Decision in Operations Management

Operations Management
Decision-Making Tools Module A

PowerPoint presentation to accompany Operations Management, 6E (Heizer & Render)
A-1
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

A-2
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

A-3
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
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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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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
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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
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The Decision-Making Process

Quantitative Analysis Logic Historical Data Marketing Research Scientific Analysis Modeling Qualitative Analysis Emotions Intuition Personal Experience and Motivation Rumors
Problem
Decision
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Ways of Displaying a Decision Problem

Decision trees Decision tables
Outcomes States of Nature Alternatives
Decision Problem
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Fundamentals of Decision Theory

The three types of decision models:
Decision making under uncertainty
Decision making under risk Decision making under certainty
A-10
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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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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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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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
Maximin
Equally likely
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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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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
A-16
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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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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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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Expected Value of Perfect Information

EVPI = EV|PI - maximum EMV
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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

EVPI = expected value with perfect information - max(EMV)
= $200,000*0.50 + 0*0.50 - $40,000
= $60,000
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Expected Opportunity Loss

EOL is the cost of not picking the best solution EOL = Expected Regret
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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
A-24
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
A-25
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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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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Sensitivity Analysis - continued

250000 200000 150000
EMV Values
Point 1
Point 2
100000 50000 0 -50000 0 -100000 -150000 -200000 Values of P

A-28
0.2
0.4
0.6
0.8
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

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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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Decision Tree
State 1
Outcome 1 Outcome 2 Outcome 3 Outcome 4
State 2 State 1
2
Decision Node
State 2
State of Nature Node

A-31

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Operations Management

Decision-Making Tools Module A

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

A More Complex Decision Tree

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

Decision making under risk

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

Models, and the Techniques of Scientific Management

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

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

Steps to Good Decisions

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

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

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

The Decision-Making Process

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

Ways of Displaying a Decision Problem

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

Fundamentals of Decision Theory

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

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

Fundamentals of Decision Theory - continued

decision maker has no control

Symbols used in decision tree:

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

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

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

Decision Making Under Uncertainty

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

Example - Decision Making Under Uncertainty

Market $200,000 $100,000 $0

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

Decision Making Under Risk

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

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

Expected Monetary Value Equation

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

Example - Decision Making Under Uncertainty

Construct large plant Construct small plant

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

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

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

Expected Value of Perfect Information (EVPI)

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

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 )

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

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

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

Expected Value of Perfect Information

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

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

Expected Value of Perfect Information

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

EMV $20,000 $40,000 $0

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

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

Expected Value of Perfect Information

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

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

Expected Opportunity Loss

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