Decision Making

Decision-making is based on information Information is used to:

Identify the fact that there is a problem in the first place Define and structure the problem Explore and choose between different possible solutions Evaluate the effectiveness of the decision

Value of Information

The value of information used in decision making is:

(value of the outcome with the Information) (value of the outcome without the Information)

Types of Decision

H. A. Simon classified decisions into

Programmed decisions Non-Programmed decisions

Classified according to the extent to which decision making can be preplanned These are the extremes of a continuous range of decision types

Programmed Decisions

Also known as Structured Decisions Characteristics

Repetitive, routine, known rules or procedures, often automated, can be delegated to low levels in the organisation, often involve things rather than people Examples - Inventory control decisions, machine loading decisions, scheduling.

Non-Programmed Decisions

Also known as Unstructured Decisions Characteristics

Novel, non-routine, rules not known, high degree of uncertainty, cannot be delegated to low levels, more likely to involve people. Examples - Acquisitions, mergers, launching new products, personnel appointments. The most common type of decision May be partially automated

Semi-Structured Decisions

Empowerment

Authority to take decisions is being delegated down the line especially in modern service industries This process is called empowerment and should enable an organisation to take a variety of decisions more quickly, thus providing a more flexible service

Empowerment

Decisions should be made:

At the lowest possible level, which accords with their nature As close to the scene of the action as possible at the level that ensures none of the activities and objectives are forgotten

Empowerment

Enabled by systems such as

Customer Relationship Management (CRM)

Gives call centre staff specialist knowledge about any customer Assists non-experts in making complex decisions

Expert Systems

Uncertainty

Uncertainty arises from incomplete information due to:

Incomplete forecasting models Conflicting data from external sources Lack of time Internal data on particular problem not collated

The uncertainty of an outcome is expressed as a probability

Rational Decision Making

The rational model of decision making is a mechanistic approach to decision making It assumes perfect knowledge of all factors surrounding the decision

Rational vs. Real Decisions

Users tend to explain their actions in terms of rational behaviour, whereas their actual performance may be governed by intuition rather than by rational analysis. Studies of managers at work have shown that there is a discrepancy between how managers claim to take decisions and their actual observed decision-making behaviour. Argyris and Schon

Payoff Matrices

The standard way to analyse simple decision problems These are constructed as follows:

Identify all available options Identify events which cause an outcome (states of nature) Estimate the likelihood of each state of nature Estimate the value/payoff of each outcome Determine the expected value for each option Choose the option with the highest expected value

Example

A company must decide on one of three development projects, A, B or C They have identified three possible events relating to market conditions that will effect this decision
Probability 60% 30% 10%

Event Boom Steady State Recession

Example

The profit and loss figures (potential payoff) for the three products under the possible market conditions have been forecast as:
D e c is io n Event Boom 60% S te a d y S ta te 3 0 % R e c e ss io n 1 0 % P ro je c t A +8M +1M -1 0 M P ro je c t B -2 M + 6M + 12M P ro je c t C + 16M 0 -2 6 M

Which one of the above projects should the company run?

Decision Criteria

In order to evaluate the alternatives, managers use a number of different criteria: Equally Likely

The consequences of each decision are summed and the result divided by the number of events Useful if probabilities are not known Determine the highest possible profit from each strategy and choose that with the highest overall profit - Usually high risk, but high gain

Maximax

Example
Decision Event Boom 60% Steady State 30% Recession 10% Project A +8M +1M -10M Project B -2M +6M +12M Project C +16M 0 -26M

Preferred Project is?

Equally Likely Maximax

Decision Criteria

Minimax

Choose that action with the smallest maximum possible loss, or the largest minimum profit. Low risk, low gain. Choose the most likely event and then choose the best strategy for that event. Low risk, low gain. Does not make full use of available information.

Maximum Likelihood

Example
Decision Event Boom 60% Steady State 30% Recession 10% Project A +8M +1M -10M Project B -2M +6M +12M Project C +16M 0 -26M

Preferred Project is?

Minimax Max Likelihood

Example
Decision Event Boom 60% Steady State 30% Recession 10% Project A +8M +1M -10M Project B -2M +6M +12M Project C +16M 0 -26M

Decision Criteria

Expected Value

A weighted average of all outcomes The weights are probabilities

EV = { P( outcomei ) payoff i }
i =1 N

Gives the average value of the decision if it were made repeatedly Uses all the information concerning events and their likelihood

Example
Decision Event Boom 60% Steady State 30% Recession 10% Project A +8M +1M -10M Project B -2M +6M +12M Project C +16M 0 -26M

Calculate EV for each option/choice

Project A (8M*0.6)+(1M*0.3)+(-10M*0.1) = 4.1M Project B (-2*0.6)+(6*0.3)+(12*0.1) = 1.8 Project C (16*0.6)+(0*0.3)+(-26*0.1) = 7.0

Preferred Project is?

Example 2
A lte r n a t iv e AA r n a t iv e AB r n a t iv e C lte lte
y y y O u tc o m e :P r o b P r o fit P r o b P r o fit P r o b P r o fit

O p tim is t ic 0 .2 5 0 0 0 0 .3 4 0 0 0 0 .1 3 0 0 0 M o s t L ik e ly0 .6 7 5 0 0 0 .5 7 0 0 0 0 .7 6 5 0 0 P e s s im is tic0 .2 9 0 0 0 0 .3 9 5 0 0 0 .2 1 0 0 0 0

Decision Criteria

Expected Value

Uses all the information concerning events and their likelihood Does not take into account decision-makers attitude to risk Does not reflect the actual outcomes in the figures

Can the company afford to lose 26M?

Decision Trees

Not all decisions will be taken in isolation A decision will have an effect of future events and outcomes An outcome in turn may effect future decision making

Decision Trees

Decision trees provide a means of structuring the decision making process to allow for alternative futures

Decision Tree

Two types of Node Decision Node

Represent decision points Decision are made by the organisation Linked to possible outcomes These are uncontrollable

Outcome Node

Example
Boom 60% Steady 30% Project A Boom 60% Project B Steady 30% Recession 10% Boom 60% Steady 30% Recession 10% -26M Recession 10% 8M 1M -10M -2M +6M +12M +16M 0

Project C

Example
Boom 60%
4.1

8M 1M -10M -2M +6M +12M +16M 0 -26M

Steady 30% Recession 10% Boom 60%

Project A

Project B
1.8

Steady 30% Recession 10% Boom 60%

Project C
7

Steady 30% Recession 10%

Example
Boom 60%
4.1

8M 1M -10M -2M +6M +12M +16M 0 -26M

Steady 30% Recession 10% Boom 60%

Project A

4.1

Project B
1.8

Steady 30% Recession 10% Boom 60%

Project C
7

Steady 30% Recession 10%