Problem Solving and

Decision making
Dr. R K Singh
Professor, Operations Management
M D I, Gurgaon

Learning Objectives
1. Process for problem identification
2. List the steps of the decision-making process
3. Describe the types of decision-making environments
4. Make decisions under uncertainty
5. Use probability values to make decisions under risk
6. Develop accurate and useful decision trees

The Problem-Definition
Problem Process
When there is a difference between the current conditions and

a more preferable set of conditions.

Problems Mean Gaps

Business performance is worse than expected business

performance.
Actual business performance is less than possible
business performance.
Expected business performance is greater than possible
business performance.

How Much Time Should Be Spent on Problem

Definition?
Budget constraints usually influence how much

effort is spent on problem definition.

The more important the decision faced by
management, the more resources should be
allocated toward problem definition.
The time taken to identify the correct problem is
usually time well spent.

Enforced Problem Solving

Concept
Purposely seek and expose the problems so that they get attention to
fix them

Rocks in the River

Two Choices
to keep the sailboat afloat and
keep moving forward :-

Mfg
flow
Rocks =
problems
D/tim
Delay
Poor e
layout Setu s Missin
Qualit
p
g
y

Inventor
y

A. Increase water level

or
B. Lower the water level to
uncover the rocks and break them
up

Cause and Effect Diagram

Machines B

Material
s

Causes
Effect

Method
s

Man

The Effect (results which is influenced by the main factors or Causes)

are placed in a fish bone diagram. Using this diagram will help to
identify the real causes
Uses :
To grasp the causal relationship between cause and effect

To analyze the possible causes

The Problem Solving

Techniques and Tools
7

Problem Solving & Decision Making

Process
Brainstorming
Technique
Case 1
How to make BEL a better
workplace?
Case 2
How to make myself enjoy the work
I am doing and the time I spent in
Dell.

Time : 15
min

8 2009 Prentice-Hall, Inc.

38

The Nominal Group Technique

6.8

1. Small group is
assembled
6. Alternatives
are rated and
best-rated one
is chosen

2. Leader
presents a
problem

5. Group clarifies
and evaluates all
suggestions

3. Members
write down
ideas
individually
4. Each participant
presents one idea
to group

Adapted from
Exhibit 6.6

Benchmarking

Benchmarking is the sistematic and continues process of determining what the best
performance and underying skills of leading organizations are in their pursuit for excellence, and
base on this, of stimulating the organizatons own strife for excellent performanceat all
organizational levels (Camp,1992)

1
8
Implement &
monitor the
plans
7
Develop
action plans

What
should be
benchmarked

2
Identify the
bencmark
partner

The bencmark
process

6
Formulate
functional
goals

5
Determine the
performance
gap

3
Gather Data

4
Analize the
Data

10

Knowledge Management
Developing a system to improve

the creation and sharing of

knowledge critical for decision
making

Tacit knowledge: Personal,

intuitive, and undocumented

private information

Explicit knowledge: Readily

sharable public information in

The Six Step Problem Solving Process

Model
1. Identify Concerns and
problem

6. Improve the
Process

2. Analyze the
Problem

5. Analyze the Outcome

3. Evaluate the Alternatives

4. Propose and Implement

the Solution

Programmed and Nonprogrammed

Decisions: A Comparison
Programmed
Decisions
Repetitive, routine,
Types of frequent; decisions
problems made according to
specific procedures
Depend on policies and
Procerules
dures

Example
s

Business firm: Periodic

reorders of inventory
Health care: Procedure
for admitting patients
University: Admission
process in B Schools

6.2

Nonprogrammed
Decisions
Novel, complex,
difficult, infrequent;
decisions require
original thinking
Require creativity,
intuition, tolerance for
ambiguity
Business firm:
Diversification into new
products and markets
Health care: Purchase
of experimental
equipment
University:
Construction of new

6.4

Factors Influencing Decision Making

Personality and
cognitive
intelligence
Intuition
Procrastination
Emotional
intelligence

Values

Decision
Maker
Crisis and
conflict

Degree of
uncertainty

Quality of
information

Political
consideration
s

Adapted from
Exhibit 6.2

The Relationship Between Uncertainty and

Confidence

Quantitative Analysis and Decision Making

Decision-Making Process

Structuring the Problem

Define
Define
the
the
Problem
Problem

Identify
Identify
the
the
Alternative
Alternative
ss

Determine
Determine
the
the
Criteria
Criteria

Analyzing the Problem

Identify
Identify
the
the
Alternative
Alternative
ss

Choose
Choose
an
an
Alternativ
Alternativ
ee

BEL Expansion plan

Step 1 Define the problem
Expand by manufacturing and
marketing a new product
Step 2 List alternatives
Construct a large new plant
A small plant
No plant at all
Step 3 Identify possible outcomes
The market could be favorable or
unfavorable

BEL Expansion plan

Step 4 List the payoffs
Identify conditional values for the
profits for large, small, and no plants
for the two possible market
conditions
Step 5 Select the decision model
Depends on the environment and
amount of risk and uncertainty
Step 6 Apply the model to the data
Solution and analysis used to help the
decision making

BEL Expansion plan

STATE OF
NATURE
UNFAV
FAVOR ORABL
ABLE
E
ALTERN MARK MARK
ATIVE
ET ($) ET ($)
Construc

t a large 200,00 180,00

plant
0
0
Construc

t a small 100,00
20,000
plant
0
Do
0
0
nothing

Types of Decision-Making
Environments
Type 1: Decision making under certainty
Decision maker knows with certainty the
consequences of every alternative or
decision choice
Type 2: Decision making under uncertainty
The decision maker does not know the
probabilities of the various outcomes
Type 3: Decision making under risk
The decision maker knows the probabilities
of the various outcomes

Decision Making Under

Uncertainty
There are several criteria for making decisions
under uncertainty
1.

Maximax (optimistic)

2.

Maximin (pessimistic)

3.

Criterion of realism (Hurwicz)

4.

Equally likely (Laplace)

5.

Minimax regret

Maximax (Optimistic)
Used to find the alternative that maximizes the
maximum payoff
Locate the maximum payoff for each alternative
Select the alternative with the maximum number
STATE OF
NATURE
FAVO
RABL UNFAV MAXI
E ORAB MUM
MAR LE IN A
ALTERN KET MARK ROW
ATIVE
($) ET ($) ($)
Constru

ct a
200,0 180,00 200,0
large
00
0
00
plant
Table 3.2
Constru

Maxima
x

Maximin (Pessimistic)
Used to find the alternative that maximizes the
minimum payoff
Locate the minimum payoff for each alternative
Select the alternative with the maximum number
STATE OF
NATURE
FAVO
RABL UNFAV MINI
E ORAB MUM
MAR LE IN A
ALTERN KET MARK ROW
ATIVE
($) ET ($) ($)
Constru

ct a
200,0 180,00 180,0
large
00
0
00
plant
Constru

Maximi
n

Criterion of Realism (Hurwicz)

A weighted average compromise between
optimistic and pessimistic
Select a coefficient of realism
Coefficient is between 0 and 1
A value of 1 is 100% optimistic
Compute the weighted averages for each

alternative
Select the alternative with the highest value
Weighted average =(maximum in row)
+ (1 )(minimum in row)

Criterion of Realism (Hurwicz)

For the large plant alternative using = 0.8

(0.8)(200,000) + (1 0.8)(180,000) = 124,000

For the small plant alternative using = 0.8
(0.8)(100,000) + (1 0.8)(20,000) = 76,000
STATE OF
NATURE
CRIT
FAVO
ERIO
RABL UNFAV N OF
E ORAB REAL
MAR LE
ISM
ALTERN KET MARK ( =
ATIVE
($) ET ($) 0.8)$
Constru

ct a
200,0 180,00 124,0
large
00
0
00
plant
Constru
ct a

Realis
m

Equally Likely (Laplace)

Considers all the payoffs for each alternative
Find the average payoff for each alternative
Select the alternative with the highest average
STATE OF
NATURE
FAVO
RABL UNFAV
E ORAB ROW
MAR LE AVER
ALTERN KET MARK AGE
ATIVE
($) ET ($) ($)
Construc

t a large 200,0 180,00 10,00

plant
00
0
0
Construc
40,00
t a small 100,0
20,000 0
plant
00
Do

Equally likely

Minimax Regret
Based on opportunity loss or regret, the
difference between the optimal profit and actual
payoff for a decision
Create an opportunity loss table by determining the

opportunity loss for not choosing the best

alternative
Opportunity loss is calculated by subtracting each
payoff in the column from the best payoff in the
column
Find the maximum opportunity loss for each
alternative and pick the alternative with the
minimum number

Minimax Regret
STATE OF NATURE

Opportunity

Loss Tables

FAVORABLE UNFAVORAB
MARKET ($) LE MARKET
($)
200,000
200,000

0 (180,000)

200,000
100,000

0 (20,000)

STATE
200,000
OF 0
NATURE
UNFAV
FAVOR ORABL
ABLE E
ALTERNATI MARK MARKE
VE
ET ($) T ($)
Construct a
0
large plant
180,000
Construct a

00

Minimax Regret
STATE OF
NATURE
FAVO
RABL UNFAV MAXI
E ORAB MUM
MAR LE IN A
ALTERN KET MARK ROW
ATIVE
($) ET ($) ($)
Constru
ct a
0 180,00 180,0
large
0
00
plant
Constru
ct a
100,0
100,0
small
20,000
00
00
plant
Do
200,0
nothing 00

0 200,0
00

Minima
x

BEL Expansion plan

Decision making when there are several possible

states of nature and we know the probabilities

associated with each possible state
Most popular method is to choose the alternative with
the highest expected monetary value (EMV)
EMV (alternative i) = (payoff of first state of nature)
x (probability of first state of nature)
+ (payoff of second state of nature)
x (probability of second state of nature)
+ + (payoff of last state of nature)
x (probability of last state of nature)

BEL Expansion plan

Each market has a probability of 0.50
Which alternative would give the highest EMV?
The calculations are
EMV (large plant)

= (0.50)($200,000) + (0.50)($180,000)
= $10,000
EMV (small plant) = (0.50)($100,000) + (0.50)($20,000)
= $40,000
EMV (do nothing) = (0.50)($0) + (0.50)($0)
= $0

BEL Expansion plan

STATE OF
NATURE
FAVO
RABL UNFAV
E ORAB
MAR LE
ALTERN KET MARK EMV
ATIVE
($) ET ($) ($)
Construc

t a large 200,0 180,00 10,00

plant
00
0
0
Construc

t a small 100,0 20,000 40,00

plant
00
0
Do
0
0
0
nothing
Probabilit
ies
0.50 0.50

Largest
EMV

Sensitivity Analysis
Sensitivity analysis examines how our decision might

change with different input data

For the BEL Expansion plan
P = probability of a favorable market
(1 P) = probability of an unfavorable market

Sensitivity Analysis
EMV(Large Plant)

= $200,000P $180,000)(1 P)
= $200,000P $180,000 + $180,000P
= $380,000P $180,000

EMV(Small Plant)

= $100,000P $20,000)(1 P)
= $100,000P $20,000 + $20,000P
= $120,000P $20,000

EMV(Do Nothing)

= $0P + 0(1 P)
= $0

Sensitivity Analysis
EMV Values
$300,000
$200,000
$100,000
0

EMV (large plant)

Point 2

EMV (small plant)

Point 1

EMV (do nothing)

$100,000

.167

.615

Values of P
$200,000
Figure 3.1

Sensitivity Analysis
Point 1:
EMV(do nothing) = EMV(small plant)

Point 2:
EMV(small plant) = EMV(large plant)

Sensitivity Analysis
BEST
ALTERNATI
VE
Do nothing

RANGE
OF P
VALUES
Less than
0.167
Construct a 0.167
small plant
0.615
Construct a Greater
2
large plantPoint than
0.615

EMV Values
$300,000
$200,000
$100,000
0

Point 1

EMV (large plant)

EMV (small plant)
EMV (do nothing)

$100,000

.167

.615

Values of P
$200,000
Figure 3.1

Assignment
The following matrix gives the pay off of different strategies
(alternatives) S1, S2, S3 against conditions N1, N2, N3, N4
Indicate the decision taken under the following approach
Pessimistic (Maximin)
Optimistic (Maximax)
Regret (Minimax)
Equal probability (laplace)
Hurwicz criteria, the degree of optimism being 0.7
N1 N2 N3 N4
S 40 - 600 180
1 00 10
0
00
0
S 20 50 400 0
2 00 00
0

 Answers-

A-Pessimistic- S2--o
B- Optimistic- S2, S320,000
C- Regret S1-16000
D-Laplace-8500
E- Hurwicz-S2= 14000

Decision Trees
Any problem that can be presented in a

decision table can also be graphically

represented in a decision tree
Decision trees are most beneficial when a
sequence of decisions must be made
All decision trees contain decision points or
nodes and state-of-nature points or nodes
A decision node from which one of several

alternatives may be chosen

A state-of-nature node out of which one state of
nature will occur

Five Steps to
Decision Tree Analysis
1.
2.
3.
4.

5.

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 (EMVs) for each state of
nature node

Structure of Decision Trees

Trees start from left to right
Represent decisions and outcomes in

sequential order
Squares represent decision nodes
Circles represent states of nature nodes
Lines or branches connect the decisions
nodes and the states of nature

Thompsons Decision Tree

A State-of-Nature Node
Favorable Market

A Decision Node

c t nt
u
tr la
s
n eP
o
C arg
L

Favorable Market

Construct
Small Plant
Do

No
th
in

Unfavorable Market

Unfavorable Market

Thompsons Decision Tree

EMV for Node
1 = $10,000

= (0.5)($200,000) + (0.5)(
$180,000)
Favorable Market (0.5)

Alternative with best

EMV is selected

c t nt
u
tr la
s
n eP
o
C arg
L

Favorable Market (0.5)

Construct
Small Plant
Do

No
th
in

Unfavorable Market (0.5)

Unfavorable Market (0.5)

EMV for Node
2 = $40,000

Payoffs
$200,000
$180,000

$100,000
$20,000

= (0.5)($100,000)
+ (0.5)($20,000)
$0

Assignment
A contractor has a choice between two courses of action
(a) A risk contract promising Rs 10 lakhs with a

probability of 0.6 and Rs 6 lakhs with a probability of 0.4

(b) A diversified portfolio consisting of two contracts with

independent outcomes each paying Rs 5 lakhs with a

probability of 0.6 and Rs 3 lakhs with a probability of 0.4.
Construct the decision tree for using EMV criteria. What
is the optimal decision by using EMV criteria.

Ans- Risky contract EMV=Rs 8.4 lakhs

Thompsons Complex Decision Tree

Payoffs

Second Decision
Point

)
45
.
(0
y ts e
e
rv ul abl
Su Res or
v
1 Sur Fa
ve
Re y (
Ne su 0.5
5)
ga lts
tiv
e

ge
Lar t
nSmall
Pla
Plant

ge
Lar t
nSmall
Pla
Plant

2
3

4
5

Favorable Market
(0.78)
Unfavorable Market
(0.22)
Favorable
Market
(0.78)
Unfavorable Market
(0.22)
No Plant
Favorable Market
(0.27)
Unfavorable Market
(0.73)
Favorable
Market
(0.27)
Unfavorable Market
(0.73)
No Plant

Co
n

du

ct

M
ar

ke

tS

ur
ve
y

First Decision
Point

Do
Not
C

Figure 3.4

ond
uct

Sur

vey

ge
Lar t
nSmall
Pla
Plant

6
7

Favorable Market
(0.50)
Unfavorable Market
(0.50)
Favorable
Market
(0.50)
Unfavorable Market
(0.50)
No Plant

$190,00
0
$190,000
$90,00
0
$30,000

$10,000
$190,00
0
$190,000
$90,00
0
$30,000

$10,000
$200,00
0
$180,000
$100,00
0

$20,000
$
0

Thompsons Complex Decision Tree

1.

Given favorable survey results,

EMV(node 2) = EMV(large plant | positive
survey)
= (0.78)($190,000) + (0.22)($190,000) =
$106,400
EMV(node 3) = EMV(small plant | positive
survey)
= (0.78)($90,000) + (0.22)($30,000) = $63,600
EMV for no plant = $10,000

2.

Given negative survey results,

EMV(node 4) = EMV(large plant | negative
survey)
= (0.27)($190,000) + (0.73)($190,000) =
$87,400
EMV(node 5) = EMV(small plant | negative

Thompsons Complex Decision Tree

3.

Compute the expected value of the

market survey,
EMV(node 1) = EMV(conduct survey)
= (0.45)($106,400) + (0.55)($2,400)
= $47,880 + $1,320 = $49,200

4.

If the market survey is not conducted,

EMV(node 6) = EMV(large plant)
= (0.50)($200,000) + (0.50)($180,000) =
$10,000
EMV(node 7) = EMV(small plant)
= (0.50)($100,000) + (0.50)($20,000) =
$40,000
EMV for no plant = $0

5.

Best choice is to seek marketing

information

Thompsons Complex Decision Tree

First Decision
Point

Payoffs

Second Decision
Point
$106,40
0

$2,400

)
45
.
(0
y ts e
e
rv ul abl
Su Res or
Su Fav
rv
e
Re y (
Ne su 0.5
5)
ga lts
tiv
e

$87,400

du

ge
$2,40
Lar t
nSmall 0
a
l
P
Plant

(0.22)
Favorable
Market
(0.78)
Unfavorable Market
(0.22)
No Plant
Favorable Market
(0.27)
Unfavorable Market
(0.73)
Favorable
Market
(0.27)
Unfavorable Market
(0.73)
No Plant

Co
n

$49,200

ct

M
ar

ke

tS

ur
ve
y

$106,40
0

ge
$63,60
Lar t
Small
n
0
Pla
Plant

Favorable Market
(0.78)
Unfavorable Market

Figure 3.4

ond
uct

$10,00
0
Sur

vey

$40,000

Do
Not
C

ge
$40,00
Lar t
Small
n
a
0
Pl
Plant

Favorable Market
(0.50)
Unfavorable Market
(0.50)
Favorable
Market
(0.50)
Unfavorable Market
(0.50)
No Plant

$190,00
0
$190,000
$90,00
0
$30,000

$10,000
$190,00
0
$190,000
$90,00
0
$30,000

$10,000
$200,00
0
$180,000
$100,00
0

$20,000
$
0

Thank You