edition 5 Step 2: Draw the random events A B C High demand (.4) Medium demand (.5) Low demand (.1) $90k $50k $10k High demand (.4) Medium demand (.5) Low demand (.1) $200k $25k -$120k High demand (.4) Medium demand (.5) Low demand (.1) $60k $40k $20k

6. Operations Management For Competitive Advantage © The McGraw-Hill Companies, Inc., 2001 C HASE A QUILANO J ACOBS ninth edition 6 Step 3: Calculate exp. values High demand (.4) Medium demand (.5) Low demand (.1) A $90k $50k $10k EV A =.4(90)+.5(50)+.1(10)=$62k $62k

7. Operations Management For Competitive Advantage © The McGraw-Hill Companies, Inc., 2001 C HASE A QUILANO J ACOBS ninth edition 7 Step 4: Select best alternative High demand (.4) Medium demand (.5) Low demand (.1) High demand (.4) Medium demand (.5) Low demand (.1) A B C High demand (.4) Medium demand (.5) Low demand (.1) $90k $50k $10k $200k $25k -$120k $60k $40k $20k $62k $80.5k $46k Alternative B generates the greatest expected profit, so our choice is B or to construct a new facility.

8. Operations Management For Competitive Advantage © The McGraw-Hill Companies, Inc., 2001 C HASE A QUILANO J ACOBS ninth edition 8 Other views and criteria  Sensitivity analysis for the estimated probabilities  Can we “buy” better information? EVPI  Risk Aversion, Utilities