BM1710

DECISION-MAKING TOOLS

The Decision Process in Operations

Fundamentals of Decision-making

Alternative –This is a course of action or strategy that may be chosen by a decision maker.

State of nature – This is an occurrence or a situation over which the decision maker has little or no control.

Symbols used in a decision tree:

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.

Case: A Simple Decision Tree

Getz Products Company is investigating the possibility of producing and marketing backyard storage
sheds. Undertaking this project would require the construction of either a large or a small manufacturing
plant. The market for the product produced—storage sheds—could be either favorable or unfavorable.
Getz, of course, has the option of not developing the new product line at all.

Figure 1. Decision Tree for Getz Products Company

Source: Operations Management Sustainability and Supply Chain Management (12th ed.), 2017, p. 680

Note: The option of “doing nothing” is included as it is usually a possible decision.

Decision Tables

States of Nature
Alternatives Favorable Market Unfavorable Market
Construct large plant $200,000 −$180,000
Construct small plant $100,000 −$20,000
Do nothing $0 $0

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Types of Decision-Making Environments

There are three (3) decision-making environments:

• Decision-making under uncertainty

• Decision-making under risk
• Decision-making under certainty

Decision-Making Under Uncertainty

1. Maximax – This method finds an alternative that maximizes the maximum outcome for every
alternative. First, we find the maximum outcome within every alternative, and then pick the
alternative with the maximum number. Because this decision criterion locates the alternative with
the highest possible gain, it has been called an “optimistic” decision criterion.
2. Maximin - This method finds the alternative that maximizes the minimum outcome for every
alternative. First, we find the minimum outcome within every alternative, and then we pick the
alternative with the maximum number. Because this decision criterion locates the alternative that
has the least possible loss, it has been called a “pessimistic” decision criterion.
3. Equally likely - This method finds the alternative with the highest average outcome. First, we
calculate the average outcome for every alternative, which is the sum of all outcomes divided by the
number of outcomes. We then pick the alternative with the maximum number. The equally likely
approach assumes that each state of nature is equally likely to occur.

Case: A Decision Table Analysis Under Uncertainty

Getz Products Company would like to apply each of these three (3) approaches now.
States of Nature
Favorable Unfavorable Maximum in Minimum in
Alternatives Row Average
Market Market Row Row
Construct
$200,000 −$180,000 $200,000 −$180,000 $10,000
large plant
Construct
$100,000 −$20,000 $100,000 −$20,000 $40,000
small plant
Do nothing $0 $0 $0 $0 $0

• The maximax choice is to construct a large plant. This is the maximum of the maximum number
within each row or alternative.
• The maximin choice is to do nothing. This is the maximum of the minimum number within each
row or alternative.
• The equally likely choice is to construct a small plant. This is the maximum of the average outcome
of each alternative.

Decision-Making Under Risk

Decision-making under risk, a more common occurrence, relies on probabilities. Several possible states
of nature may occur, each with an assumed probability. The states of nature must be mutually exclusive
and collectively exhaustive, and their probabilities must sum to 1. Given a decision table with conditional
values and probability assessments for all states of nature, we can determine the expected monetary
value (EMV) for each alternative. This figure represents the expected value or mean return for each
alternative if we could repeat this decision (or similar types of decisions) a large number of times (Heizer,
Render, & Munson, 2017).

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𝑬𝑬𝑬𝑬𝑬𝑬 (𝑨𝑨𝑨𝑨𝑨𝑨𝑨𝑨𝑨𝑨𝑨𝑨𝑨𝑨𝑨𝑨𝑨𝑨𝑨𝑨𝑨𝑨 𝒊𝒊) = [(𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃 𝑜𝑜𝑜𝑜 1𝑠𝑠𝑠𝑠 𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠 𝑜𝑜𝑜𝑜 𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛) × (𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃 𝑜𝑜𝑜𝑜 1𝑠𝑠𝑠𝑠 𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠 𝑜𝑜𝑜𝑜 𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛)]
+[(𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃 𝑜𝑜𝑜𝑜 2𝑛𝑛𝑛𝑛 𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠 𝑜𝑜𝑜𝑜 𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛) × (𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃 𝑜𝑜𝑜𝑜 2𝑛𝑛𝑛𝑛 𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠 𝑜𝑜𝑜𝑜 𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛)]
+ ⋯ + [(𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃 𝑜𝑜𝑜𝑜 𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙 𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠 𝑜𝑜𝑜𝑜 𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛) × (𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃 𝑜𝑜𝑜𝑜 𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙 𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠 𝑜𝑜𝑜𝑜 𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛)]

Case: Expected Monetary Value

Getz Products’ operations manager believes that the probability of a favorable market is 0.6 and that
of an unfavorable market is 0.4. He can now determine the EMV for each alternative.
States of Nature
Alternatives Favorable Market Unfavorable Market
Construct large plant (𝐴𝐴1 ) $200,000 −$180,000
Construct small plant (𝐴𝐴2 ) $100,000 −$20,000
Do nothing (𝐴𝐴3 ) $0 $0
Probability 0.6 0.4

𝑬𝑬𝑬𝑬𝑬𝑬 (𝑨𝑨𝟏𝟏 ) = (0.6 × $200,000) + [0.4 × (−$180,000)] = 120,000 − 72,000 = $𝟒𝟒𝟒𝟒, 𝟎𝟎𝟎𝟎𝟎𝟎
𝑬𝑬𝑬𝑬𝑬𝑬 (𝑨𝑨𝟐𝟐 ) = (0.6 × $100,000) + [0.4 × (−$20,000)] = 60,000 − 8,000 = $𝟓𝟓𝟓𝟓, 𝟎𝟎𝟎𝟎𝟎𝟎
𝑬𝑬𝑬𝑬𝑬𝑬 (𝑨𝑨𝟑𝟑 ) = (0.6 × $0) + [0.4 × ($0)] = $𝟎𝟎

Note: The maximum EMV is seen in alternative𝐴𝐴2. Thus, according to the EMV decision criterion, Getz
should build a small facility.

Decision-Making Under Certainty

Expected Value of Perfect Information (EVPI)

𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬 = 𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸 𝑣𝑣𝑣𝑣𝑣𝑣𝑣𝑣𝑣𝑣 𝑤𝑤𝑤𝑤𝑤𝑤ℎ 𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝 𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖 − 𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀 𝐸𝐸𝐸𝐸𝐸𝐸

To find the EVPI, we must first compute the expected value with perfect information (𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸), which is
the expected (average) return if we have perfect information before a decision has to be made.

𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬 = [(𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵 𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜 𝑜𝑜𝑜𝑜 𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐 𝑓𝑓𝑓𝑓𝑓𝑓 1𝑠𝑠𝑠𝑠 𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠 𝑜𝑜𝑜𝑜 𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛)
× (𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃 𝑜𝑜𝑜𝑜 1𝑠𝑠𝑠𝑠 𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠 𝑜𝑜𝑜𝑜 𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛)]

+[(𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵 𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜 𝑜𝑜𝑜𝑜 𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐 𝑓𝑓𝑓𝑓𝑓𝑓 2𝑛𝑛𝑛𝑛 𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠 𝑜𝑜𝑜𝑜 𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛)

× (𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃 𝑜𝑜𝑜𝑜 2𝑛𝑛𝑛𝑛 𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠 𝑜𝑜𝑜𝑜 𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛)]

+ ⋯ + [(𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵 𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜 𝑜𝑜𝑜𝑜 𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐 𝑓𝑓𝑓𝑓𝑓𝑓 𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙 𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑒𝑒 𝑜𝑜𝑜𝑜 𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛)

× (𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃 𝑜𝑜𝑜𝑜 𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙 𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠 𝑜𝑜𝑜𝑜 𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛)]

Case: Expected Value of Perfect Information

The Getz operations manager would like to calculate the maximum that he would pay for information –
that is, the expected value of perfect information or EVPI.
States of Nature
Alternatives Favorable Market Unfavorable Market
Construct large plant (𝐴𝐴1 ) $200,000 −$180,000
Construct small plant (𝐴𝐴2 ) $100,000 −$20,000
Do nothing (𝐴𝐴3 ) $0 $0
Probability 0.6 0.4

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𝑬𝑬𝑬𝑬𝑬𝑬 (𝑨𝑨𝟏𝟏 ) = (0.6 × $200,000) + [0.4 × (−$180,000) = 120,000 − 72,000 = $𝟒𝟒𝟒𝟒, 𝟎𝟎𝟎𝟎𝟎𝟎

𝑬𝑬𝑬𝑬𝑬𝑬 (𝑨𝑨𝟐𝟐 ) = (0.6 × $100,000) + [0.4 × (−$20,000) = 60,000 − 8,000 = $𝟓𝟓𝟓𝟓, 𝟎𝟎𝟎𝟎𝟎𝟎
𝑬𝑬𝑬𝑬𝑬𝑬 (𝑨𝑨𝟑𝟑 ) = (0.6 × $0) + [0.4 × ($0) = $𝟎𝟎

𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬 = (0.6 × 200,000) + (0 × 0.4) = 𝟏𝟏𝟏𝟏𝟏𝟏, 𝟎𝟎𝟎𝟎𝟎𝟎

The maximum EMV is $52,000 for𝐴𝐴2, which is the expected outcome without perfect information.
Therefore,
𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬 = 𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸 − 𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀 𝐸𝐸𝐸𝐸𝐸𝐸 = $120,000 − $52,000 = $𝟔𝟔𝟔𝟔, 𝟎𝟎𝟎𝟎𝟎𝟎
Note: The most Getz should be willing to pay for perfect information is $68,000.
Decision Trees

A decision tree is a graphic display of the decision process that indicates decision alternatives, states of
nature and their respective probabilities, and payoffs for each combination of decision alternative and state
of nature.

Expected monetary value (EMV) is the most commonly used criterion for decision tree analysis. One of the
first steps in such analysis is to graph the decision tree and to specify the monetary consequences of all
outcomes for a particular problem (Heizer, Render, & Munson, 2017).

Five (5) steps in analyzing problems with decision trees:

1. Define the problem.

2. Structure or draw the decision tree.
3. Assign probabilities to the states of nature.
4. Estimate payoffs for each possible combination of decision alternatives and states of nature.
5. Solve the problem by computing the expected monetary values (EMV) for each state-of-nature node.

Case: Solving a Tree for EMV

Getz wants to develop a completed and solved decision tree.

Figure 2. Decision Tree with EMV

Source: Operations Management Sustainability and Supply Chain Management (12th Edition), 2017, p. 680
Note: The branch leaving the decision node leading to the state-of-nature node with the highest EMV
will be chosen. In Getz’s case, a small plant should be built.
References
Heizer, J., Render, B., & Munson, C. (2017). Operations management: Sustainability and supply chain management (12th ed.). Boston: Pearson Education Inc.
Krajewski, L. J., Malhotra, M. K., & Ritzman, L. P. (2016). Operations management: Processes and supply chains (11th ed.). Essex: Pearson Education Limited.

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