Assignment No.

Quantitative Techniques
(5564) Col MBA/MPA

DECISION THEORY

Fayyaz Ahmed Kayani Roll No. AD593483 Semester: Autumn 2009

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ACKNOWLEDGEMENT No one writes alone. So I would like to thanks all those who helped and assisted a great source in completion of assignment. Assigned topic was a new for me and it was not possible to accomplish it without their magnificent support. They have been a source of knowledge for me as they helped me much in understanding the assigned Topic. I especially thank to my honorable tutor who guided me in every juncture. I also pay my gratitude to Department of Business Administration, AIOU, Islamabad for their marvelous selection of issues for MBA students through which they are gaining treasure of knowledge after completion of given task for their future.

DECISION THEORY
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INTRODUCTION Every day we, are humans, make many decisions; and occasionally we make an important decision that can have immediate and/or long-term effects on our lives. Such decisions as where to attend school, whether to rent or buy, whether your company should accept a merger proposal, and so on, are important decisions for which we would prefer to make correct choice. The success or failure that an individual or organization experiences, depends to a large extent on the ability of making appropriate decisions. Making of a decision requires an enumeration of feasible and viable alternatives (courses of action or strategies), the projection of consequences associated with different alternatives, and the measure of effectiveness (or an objective) to identify best alternative to be used. Everyone engages in the process of making decisions on a daily basis. Some of these decisions are quite easy to make and almost automatic. Other decisions can be very difficult to make and almost debilitating. Likewise, the information needed to make a good decision varies greatly. Some decisions require a great deal of information whereas others much less. Sometimes there is not much if any information available and hence the decision becomes intuitive, if not just a guess. Many, if not most, people make decisions without ever truly analyzing the situation and the alternatives that exist. There is a subjective and intrinsic aspect to all decision making, but there are also systematic ways to think about problems to help make decisions easier. The purpose of decision analysis is to develop techniques to aid the process of decision making, not replace the decision maker. Earlier, the decisions were taken subjectively based on the skill, experience and intuition of the decision maker. But in todays world of dynamism, the decision making has become very complex, particularly in business, marketing and management because they involve a number of interactive variables (factors) whose values and relationships cannot be determined accurately. In such situations, mere intuition and expertise of the decision maker are inadequate and we require well considered judgment and analysis based on the use of several quantitative techniques and even computers in solving problems. It is in this context that we need a full-

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fledged decision theory which provides a sound and scientific basis for improved decision making. Decision making is the essence of management. In general, the process of making decisions calls for (i) identifying the alternatives, (ii) gathering all the relevant information about them, and (iii) selecting the best alternative on the basis of some criterion. The decision theory, also called the decision analysis, is used to determine optimal strategies where a decision-maker is faced with several decision alternatives and an uncertain, or risky, pattern of future events. To recapitulate, all decisionmaking situations are characterized by the fact that two or more alternative courses of action are available to the decision-maker to choose from. Further, a decision may be defined as the selection by the decision-maker of an act, considered to be best according to some pre-designated standard, from among the available options. When analyzing the decision making process, the context or environment of the decision to be made allows for a categorization of the decisions based on the nature of the problem or the nature of the data or both. There are two broad categories of decision problems: decision making under certainty and decision making under uncertainty. THEORETICAL QUESTIONS ABOUT DECISIONS The following are examples of decisions and of theoretical problems that they give rise to. Shall I bring the umbrella today? The decision depends on something which I do not know, namely whether it will rain or not. I am looking for a house to buy. Shall I buy this one? This house looks fine, but perhaps I will find a still better house for the same price if I go on searching. When shall I stop the search procedure? Am I going to smoke the next cigarette? One single cigarette is no problem, but if I make the same decision sufficiently many times it may kill me. The court has to decide whether the defendant is guilty or not. There are two mistakes that the court can make, namely to convict an innocent person and to acquit a guilty person. What principles should the court apply if it considers the first of these mistakes to be more serious than the second?
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A committee has to make a decision, but its members have different opinions. What rules should they use to ensure that they can reach a conclusion even if they are in disagreement? Almost everything that a human being does involves decisions. Therefore, to theorize about decisions is almost the same as to theorize about human activities. However, decision theory is not quite as all-embracing as that. It focuses on only some aspects of human activity. In particular, it focuses on how we use our freedom. In the situations treated by decision theorists, there are options to choose between, and we choose in a non-random way. Our choices, in these situations, are goal-directed activities. Hence, decision theory is concerned with goal-directed behaviour in the presence of options.

A Truly Interdisciplinary Subject

Modern decision theory has developed since the middle of the 20th century through contributions from several academic disciplines. Although it is now clearly an academic subject of its own right, decision theory is typically pursued by researchers who identify themselves as economists, statisticians, psychologists, political and social scientists or philosophers. There is some division of labour between these disciplines. A political scientist is likely to study voting rules and other aspects of collective decision-making. A psychologist is likely to study the behaviour of individuals in decisions, and a philosopher the requirements for rationality in decisions. However, there is a large overlap, and the subject has gained from the variety of methods that researchers with different backgrounds have applied to the same or similar problems. Normative and Descriptive Theories The distinction between normative and descriptive decision theories is, in principle, very simple. A normative decision theory is a theory about how decisions should be made, and a descriptive theory is a theory about how decisions are actually made. The should in the foregoing sentence can be interpreted in many ways. There is, however, virtually complete agreement among decision scientists that it refers to the prerequisites of rational decision-making. In other words, a normative decision theory is a theory about how decisions should be made in order to be rational. This is a very limited sense of the word normative. Norms of rationality are by no means the only
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 or even the most important norms that one may wish to apply in decision-making. However, it is practice to regard norms other than rationality norms as external to decision theory. Decision theory does not, according to the received opinion, enter the scene until the ethical or political norms are already fixed. It takes care of those normative issues that remain even after the goals have been fixed. This remainder of normative issues consists to a large part of questions about how to act in when there is uncertainty and lack of information. It also contains issues about how an individual can coordinate her decisions over time and of how several individuals can coordinate their decisions in social decision procedures. If the general wants to win the war, the decision theorist tries to tell him how to achieve this goal. The question whether he should at all try to win the war is not typically regarded as a decision-theoretical issue. Similarly, decision theory provides methods for a business executive to maximize profits and for an environmental agency to minimize toxic exposure, but the basic question whether they should try to do these things is not treated in decision theory. Although the scope of the normative is very limited in decision theory, the distinction between normative (i.e. rationality-normative) and descriptive interpretations of decision theories is often blurred. It is not uncommon, when you read decision-theoretical literature, to find examples of disturbing ambiguities and even confusions between normative and descriptive interpretations of one and the same theory. Probably, many of these ambiguities could have been avoided. It must be conceded, however, that it is more difficult in decision science than in many other disciplines to draw a sharp line between normative and descriptive interpretations. This can be clearly seen from consideration of what constitutes a falsification of a decision theory. It is fairly obvious what the criterion should be for the falsification of a descriptive decision theory. ELEMENTS OF DECISION MAKING Decision Maker: The entity responsible for making the decision. This may be a single person, a committee, company, and the like. It is viewed here as a single entity, not a group. Alternatives: A finite number of possible decision alternatives or courses of action available to the decision maker. The decision maker generally has control over the
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specification and description of the alternatives. These alternatives are also called courses of action (actions, acts or strategies) and are known to the decision-maker. States of Nature: The scenarios or states of the environment that may occur but are not under control of the decision maker. These are the circumstances under which a decision is made. The states of nature are mutually exclusive events and exhaustive. This means that one and only one state of nature is assumed to occur and that all possible states are considered. Payoff or Outcome: Outcomes are the measures of net benefit, or payoff, received by the decision maker. This payoff is the result of the decision and the state of nature. Hence, there is a payoff for each alternative and outcome pair. The measures of payoff should be indicative of the decisions makers values or preferences. The payoffs are generally given in a payoff matrix in which a positive value represents net revenue, income, or profit and a negative value represents net loss, expenses, or costs. This matrix yields all alternative and outcome combinations and their respective payoff and is used to represent the decision problem. General form of payoff matrix Courses of Action (Alternatives) States of Nature Pr obability S1 S2 L Sn N1 N2 M Nm p1 p2 M pm p11 p21 M pm1 p12 p22 M pm2 L L L L p1n p2n M pmn

STEPS OF DECISION MAKING PROCESS The decision making process involves the following steps: 1. Identify and define the problem. 2. Listing of all possible future events, called states of nature, which can occur in the context of the decision problem. Such events are not under the control of decision-maker because these are erratic in nature. 3. Identification of all the courses of action (alternatives or decision choices) which are available to the decision-maker. The decision-maker has control over these courses of action.
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4. Expressing the payoffs resulting from each pair of course of action and state of nature. These payoffs are normally expressed in a monetary value.
5. Apply an appropriate mathematical decision theory model to select best course

of action from the given list on the basis of some criterion (measure of effectiveness) that results in the optimal (desired) payoff. TYPES OF DECISION-MAKING ENVIRONMENTS To arrive at a good decision it is required to consider all available data, an exhaustive list of alternatives, knowledge of decision environment, and use of appropriate quantitative approach for decision-making. In this section four types of decisionmaking environments: Certainty, uncertainty, risk and conflict have been described. The knowledge of these environments helps in choosing appropriate quantitative approach for decision-making. Type 1 - Decision-Making under Certainty The process of choosing an act or strategy when the state of nature is completely known is called decision making under certainty. The decision-maker has the complete knowledge (perfect information) of consequence of every decision choice (course of action or alternative) with certainty. Obviously, he will select an alternative that yields the largest return (payoff) for the known future (state of nature). In such situation, each act will only result in one event and the outcome of the act can be predetermined with certainty. Hence, such situations are also termed as deterministic situations. For example, the decision to purchase either National Saving Certificate (NSC); or deposit in National Saving Scheme is one in which it is reasonable to assume complete information about the future because there is no doubt that the Pakistani government will pay the interest when it is due and the principal at maturity. In this decision-model, only one possible state of nature (future) exists. Type 2 - Decision-Making under Risk In this case the decision-maker has less than complete knowledge with certainty of the consequence of every decision choice (course of action) because it is not definitely known which outcome will occur. This means there is more than one state of nature (future) and for which he makes an assumption of the probability with which each state of nature will occur. For example, probability of getting head in the toss of a coin is 0.5. Decision-making under risk is a probabilistic decision situation, in which more than one state of nature exists and the decision-maker has sufficient
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information to assign probability values to the likely occurrence of each of these states. The probabilities of various outcomes may be determined objectively from the past data. Knowing the probability distribution of the states of nature, the best decision is to select that course of action which has the largest expected payoff value. The expected (average) payoff of an alternative is the sum of all possible payoffs of that alternative weighted by the probabilities of those payoffs occurring. However, past records may not be available to arrive at the objective probabilities. In many cases the decision-maker may, on the basis of his experience and judgment, be able to assign subjective probabilities to the various outcomes. The problem can then be solved as decision problem under risk. Under conditions of risk, the most popular decision criterions for evaluating the alternative is the expected monetary value/expected opportunity loss of the expected payoff. (i) Expected monetary value (EMV) More generally, the decision-making in situations of risk is on the basis of the expectation principle, with the event probabilities assigned, objectively or subjectively as the case may be, the expected pay-off for each strategy is calculated by multiplying the pay-off values with their respective probabilities and then adding up these products. The strategy with the highest expected pay-off represents the optimal choice. It goes without saying that in problems involving pay-off matrix in terms of costs, optimal strategy is that corresponding to which the expected value is the least. (ii) Expected Opportunity Loss (EOL) An alternative approach to maximizing expected monetary value (EMV) is to minimize the expected opportunity loss (EOL), also called expected value of regret. The EOL is defined as the difference between the highest profit (or payoff) for a state of nature and the actual profit obtained for the particular course of action taken. In other words, EOL is the amount of payoff that is lost by not selecting the course of action that has the greatest payoff for the state of nature that actually occurs. The course of action due to which EOL is minimum, is recommended. Since EOL is an alternative decision criterion for decision-making under risk, therefore, the results will always be the same as those obtained by EMV criterion discussed earlier.
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The steps for calculating EOL are summarized as follows: (a) Prepare a profit (cost) table for each course of action and state of nature combination along with the associated probabilities. (b) For each state of nature calculate the opportunity loss (OL) values by subtracting each payoff from the maximum payoff for that outcome. (For each state of nature calculate the opportunity loss (OL) values by subtracting the minimum payoff for that outcome from each payoff.) (c) Calculate EOL for each course of action by multiplying the probability of each state of nature with the OL value and then adding the values. (d) Select a course of action for which the EOL value is minimum. Expected value of perfect information (EVPI) The expected profit with perfect information is the expected return, in the long run, if we have perfect information before a decision is made. The Expected Value of Perfect Information (EVPI) may be defined as the maximum amount one would be willing to pay, to acquire perfect information as to which event would occur. EPPI represents the maximum obtainable EMV with perfect information as to which event will actually occur (as calculated before information is received). If EMV represents the maximum obtainable EMV without perfect information, perfect information would increase expected profit from EMV up to the value of EPPI, so the amount of that increase would be equal to EVPI. Thus, we have EVPI = EPPI EMV Type 3 - Decision-Making under Uncertainty In this case the decision-maker is unable to specify the probabilities with which the various states of nature (futures) will occur. However, this is not the case of decision-making under ignorance, because the possible states of nature are known. Thus, decisions under uncertainty are taken even with less information than decisions under risk. For example, the probability that Mr. X will be the prime minister of the country 15 years from now is not known. The decision situations where there is no way in which the decision-maker can assess the probabilities of the various states of nature are called decisions under uncertainty. In such situations, the decision-maker has no idea at all as to which of the possible states of nature would occur nor has he a reason to believe why a given
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state is more, or less, likely to occur as another. With probabilities of the various outcomes unknown, the actual decisions are based on specific criteria. The several principles which may be employed for taking decisions in such conditions include (i) Laplace Criterion, (ii) Maximin or Minimax Criterion, (iii) Maximax or Minimin Criterion, (iv) Savage Criterion, (v) Hurwicz Criterion (or Criterion of Realism). Such situations are frequent in business and management. Will the new plant or industrial unit be successful? Will the new product be able to compete with others in the market? How much to produce and stock to get maximum returns?
(i) Optimism (Maximax (Profit) or Minimin (Cost)) Criterion

In this criterion the decision-maker ensures that he should not miss the opportunity to achieve the largest possible profit (maximax) or lowest possible cost (minimin). Thus, he selects the alternative (decision choice or course of action) that represents the maximum of the maxima (or minimum of the minima) payoffs (consequences or outcomes). The working method is summarized as follows: (a) Locate the maximum (or minimum) payoff values corresponding to each alternative (or course of action), then (b) Select an alternative with best anticipated payoff value (maximum for profit and minimum for cost). Since in this criterion the decision-maker selects an alternative with largest (or lowest) possible payoff value, it is also called an optimistic decision criterion.
(ii) Pessimism (Maximin (Profit) or Minimax (Cost)) Criterion

This principle is adopted by pessimistic decision-makers who are conservative in their approach. Using this approach, the minimum pay-offs resulting from adoption of various strategies are considered and among these values the maximum one is selected. It involves, therefore, choosing the best (the maximum) profit from the set of worst (the minimum) profits. When dealing with the costs, the maximum cost associated with each alternative is considered and the alternative which minimizes this maximum cost is chosen. In this context, therefore, the principle is used minimax-the best (the minimum cost) of the worst (the maximum cost). The working method is summarized as follows:
(a) Locate the minimum (or maximum in case of profit) payoff value in case of
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loss (or cost) data corresponding to each alternative, then

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(b) Select an alternative with best anticipated payoff value (maximum for

profit and minimum for loss or cost). Since in this criterion the decision-maker is conservative about the future and always anticipates worst possible outcome (maximum for profit and minimum for loss or cost), it is called a pessimistic decision criterion. This criterion is also known as Walds criterion. (iii) Equal probabilities (Laplace) Criterion Since the probabilities of states of nature are not known, it is assumed that all states of nature will occur with equal probability, i.e. each state of nature is assigned an equal probability. As states of nature are mutually exclusive and collectively exhaustive, so the probabilities of each of these must be 1 . The working method is summarized as follows: number of states of nature (a) Assign equal probability value to each state of nature by using the formula: 1 . number of states of nature (b) Compute the expected (or average) payoff for each alternative (course of action) by adding all the payoffs and dividing by the number of possible states of nature or by applying the formula:

(Probability of state of nature j) (Payoff value for the combination of alternative, i and state of nature j) (c) Select the best expected payoff value (maximum for profit and minimum for cost). This criterion is also known as the criterion of insufficient reason because, except in a few cases, some information of the likelihood of occurrence of states of nature is available.
(iv)

Coefficient of optimism (Hurwicz) Criterion This criterion suggests that a rational decision-maker should be neither

completely optimistic nor pessimistic and, therefore must display a mixture of both. Hurwicz, who suggested this criterion, introduced the idea of a coefficient of optimism (denoted by ) to measure the decision-makers degree of optimism. This coefficient lies between 0 and 1, where 0 represents a
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complete pessimistic attitude about the future and 1 a complete optimistic attitude about the future. Thus, if is the coefficient of optimism, then (1 ) will represent the coefficient of pessimism. In case of profits, the Hurwicz approach suggests that the decision-maker must select an alternative that maximizes H (Criterion of realism) = (Maximum in column) + (1 ) (Minimum in column) The working method is summarized as follows: (a) Decide the coefficient of optimism (alpha) and then coefficient of pessimism (1 ). (b) For each alternative select the largest and lowest payoff value and multiply these with and (1 ) values, respectively. Then calculate the weighted average, H by using above formula. (c) Select an alternative with best anticipated weighted average payoff value. In the case of costs, the principle works like this. The minimum of the costs for each course of action is multiplied by (the indicator of the degree of optimism of the decision maker), and the maximum of the costs for each alternative is multiplied by(1 ). Then the sum of the products for each action strategy is obtained the alternative for which the sum is the least is selected. (v) Regret savage criterion This criterion is also known as opportunity loss decision criterion or minimax regret decision criterion because decision-maker feels regret after adopting a wrong course of action (or alternative) resulting in an opportunity loss of payoff. Thus, he always intends to minimize this regret. The working method is summarized as follows: (a) From the given payoff matrix, develop an opportunity loss (or regret) matrix as follows: (i) Find the best payoff corresponding to each state of nature, and (ii)Subtract all other entries (payoff values) corresponding to each state of nature from this value. (b) For each course of action (strategy or alternative) identify the worst or maximum regret value. Record this number in a new row. (c) Select the course of action (alternative) with the smallest anticipated
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opportunity loss value.

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In the case of costs, the principle works like this. (a) From the given payoff matrix, develop an opportunity loss (or regret) matrix as follows: (i) Find the worst payoff corresponding to each state of nature, and (ii)Subtract all other entries (payoff values) corresponding to each state of nature from this value. (b) For each course of action (strategy or alternative) identify the best or minimum regret value. Record this number in a new row. (c) Select the course of action (alternative) with the greatest anticipated opportunity loss value. Type 4 - Decision-Making under Conflict In many situations, neither states-of-nature are completely known nor are they completely uncertain. Partial knowledge is available and therefore it may be termed as decision-making under partial uncertainty. An example of this is the situation of conflict involving two or more competitors marketing the same product.

Some Examples related to Different Decision-Making Environments Example 1: A food product company is contemplating the introduction of a revolutionary new product with new packaging or replace the existing product at much higher price (S1) or a moderate change in the composition of the existing product with a new packaging at a small increase in price (S 2) or a small change in the composition of the existing product except the word New with a negligible increase in price (S3). The three possible states of nature or events are: (i) high increase in sales (N1), (ii) no change in sales (N2) and (iii) decrease in sales (N3). The marketing department of the company worked out the payoffs in terms of yearly net profits for
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each of the strategies of three events (expected sales). This is represented in the following table: Strategies S1 S2 S3 N1 7,00,000 5,00,000 3,00,000 N2 3,00,000 4,50,000 3,00,000 N3 1,50,000 0 3,00,000 Which strategy should the concerned executive choose on the basis of the following? (a) Maximin criterion (c) Minimax regret criterion (a) Maximin Criterion States of Nature Strategies S1 S2 S3 N1 7,00,000 5,00,000 3,00,000 N2 3,00,000 4,50,000 3,00,000 N3 1,50,000 0 3,00,000 Column (minimum) 1,50,000 0 3,00,000 Maximin The maximum of column minima is 3,00,000. Hence, the company should adopt strategy S3. (b) Maximax Criterion Strategies S1 S2 S3 N1 7,00,000 5,00,000 3,00,000 N2 3,00,000 4,50,000 3,00,000 N3 1,50,000 0 3,00,000 Column (maximum) 7,00,000 5,00,000 3,00,000 Maximax The maximum of column maxima is 7,00,000. Hence, the company should adopt strategy S1. (c) Minimax Regret Criterion (opportunity loss in case of profits) Strategies S1 S2 S3 N1 7,00,000 7,00,000 = 7,00,000 5,00,000 = 7,00,000 3,00,000 = 0 2,00,000 4,00,000 N2 4,50,000 3,00,000 = 4,50,000 4,50,000 = 4,50,000 3,00,000 = 1,50,000 0 1,50,000 1,50,000 = 3,00,000 0 N3 3,00,000 = 3,00,000 3,00,000 = 1,50,000 3,00,000 0 Column 1,50,000 3,00,000 4,00,000 (maximum) Minimax regret Hence, the company should adopt minimum opportunity loss strategy, S1.
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States of Nature

(b) Maximax criterion (d) Laplace criterion

Solution: The payoff matrix is rewritten as follows:

States of Nature

States of Nature

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(d)Laplace Criterion Since, we do not know the probabilities of states of nature, assume that they are equal. For this example, we would assume that each state of nature has a probability 1/3 of occurrence. Thus, Expected Return (Rs) S1 (7,00,000 + 3,00,000 + 1,50,000)/3 = 3,83,333.33 S2 (5,00,000 + 4,50,000 + 0)/3 = 3,16,666.66 S3 (3,00,000 + 3,00,000 + 3,00,000)/3 = 3,00,000 Since, the largest expected return is from strategy S1; the executive must select strategy S1. Example 2: A Super Bazaar must decide on the level of supplies it must stock to meet the needs of its customers during Eid days. The exact number of customers is not known, but it is expected to be in one of the four categories; 300, 350, 400 or 450 customers. Four levels of supplies are thus suggested with level j being ideal (from the viewpoint of incurred costs) if the number of customers falls in category j. Deviations from the ideal levels results in additional costs either because extra supplies are stocked needlessly or because demand cannot be specified. The table below provides these costs in thousands of rupees. Customer category E1 E2 E3 E4 (a) Which Supplies level A1 A2 A3 A4 7 12 20 27 10 9 10 25 23 20 14 23 32 24 21 17 level of inventory is chosen on the basis of (i) Laplace criterion (ii) minimax Strategy

criterion (iii) minimin criterion? (b) Now consider payoff matrix as profit matrix then which level of inventory is chosen on the basis of Hurwicz criterion Solution: (a) (i) Laplace Criterion Since, we do not know the probabilities of states of nature, assume that they are equal. For this question, we would assume that each state of nature has a probability 1/4 of occurrence. Thus, Strategy A1 A2 A3 A4 Expected Return (Rs) (7 + 10 + 23 + 32)/4 = 18 (12 + 9 + 20 + 24)/4 = 16.25 (20 + 10 + 14 + 21)/4 = 16.25 (27 + 25 + 23 + 17)/4 = 23
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Since, the lowest expected return is from strategy A2 and A3; the executive must select strategy A2 or A3. (ii)Minimax Criterion States of Nature A1 E1 7 E2 10 E3 23 E4 32 Column 32 (maximum) The minimum of column (iii) Minimin Criterion Strategies A1 A2 A3 A4 E1 7 12 20 27 E2 10 9 10 25 E3 23 20 14 23 E4 32 24 21 17 Column 7 9 10 17 (minimum) Minimin The minimum of column minima is 7. Hence, the company should adopt strategy A1. States of Nature Strategies A2 A3 A4 12 20 27 9 10 25 20 14 23 24 21 17 27 24 21 Minimax maxima is 21. Hence, the company should adopt strategy A3.

(b) In the context of profit data, Hurwicz Criterion, HC = (Max Value) + (1 ) (Min Value). Its value for various strategies is as follows:

State of Profit from optimal Course of Nature Action(thousand Rs) (1) (2) (3) (4) (5) (6) (7) (8) A1 A2 A3 A4 Profit (Max in 0.5 x Profit (Min in 0.5 columns (1, 2, (5) columns (1, 2, x (7) 3 & 4)) 3 & 4)) E1 7 12 20 27 32 16 7 3.5 E2 10 9 10 25 24 12 9 4.5 E3 23 20 14 23 21 10.5 10 5 E4 32 24 21 17 27 13.5 17 8.5 Since, maximum is 22, so, it is optimal to adopt strategy A4.

(6) + (8) 19.5 16.5 15.5 22

Example 3: Al Abbas Ltd has installed a machine costing Rs 4 lacs and is in the process of deciding on an appropriate number of a certain spare parts required for repairs. The spare parts cost Rs 4000 each but are available only if they are ordered now. In case the machine fails and no spares are available, the cost to the company
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of mending the plant would be Rs 18000. The plant has an estimated life of 8 years and the probability distribution of failures during the time, based on experience with similar machines, is as follows: No. of failures during 8-yearly period 0 1 2 3 4 5 Probability 0.1 0.2 0.3 0.2 0.1 0.1 Ignoring any discounting for time value of money, determine the following: (a) The expected number of failures in the 8-year period.
(b) The optimal number of units of the spare part on the basis of Hurwicz principle

(taking =0.7).
(c) EVPI.

Solution: Since the availability of number of spares at the time of the failure of any machine is under the control of decision-maker, no. of spares per year is considered as course of action (decision choice) and the no. of failures of machines is uncertain and only known with probability, therefore, it is considered as a state of nature (event). Let S be the quantity (number of spares to be available). And F is the no. of failures within one year. It is given that cost of storing a spare is Rs. 4000. Cost of not storing the spare is Rs. 18000. Cost function = 4,000S, S F 4,000S + 18000 (F S), S < F (a) The expected number of failures in the 8 year period, is given by E(F) = pi Fi = 0.1 0 + 0.2 1 + 0.3 2 + 0.2 3 + 0.1 4 + 0.1 5 = 2.3
i =1 6

State of Nature (F)

Probability

Cost (thousand Rs) Due to Course of Action (purchase) (2) 0 0 18 36 54 72 90 (3) 1 4 4 22 40 58 76 (4) 2 8 8 8 26 44 62 (5) 3 12 12 12 12 30 48 (6) 4 16 16 16 16 16 34 (7) 5 20 20 20 20 20 20

Expected Cost (thousand Rs) Due to Course of Action (1) x (2) 0 0 3.6 10.8 10.8 7.2 9 41.4 (1) x (3) 1 0.4 0.8 6.6 8 5.8 7.6 29.2 (1) x (4) 2 0.8 1.6 2.4 5.2 4.4 6.2 20.6 (1) x (5) 3 1.2 2.4 3.6 2.4 3 4.8 17.4 (1) x (6) 4 1.6 3.2 4.8 3.2 1.6 3.4 17.8 (1) x (7) 5 2 4 6 4 2 2 20

(1)

0 0.10 1 0.20 2 0.30 3 0.20 4 0.10 5 0.10 Expected Cost (EC)

(b) In the context of cost data, Hurwicz Criterion, HC = (Min Value) + (1 ) (Max Value). Its value for various strategies is as follows:
Cost (thousand Rs) Due to Cost from optimal Course of Action Action(thousand Rs) Fayyaz Ahmed Kayani Roll No. 593483 Probability Course of

State of

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Nature (1) (2) 0 (3) 1 (4) 2 (5) 3 (6) 4 (7) 5 (8) Cost (Min in columns (2, 3, 5, 6 & 7)) 0 4 8 12 16 20 (9) 0.7 x (8) 0 2.8 5.6 8.4 11.2 14 (10) Cost (Max in columns (2, 3, 5, 6 & 7)) 90 76 62 48 34 20 (11) 0.3 x (10) 27 22.8 18.6 14.4 10.2 6 (9) + (11) 27 25.6 24.2 22.8 21.4 20

0 1 2 3 4 5

0.05 0.10 0.20 0.30 0.20 0.15

0 18 36 54 72 90

4 4 22 40 58 76

8 8 8 26 44 62

12 12 12 12 30 48

16 16 16 16 16 34

20 20 20 20 20 20

Since, minimum is 20, so, it is optimal to keep 5 spare parts. (c)

State Nature of Probability (1) Cost (thousand Rs) Due to Course of Action (2) (3) (4) (5) (6) (7) 0 1 2 3 4 5 8 8 8 26 44 62 (ECPI) 12 12 12 12 30 48 16 16 16 16 16 34 20 20 20 20 20 20 Cost from optimal Course of Action(thousand Rs) (8) (1) x (8) Cost (Min in (2, 3, Weighted 5, 6 & 7)) Cost 0 0 4 0.8 8 2.4 12 2.4 16 1.6 20 2 9.2

0 0.05 0 4 1 0.10 18 4 2 0.20 36 22 3 0.30 54 40 4 0.20 72 58 5 0.15 90 76 Expected Cost with Perfect Information

Now, EVPI = EC* ECPI = 17.4 9.2 = 8.2 thousand rupees Example 4: An investor is given the following investment alternatives and percentage rates of return.
Investment alternatives Regular Shares Risky Shares Property State of Nature (Market Conditions) Low Medium High 7% 10% 15% -10% 12% 25% -12% 18% 30%

Over the past 300 days, 150 days have been medium market conditions and 60 days have had high market increases. On the basis of these data, state the optimum investment strategy for the investment. Solution: According to the given information, the probabilities of low, medium and high market conditions would be 0.30 (300 (150 + 60) = 90/300), 0.50 (150/300) and 0.20 (60/300) respectively. The expected pay-offs for each of the alternatives are calculated and shown in the table below:
Market Conditions Probability Profit (Rs) Due to Course of Action Expected Payoff (Rs) Due to Course of Action

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(2) Regular shares Low 0.30 0.07 Medium 0.50 0.10 High 0.20 0.12 Expected monetary value (EMV)

(1)

(3) Risky shares 0.10 0.12 0.18

(4) Property 0.15 0.25 0.30

(1) x (2) Regular shares 0.021 0.05 0.024 0.053

(1)x (3) Risky shares 0.03 0.06 0.036 0.126

(1) x (4) Property 0.045 0.125 0.06 0.230

Since the expected return of 23% is the highest for property, the investor should invest in this alternative. Example 5: A company manufactures goods for a market in which the technology of the product is changing rapidly. The research and development department has produced a new product which appears to have potential for commercial exploitation. A further Rs 60,000 is required for development testing. The company has 100 customers and each customer might purchase at the most one unit of the product. Market research suggests that a selling price of Rs 6000 for each unit with total variable costs of manufacturing and selling estimate are Rs 2,000 for each unit. From previous experience, it has been possible to derive a probability distribution relating to the proportion of customers who will buy the product as follows:
Proportion of customers Probability 0.04 0.10 0.08 0.10 0.12 0.20 0.16 0.40 0.20 0.20

Determine the expected opportunity losses, given no other information than that stated above, and state whether or not the company should develop the product. Solution: If p is the proportion of customers who purchase the new product, the profit is: (6,000 2,000) x 100p 60,000 = Rs (4,00,000p 60,000). Let Ni (I = 1, 2, , 5) be the possible states of nature, i.e. proportion of the customers who will buy the new product and S1 (develop the product) and S2 (do not develop the product) be the two courses of action. The profit values (payoffs) for each pair of Nis and Sjs are shown in the following table:
State of Nature Ni (Proportion of Customers, p) 0.04 0.08 Prob abilit y (1) 0.1 0.1 Profit = Rs (4,00,000p 60,000)Cours e of Action S1 S2 44,000 0 28,000 0 Opportunity Loss (Rs) (2) S1 0 (44,000) = 44,000 0 (28,000) = 28,000 (3) S2 00=0 00=0 (1) x (2) S1 4,400 2,800 (1) x (3) S2 0 0

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0.12 0.2 12,000 0.16 0.4 4,000 0.20 0.2 20,000 Expected Opportunity Loss (EOL)

0 0 0

0 (12,000) = 12,000 4,000 4,000 = 0 20,000 20,000 = 0

00=0 4,000 0 = 4,000 20,000 0 = 20,000

2,400 0 0 9,600

0 1,600 4,000 5,600

(Note: All the entries of column S2 would be 0. Since, we are not developing anything then no profit will be earned) Since, the company seeks to minimize the expected opportunity loss, the company should select course of action S2 (do not develop the product) with minimum EOL. Example 6: A retailer purchases cherries every morning at Rs 50 a case and sells them for Rs 80 a case. Any case remaining unsold at the end of the day can be disposed of next day at a salvage value of Rs 20 per case (thereafter they have no value). Past sales have ranged from 15 to 18 cases per day. The following is the record of sales for the past 120 days:
Cases sold Number of days 15 12 16 24 17 48 18 36

Find how many cases the retailer should purchase per day to maximize his profit. Solution: Since number of cherries (in cases) purchased is under the control of decision-maker, purchase per day is considered as course of action (decision choice) and the daily demand of the cherries is uncertain and only known with probability, therefore, it is considered as a state of nature (event). Let P be the quantity (number of cases of cherries to be purchased). And D is the demand within a day. Profit = (80-50) P, D>=P (80-50)D (50-20) (P-D), D < P The resulting profit values and corresponding expected payoffs are computed in the following table:
States of Nature D (Demand per week) Probability Profit (Rs) Due to Courses of Action P (Purchase per day) 16 (3) 420 480 480 480 17 (4) 390 450 510 510 18 (5) 360 420 480 540 Expected Payoff (Rs) Due to Courses of Action (Purchase per Day) 15 (1)x(2) 45 90 180 135 450 16 (1)x(3) 42 96 192 144 474 17 (1)x(4) 39 90 204 153 486 18 (1)x(5) 36 84 192 162 474

15 (1) (2) 15 12/120 = 450 0.1 16 24/120 = 450 0.2 17 48/120 = 450 0.4 18 36/120 = 450 0.3 Expected monetary value (EMV)

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Since the highest EMV of Rs 486 is corresponding to course of action 17, the retailer must purchase 17 cases of cherries every morning. Example 7: A company needs to increase its production beyond its existing capacity. It has narrowed the alternatives to two approaches to increase the production capacity: (a) expansion, at a cost of Rs 8 million, or (b) modernization at a cost of Rs 5 million. Both approaches would require the same amount of time for implementation. Management believes that over the required payback period, demand will either be high or moderate. Since high demand considered being somewhat less likely than moderate demand, the probability of high demand has been set at o.35. If the demand is high, expansion would gross estimated additional Rs 12 million but modernization only additional Rs 6 million, due to lower maximum product capability. On the other hand, if the demand is moderate, the comparable figures would be Rs 7 million for expansion and Rs 5 million for modernization. (a) Calculate the profit in relation to various action and outcome combinations and states of nature. (b) If the company wishes to maximize its EMV, should it modernize or expand? (c) Calculate the EVPI. (d) Construct the conditional opportunity loss table and also calculate EOL. Solution: Defining the states of nature: high demand and moderate demand (over which the company has no control) and courses of action (companys possible decisions): Expand and Modernize. Since the probability that the demand is high estimated at 0.35, the probability of moderate demand must be (1 0.35) = 0.65. The resulting profit values, corresponding expected payoffs and Expected Opportunity Loss (EOL) values are computed in the following table:
State of Nature (Dema nd) Prob abilit y (1) Profit (million Rs) Due to Course of Action (2) Expand (S1) (3) Moder nize(S 2) Expected Payoff (million Rs) Due to Course of Action (1) x (1) x (2) (3) Expan Mode d (S1) rnize (S2) Profit from optimal Course of Action(million Rs) (4) (1) x (4) Profit Weigh (Max in ted (2 & Profit 3)) Opportunity Loss (million Rs) Due to Course of Action (5) (6) S1 S2 (1) x (5) (1) x (6)

S1

S2

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(N2)Moderate Demand (N1)High Demand

0.35

12 8 = 4

65= 1

1.4

0.35

1.40

44= 0

41 =3

1.05

0.65

78= 1

55= 0

0.65

0(1) = 1

00 =0

0.65

Expected monetary value (EMV) 0.75 0.35 Expected Profit with Perfect Information (EPPI) Expected Opportunity Loss (EOL)

1.40 0.65 1.05

(b) Since the highest EMV of Rs 0.75 million is corresponding to course of action Expand, the company must expand it. (c) EVPI = EPPI EMV =1.40 0.75 = Rs. 0.65 Million (d)Since, the company seeks to minimize the expected opportunity loss (EOL), the company should select course of action S1 (Expand).

Example 8: A toy manufacturer is considering a project of manufacturing a dancing doll with three different movement designs. The doll will be sold at an average of Rs 10. The first movement design using gears and levels will provide the lowest tooling and set up cost of Rs 1,00,000 and Rs 5 per unit of variable cost. A second design with spring action will have a fixed cost of Rs. 1, 60,000 and variable cost of Rs 4 per unit. Yet another design with weights and pulleys will have a fixed cost of Rs. 3, 00,000 and variable cost of Rs 3 per unit. One of the following demand events can occur for the doll with the probabilities:
Light demand Moderate demand Heavy demand Demand (units) 25,000 1,00,000 1,50,000 Probability 0.10 0.70 0.20

(a) Construct a payoff table for the above project. (b) Which is the optimum design?

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(c) How much can be decision-maker afford to pay to obtain perfect information about the demand? Solution: Payoff (Profit) = Revenue Cost = (Selling Price x no. of units demanded) (fixed cost + variable cost) = (Selling Pricexno. of units demanded)(fixed cost+(no. of units demandedxper unit cost))
State of Nature (Demand) Probability Profit (Rs) Due to Course of Action Expected Payoff (Rs) Due to Course of Action (1) x (2) Gears & Levels 2,500 2,80,000 1,30,000 4,12,500 (1) x (3) Spring Action 1,000 3,08,000 1,48,000 4,55,000 (1) x (4) Weights & Pulleys 12,500 2,80,000 1,50,000 4,17,500

(2) Gears & Levels Light 0.10 25,000 Moderate 0.70 4,00,000 Heavy 0.20 6,50,000 Expected monetary value (EMV)

(1)

(3) Spring Action 10,000 4,40,000 7,40,000

(4) Weights & Pulleys 1,25,000 4,00,000 7,50,000

Since, EMV is largest for spring action, it must be selected.

State of Nature (Demand)

Probability

Profit (Rs) Due to Course of Action

Profit from optimal Course of Action(Rs)

(1)

(2) Gears

&

(3) Spring

(4) Weights Pulleys 1,25,000 4,00,000 7,50,000

&

(4) Profit (Max in (2, 3 & 4)) 25,000 4,40,000 7,50,000

(1) x (4) Weighted Profit 2,500 3,08,000 1,50,000 4,60,500

Levels Action Light 0.10 25,000 10,000 Moderate 0.70 4,00,000 4,40,000 Heavy 0.20 6,50,000 7,40,000 Expected Profit with Perfect Information (EPPI)

The maximum amount of money that the decision-maker would be willing to pay to obtain perfect information regarding demand for the doll will be EVPI = EPPI EMV =4,60,000 4,55,000 = Rs 5,500 DECISION TREE ANALYSIS Decision-making problems discussed so far have been limited to a single decision over one period of time, because the payoffs, states of nature, courses of action and probabilities associated with the occurrence of states of nature are not subject to change.

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However, situations may arise when a decision-maker needs to revise his previous decisions on getting new information and make a sequence of several interrelated decisions over several future periods. Thus he should consider the whole series of decisions simultaneously. Such a situation is called a sequential or multi period decision process. Decision tree is a network which exhibits graphically the logical relationship between the different parts of the complex decision process. It is a graphic model of each combination of various acts and states of nature {S i, Aj}; (I = 1, 2, , m; j = 1, 2, , n) along with their payoffs, the probability distribution of the various states of nature and the EMV or EOL for each act. Decision tree is a very effective device in making decisions in various diversified problems relating to personnel, investment, portfolios, project management, new project strategies, etc. Each combination (Si, Aj) is depicted by a distinct path through the decision tree. An essential feature of the decision tree is that the flow should be from left to right in a chronological order. Standard symbols are used in drawing a decision tree.
(i) A square (

) is used to represent a decision point or decision node at which

the decision maker has to decide about one of the various acts or alternatives available to him.
(ii) Each act or alternative is shown as a line, representing a branch of the tree

emanating from the square. (iii) A circle ( ) is used to represent a chance event or chance node at which various events or states of nature are represented by lines, which depict the sub-branches of the tree emanating from the circle. (iv) Each branch of the tree (corresponding to each act or strategy) has as many sub-branches as the number of events or states of nature.
(v) Along the branches/sub-branches are also shown the probabilities of various

states of nature and the payoffs for each combination (Si, Aj); I = 1, 2, , m; j = 1, 2, , n along with the EMV or EOL for each act. (vi) As a branch can sub-branch again, we obtain a tree like structure, which represents the various steps in a decision problem. Roll Back Technique of Analyzing a Decision Tree
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A decision tree is extremely useful in multistage situations which involve a number of decisions, each depending on the preceding one. At any stage, to decide about any strategy or act, the decision maker has to take into consideration all future outcomes that may result from choosing the said act. Consequently to analyze a decision tree, we start from the end of the tree (extremely RHS) i.e., we start from the last decision/event node, say Dl and work backwards. This technique of analyzing the decision tree, called the roll-back technique is explained in the following steps. 1. (a) for each branch of the event node (of Dl) we compute the conditional expected payoffs. (b) Adding these expected payoffs for each event-nodal branch, we obtain the EMV for the given path (act or strategy) emanating from the square (decision node Dl). (c) The optimal act or strategy at Dl is the one which corresponds to the highest EMV. 2. Next we move to the last but one decision node (Dl-1), make the EMV analysis as in steps 1 (a), (b) and (c) and then move back to the preceding decision node (Dl-2) and so on. 3. This roll-back process is continued till we reach the first decision node (Dl). Example 1: A manufacturing company has to select one of the two products X or Y for manufacturing. Product X requires investment of Rs. 30,000 and product Y, Rs. 50,000. Market result survey shows high, medium and low demands with corresponding probabilities and return from sales, (in thousand rupees), for the two products, as given in the following table.
Demand High Medium Low Probability Product X Product Y 0.4 0.3 0.4 0.4 0.2 0.3 Return from Sales (ooo Rs.) Product X Product Y 75 55 35 100 80 70

Construct the appropriate decision tree. What decision the company should take? Solution:

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0.4) nd ( ema D High 00 750

Medium Demand (0.4)

L ow

55000

tX d uc Pro
00 -300

De m a nd

35 000

(0.2 )

- 50 0

P rod

uct Y 00

De H ig h

d ma n
000

) (0 .3

10 0

Medium Demand (0.4)

80000

Low D em an d (0.3) 700

00

Net Payoff (Rs.) 75000-30000=45000 55000-30000=25000 35000-30000=5000 Total 100000-50000=50000 80000-50000=30000 70000-50000=20000 Total

Expected Payoff (Rs.) 45000 0.4=18000 25000 0.4=10000 5000 0.2=1000 29000 (EMV) 50000 0.3=15000 30000 0.4=12000 20000 0.3=6000 33000 (EMV)

Example 2: A businessman has two independent investments A and B available to him but he lacks the capital to undertake both of them simultaneously. He can choose to take A first and then stop, or if A is successful then take B, or vice versa. The probability of success for A is 0.7 while for B it is 0.4. Both investments require an initial capital outlay of Rs. 2000; and both return nothing if the venture is unsuccessful. Successful completion of A will return Rs. 3000 (over cost), and successful completion of B will return Rs. 5,000 (over cost). Draw and evaluate the decision tree by the roll back technique and determine the best strategy. Solution:
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St

op

ss ce c Su

3000 (0.7)

D2 (C o Ac st 20 cep 00) tB

s es cc Su

5000 (0.4)

EMV = 2060

EMV = 800 Fai lur e

ure

-2000 (0.6)

(C pt A os t2 00 0)

Fai l

Ac c

-2000 (0.3)

D1

Do Nothing

(0)
op St

(C os t2
B

00 0)
S

ss ce uc

5000 (0.4)

D3 (C Ac ost 20

cep 00) tA

s es cc Su

3000 (0.7)

Decision Node D3 (i) Accept A

D2

(ii) Stop (i) Accept B

D1

(ii) Stop (i) Accept A

(ii) Accept B

pt ce Ac

EMV = 1400

Fa il

ur e

-2000 (0.6)

EMV = 1500 Fai lu re

-2000 (0.3)

Event Succes s Failure Succes s Failure Succes s Failure Succes

Probability (p) 0.7 0.3 0.4 0.6 0.7 0.3 0.4

Conditional Payoff (in Expected Payoff (Rs.) Rs.) P 3000 -2000 5000 -2000 3000 + 800 = 3800 -2000 5000 + 1500 = 6500 p P 2100 -600 EMV = 1500 0 2000 -1200 EMV = 800 0 2660 -600 EMV = 2060 2600 Page 11

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s Failure (iii)Do Nothing

0.6

-2000

-1200 EMV = 1400 0

From the above table we conclude that the best strategy is to accept investment A first and if it is successful, then accept the investment B.

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PRACTICAL STUDY OF THE ORGANIZATION WITH RESPECT OF THE TOPIC

ORGANIZATION: SYSTEM STUDIED:

GLAXOSMITHKLINE Pakistan Limited RISK MANAGEMENT SYSTEM

In GSK, the Risk Management System is used as proactive approach to eliminate / reduce the potential risks associated with their business. Decision theory is used extensively in Risk Management System for scoring the risks on the basis of likelihood and consequences.

Note : This is only the overview of Risk Management System. Original documents could not be part of assignment due to their confidentiality.

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COMPANY INTRODUCTION

GlaxoSmithKline Pakistan Limited was created on January Ist 2002 through the merger of SmithKline and French of Pakistan Limited, Beecham Pakistan (Private) Limited and Glaxo Wellcome (Pakistan) Limited- standing today as the largest pharmaceutical company in Pakistan. As leading international pharmaceutical company they make a real difference to global healthcare and specifically to the developing world. Company believes this is both an ethical imperative and key to business success. Companies that respond sensitively and with commitment by changing their business practices to address such challenges will be the leaders of the future. GSK Pakistan operates mainly in two industry segments: Pharmaceuticals (prescription drugs and vaccines) and consumer healthcare (over-the-counter- medicines, oral care and nutritional care). GSK leads the industry in value, volume and prescription market share. Company is proud of their consistency and stability in sales, profits and growth. Some of their key brands include Augmentin, Panadol, Seretide, Betnovate, Zantac and Calpol in medicine and renowned consumer healthcare brands include Horlicks, Aquafresh, Macleans and ENO. In addition, company is also deeply involved with our communities and undertakes various Corporate Social Responsibility initiatives including working with the National Commission for Human Development (NCHD) for whom GSK was one of the largest corporate donors. GSK consider it their responsibility to nurture the environment we operate in and persevere to extend their support to our community in every possible way. GSK participates in year round charitable activities which include organizing medical camps, supporting welfare organizations and donating to / sponsoring various developmental concerns and hospitals. Furthermore, GSK maintains strong partnerships with non-government organizations such as Concern for children, which is also extremely involved in the design, implementation and replication of models for the sustainable development of children with specific emphasis on primary healthcare and education.

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GSKs MISSION STATEMENT Excited by the constant search for innovation, we at GSK undertake our quest with the enthusiasm of entrepreneurs we value performance achieved with integrity. We will attain success as a world class global leader with each and every one of our people contributing with passion and an unmatched sense of urgency. Our mission is to improve the quality of human life by enabling people to do more, feel better and live longer. Quality is at the heart of everything we do-from the discovery of a molecule to the development of a medicine.

RISK MANAGEMENT SYSTEM

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Risk management is an essential component of the system of internal control and governance and is regarded as good management practice throughout GSK. A systematic, standardized and effective approach to risk management is required in order to:
Establish a common language and protocols for communicating risks in order to

take right decisions at right time. Ensure that responsibilities for managing risks are clearly stated, understood and accepted. Establish appropriate mechanisms for communication, reporting and escalation of risks. Ensure that business objectives are achieved. SCOPE OF RISK MANAGEMENT PROCESS

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PROCESS STEP ACTIVITIES Following are the different steps involved in the risk management system: Establish the Risk Management Organization for the risk assessment area. Identify, Record and Priorities Scored Risks. Confirm and Approve Risk Mitigation plans. Implementation, monitoring and of risk mitigation plans. Governance and Maintenance.

Figure Risk Management Process Decision Theory comes into play when a risk is going to be scored (Analyse the risks). Risks are scored on the basis of likelihood and consequences. INFORMATION STRUCTURE IN RISK MANAGEMENT SYSTEM
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 A Risk is the basic record.

Risk requirements now split into three components. Mandated requirements to progress risks through workflow.
A number of Risk Mitigation Plans may be attached to Risk. A Risk must have at

least one Risk Mitigation Plan.

A number of Action Plans may be attached to each Risk Mitigation Plan. A Risk

Mitigation Plan must have at least one Action Plan. The diagram below depicts the structure of a Risk Record. RISK SCORING
Risk scoring is subjective there is no right or wrong answer it is based on personal

judgment or consensus. Review the consequence of a risk first and only when this is agreed review the associated likelihood of the scored consequence. The subjectivity on assessment of likelihood is inherently higher than that for consequence and influenced by individual perception, background, and local objectives a team based approach is always used to reach consensus on likelihood.
The key requirement for the risk management process is that the significant risks

are identified and managed appropriately the precise scoring is a secondary consideration. It is essential that risks assessment area are consistently scored and prioritized and a group view is required by the Quality management process to avoid personal bias in scoring. The scoring supports the prioritization of risks but, even then, judgment is required where several risks all have the same score and decisions are required in terms of resource allocation.

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 The scoring supports the prioritisation of risks but, even then, judgment

is

required where several risks all have the same score and decisions are required in terms of resource allocation.
Comparisons of numbers of risks on aggregation of risk assessment areas are of

little value any analysis and trending should focus on topics and not scores.
Differences in number and ratings of risks across risk assessment areas should be

explored in terms of processes, resources and approach to generate them.

As with risk description, scoring is based on the current environment taking into

account all controls. A control can impact the consequence or likelihood. A control should be considered as something which impacts how severe a risk can become and not be limited to physical controls, written procedures or failsafe controls.
Risks should be assessed and scored from a GSK perspective. Hence, the

consequence and likelihood Matrix has been changed, to focus on the impact of the Regulators detecting risks e.g. observations.

***************************************************

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RISK MANAGEMENT SYSTEM (HOME PAGE)

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RISK MANAGEMENT SYSTEM WORKFLOW

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RISK IDENTIFICATION TOOLS

5 Whys

Brainstorming Surveys Interviews FMEA (Failure Mode Effect Analysis)

SWOT (Strengths, Weaknesses, Opportunities & Threats) Analysis PEST (political, Economic, Socio-Cultural, Technological) Analysis Kaizen (Continuous Improvement)

GEMBA (Go and See) Affinity & Fishbone diagrams Reality Trees Process flowcharts Potential Problem Analysis (Kepnor Tregoe) Benchmarking Mind maps IPO

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REFERENCES

1. Quantitative Techniques (AIOU)

2. www.infra.kth.se/~soh/decisiontheory.pdf 3. en.wikipedia.org/wiki/Decision_theory 4. www.answers.com/topic/decision-theory 5. www.mendeley.com/.../decision-theory-a-brief-introduction 6. books.google.com 7. www.stat.tamu.edu/~hart/632/Bayes2 8. www.rapidmore.com/rapidshare.php?...decision+theory...brief+introduction 9. darwin.eeb.uconn.edu/eeb310/lecture.../decision/decision.html 10.www.morehouse.edu/facstaff/ajohnson/ai.../6.825-lecture-19.pdf 11.www.springerlink.com/index/R456425111457PK7.pdf 12.www.cse.unr.edu/~bebis/CS679/Handouts/DHS2.11Revised.pdf 13.www.envisionsoftware.com/.../Normative_Decision_Making_Theory.html 14.economics.stanford.edu/.../normative-decision-theory 15.home.ubalt.edu/ntsbarsh/opre640a/partix.htm 16.www.mindtools.com Decision Making 17.www.businessdictionary.com/definition/decision-theory.html 18.encyclopedia2.thefreedictionary.com/decision+theory 19.Lectures delivered by worthy Tutors in the class

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