Operations Management

Decision-Making Tools Module A

PowerPoint presentation to accompany Operations Management, 6E (Heizer & Render)

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2001 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458

Outline
The Decision Process in Operations Fundamentals of Decision Making Decision Tables
Decision Making under Uncertainty Decision Making Under Risk Decision Making under Certainty Expected Value of Perfect Information (EVPI)

Decision Trees

A More Complex Decision Tree

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2001 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458

PowerPoint presentation to accompany Operations Management, 6E (Heizer & Render)

Learning Objectives
When you complete this chapter, you should be able to : Identify or Define:
Decision trees and decision tables Highest monetary value Expected value of perfect information Sequential decisions

Describe or Explain:

Decision making under risk

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2001 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458

PowerPoint presentation to accompany Operations Management, 6E (Heizer & Render)

Models, and the Techniques of Scientific Management

Can Help Managers To:

Gain deeper insight into the nature of business relationships Find better ways to assess values in such relationships; and See a way of reducing, or at least understanding, uncertainty that surrounds business plans and actions

PowerPoint presentation to accompany Operations Management, 6E (Heizer & Render)

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2001 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458

Steps to Good Decisions

Define problem and influencing factors Establish decision criteria Select decision-making tool (model) Identify and evaluate alternatives using decision-making tool (model) Select best alternative Implement decision Evaluate the outcome
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2001 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458

Models
Are less expensive and disruptive than experimenting with the real world system Allow operations managers to ask What if types of questions Are built for management problems and encourage management input Force a consistent and systematic approach to the analysis of problems Require managers to be specific about constraints and goals relating to a problem Help reduce the time needed in decision making
PowerPoint presentation to accompany Operations Management, 6E (Heizer & Render)

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2001 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458

Limitations of Models
They
may be expensive and time-consuming to develop and test are often misused and misunderstood (and feared) because of their mathematical and logical complexity tend to downplay the role and value of nonquantifiable information often have assumptions that oversimplify the variables of the real world
PowerPoint presentation to accompany Operations Management, 6E (Heizer & Render)

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2001 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458

The Decision-Making Process

Quantitative Analysis Logic Historical Data Marketing Research Scientific Analysis Modeling Qualitative Analysis Emotions Intuition Personal Experience and Motivation Rumors
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Problem

Decision

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2001 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458

Ways of Displaying a Decision Problem

Decision trees Decision tables
Outcomes States of Nature Alternatives

Decision Problem
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2001 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458

Fundamentals of Decision Theory

The three types of decision models:
Decision making under uncertainty
Decision making under risk Decision making under certainty

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2001 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458

Fundamentals of Decision Theory - continued

Terms:
Alternative: course of action or choice State of nature: an occurrence over which the

decision maker has no control

Symbols used in decision tree:

A decision node from which one of several alternatives may be selected A state of nature node out of which one state of nature will occur
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2001 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458

Decision Table
States of Nature Alternatives Alternative 1 Alternative 2 State 1 Outcome 1 Outcome 3 State 2 Outcome 2 Outcome 4

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2001 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458

Decision Making Under Uncertainty

Maximax - Choose the alternative that maximizes the maximum outcome for every alternative (Optimistic criterion) Maximin - Choose the alternative that maximizes the minimum outcome for every alternative (Pessimistic criterion) Equally likely - chose the alternative with the highest average outcome.
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2001 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458

Example - Decision Making Under Uncertainty

States of Nature
Alternatives Favorable Unfavorable Maximum Minimum Construct large plant Construct small plant

Market $200,000 $100,000 $0

Row Market in Row in Row Average -$180,000 $200,000 -$180,000 $10,000 -$20,000 $100,000 $0 $0 -$20,000 $40,000 $0 $0

Maximax
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Maximin

Equally likely

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2001 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458

Decision Making Under Risk

Probabilistic decision situation States of nature have probabilities of occurrence Select alternative with largest expected monetary value (EMV)

EMV = Average return for alternative if decision were repeated many times

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2001 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458

Expected Monetary Value Equation

Number of states of nature Value of Payoff

EMV ( A i ) =

V i * P (V i )
i =1

Probability of payoff

= V 1 * P (V 1 ) + V 2 * P (V 2 ) + ... +V N * P (V N )
Alternative i
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2001 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458

Example - Decision Making Under Uncertainty

States of Nature
Alternatives

Construct large plant Construct small plant

Favorable Unfavorable Market Market P(0.5) P(0.5) $200,000 -$180,000 $100,000 $0 -$20,000 $0

Expected value $10,000 $40,000 Best choice $0

Do nothing

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2001 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458

Expected Value of Perfect Information (EVPI)

EVPI places an upper bound on what one would pay for additional information EVPI is the expected value with perfect information minus the maximum EMV

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2001 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458

Expected Value With Perfect Information (EV|PI)

EV | PI = (Best outcome for the state of nature j) * P(S j )

j =1

where j=1 to the number of states of nature, n

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2001 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458

Expected Value of Perfect Information

EVPI = EV|PI - maximum EMV

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2001 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458

Expected Value of Perfect Information

Alternative
Construct a large plant Construct a small plant Do nothing

State of Nature Favorable Unfavorable Market ($) Market ($)

200,000 $100,000 $0 0.50
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EMV $20,000 $40,000 $0

-$180,000 $20,000 $0 0.50

Probabilities
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2001 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458

Expected Value of Perfect Information

EVPI = expected value with perfect information - max(EMV)
= $200,000*0.50 + 0*0.50 - $40,000

= $60,000

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2001 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458

Expected Opportunity Loss

EOL is the cost of not picking the best solution EOL = Expected Regret

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2001 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458

Computing EOL - The Opportunity Loss Table

Alternative Large Plant Small Plant Do Nothing Probabilities State of Nature Favorable Market Unfavorable ($) Market ($) 200,000 - 200,000 0 - (-180,000) 200,000 - 100,000 0 -(-20,000) 200,000 - 0 0-0 0.50 0.50

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2001 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458

The Opportunity Loss Table continued

Alternative Large Plant Small Plant Do Nothing Probabilities State of Nature Favorable Market Unfavorable ($) Market ($) 0 180,000 100,000 20,000 200,000 0 0.50 0.50

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2001 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458

The Opportunity Loss Table continued

Alternative Large Plant Small Plant Do Nothing (0.50)*$0 + (0.50)*($180,000) (0.50)*($100,000) + (0.50)(*$20,000) (0.50)*($200,000) + (0.50)*($0) EOL $90,000 $60,000 $100,000

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2001 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458

Sensitivity Analysis
EMV(Large Plant) = $200,000P - (1-P)$180,000 EMV(Small Plant) = $100,000P - $20,000(1-P) EMV(Do Nothing) = $0P + 0(1-P)

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2001 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458

Sensitivity Analysis - continued

250000 200000 150000
EMV Values

Point 1

Point 2

100000 50000 0 -50000 0 -100000 -150000 -200000 Values of P

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2001 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458

0.2

0.4

0.6

0.8

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Decision Trees
Graphical display of decision process Used for solving problems

With 1 set of alternatives and states of nature, decision tables can be used also With several sets of alternatives and states of nature (sequential decisions), decision tables cannot be used

EMV is criterion most often used

PowerPoint presentation to accompany Operations Management, 6E (Heizer & Render)

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2001 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458

Analyzing Problems with Decision Trees

Define the problem Structure or draw the decision tree Assign probabilities to the states of nature Estimate payoffs for each possible combination of alternatives and states of nature Solve the problem by computing expected monetary values for each state-of-nature node
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A-30

2001 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458

Decision Tree
State 1

Outcome 1 Outcome 2 Outcome 3 Outcome 4

State 2 State 1

2
Decision Node
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State 2

State of Nature Node

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2001 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458