OPERATIONS MANAGEMENT

O P M
DECISION ANALYSIS
By: HAKEEM UR REHMAN PCBA UCP

DECISION ANALYSIS / DECISION THEORY

 QUANTITATIVE METHODS  A set of tools for operations manager  DECISION ANALYSIS  a set of quantitative decision-making decisiontechniques for decision situations in which uncertainty exists

DECISION PROCESS
Fundamental process of management involves 6 steps: 1. Specify objectives and the criteria for decision making. 2. Develop Alternatives. 3. Analyze and compare alternatives. 4. Select the best alternative 5. Implement the chosen alternative 6. Monitor the results to ensure that the desired results are achieved.

DECISION ENVIRONMENTS
There are three scenarios which refer to CERTAINTY, RISK & UNCERTAINTY. UNCERTAINTY.  Certainty:
 

You have an order for 3000 units (Demand = 3000 units). Profit per unit is RS. 30 probabilities can be assigned to the occurrence of states of nature in the future There is a 25% chance of 2000 units, 50% chance of 1000 units & 25% chance of an order of 500 units. probabilities can NOT be assigned to the occurrence of states of nature in the future.

Risk:
 

Uncertainty:


DECISION ENVIRONMENTS --CONT.

 STATES OF NATURE:
 

Events that may occur in the future Examples of states of nature:  high or low demand for a product  good or bad economic conditions Outcome of a decision

 PAYOFF:


PAYOFF TABLE
 Payoff

table: a method for organizing and illustrating the payoffs from different decisions given various states of nature.

Decision 1 2

States Of Nature a b Payoff 1a Payoff 1b Payoff 2a Payoff 2b

DECISION MAKING CRITERIA UNDER UNCERTAINTY

 Maximax

 Maximin  Minimax regret  Equal likelihood

EXAMPLE: SOUTHERN TEXTILE COMPANY

STATES OF NATURE
Good Foreign Poor Foreign Competitive Conditions

DECISION Expand Maintain status quo Sell now

Competitive Conditions

$ 800,000 1,300,000 320,000

$ 500,000 -150,000 320,000

MAXIMAX SOLUTION
 Maximax (the maximum of the maxima) criterion is very optimistic.  Choose decision with the maximum of the maximum payoffs  Maximax determines the best possible outcome STATES OF NATURE DECISION Expand Maintain status quo Sell now
Good Foreign Competitive Conditions Poor Foreign Competitive Conditions

$ 800,000 1,300,000 320,000

$ 500,000 -150,000 320,000

Expand: Status quo: Sell:

$800,000 1,300,000 n Maximum 320,000 Decision: Maintain status quo

MAXIMIN SOLUTION
 The maximin (the maximum of minima) criterion is pessimistic  Choose decision with the maximum of the minimum payoffs  Maximin determines the worst payoff for each alternative; the operations manager chooses the best worst alternative. Meaning the least (best) of the worst. worst.

STATES OF NATURE
Good Foreign Poor Foreign Competitive Conditions

DECISION Expand Maintain status quo Sell now

Competitive Conditions

$ 800,000 1,300,000 320,000

$ 500,000 -150,000 320,000

Maximum

Expand: Status quo: Sell:

$500,000 n -150,000 320,000 Decision: Expand

MINIMAX REGRET SOLUTION

Choose decision with the minimum of the maximum regrets for each alternative

Good Foreign Competitive Conditions

$1,300,000 - 800,000 = 500,000 1,300,000 - 1,300,000 = 0 1,300,000 - 320,000 = 980,000

Poor Foreign Competitive Conditions

$500,000 - 500,000 = 0 500,000 - (-150,000)= 650,000 500,000 - 320,000= 180,000

Expand: Status quo: Sell:

$500,000 n Minimum 650,000 980,000 Decision: Expand

EQUAL LIKELIHOOD CRITERIA



Choose decision in which each state of nature is weighted equally

STATES OF NATURE

DECISION Expand Maintain status quo Sell now

Good Foreign Competitive Conditions

Poor Foreign Competitive Conditions

$ 800,000 1,300,000 320,000

$ 500,000 -150,000 320,000

Two states of nature each weighted 0.50

Expand: $800,000(0.5) + 500,000(0.5) = $650,000 Status quo: 1,300,000(0.5) -150,000(0.5) = 575,000 Sell: 320,000(0.5) + 320,000(0.5) = 320,000
n Maximum

Decision: Expand

DECISION ENVIRONMENTS
There are three scenarios which refer to CERTAINTY, RISK & UNCERTAINTY. UNCERTAINTY.  Certainty:
 

You have an order for 3000 units (Demand = 3000 units). Profit per unit is RS. 30 probabilities can be assigned to the occurrence of states of nature in the future There is a 25% chance of 2000 units, 50% chance of 1000 units & 25% chance of an order of 500 units. probabilities can NOT be assigned to the occurrence of states of nature in the future.

Risk:
 

Uncertainty:


DECISION MAKING WITH PROBABILITIES (RISK)

 Risk involves assigning probabilities to states of nature  Expected value  a weighted average of decision outcomes in which each future state of nature is assigned a probability of occurrence
n

EV (x) = (x
where

p(xi)xi
i =1

xi = outcome i p(xi) = probability of outcome i

DECISION MAKING WITH PROBABILITIES: EXAMPLE

STATES OF NATURE
Good Foreign Poor Foreign Competitive Conditions

DECISION Expand Maintain status quo Sell now

Competitive Conditions

$ 800,000 1,300,000 320,000

$ 500,000 -150,000 320,000

p(good) = 0.70

p(poor) = 0.30

EV(expand): $800,000(0.7) + 500,000(0.3) = $710,000 EV(status quo): 1,300,000(0.7) -150,000(0.3) = 865,000 n Maximum EV(sell): 320,000(0.7) + 320,000(0.3) = 320,000

Decision: Status quo

SEQUENTIAL DECISION TREES

 A graphical method for analyzing decision situations that require a sequence of decisions over time  Decision tree consists of  Square nodes - indicating decision points  Circles nodes - indicating states of nature  Arcs - connecting nodes

EXAMPLE: (How to Develop A Decision Tree?)

A firm that plans to expand its product line must decide whether to build a small or a large facility to produce the new products. If it builds a small facility and demand is low, the net present value after deducting for building costs will be $400,000. If demand is high, the firm can either maintain the small facility or expand it. Expansion would have a net present value of $450,000 and maintaining the small facility would have a net present value of $50,000. If a large facility is built and demand is high, the estimated net present value is $800,000. If demand turns out to be low, the net present value will be -$10,000. The probability that demand will be high is estimated to be 0.60, and the probability of low demand is estimated to be 0.40. Analyze using a tree diagram.

$400,000 $50,000

Demand High (0.6)

2
$450,000 $ 10,000

Demand Low (0.4)

$800,000

QUESTIONS