CHAPTER 2

Operations Decision-
Making
OPERATIONS DECISION-MAKING
 Thousand of business decisions are made
everyday. Not all the decisions will make or
break the organization. But each one adds a
measure of success or failure to the
operations. Hence decision-making essentially
involves choosing a particular course of action,
after considering the possible alternatives.
Management as a Science
 Management scientists hold that, education, scientific
training and experience can improve a person’s ability to
make decisions.
Thus management as a science is characterized by
1.Organized principle of knowledge.
2.Use of empirical data.
3. Systematic analysis of data.
4. Repeatable results
Characteristics of decisions-making
 Operations decision range from simple judgments to complex
analyses, which also involves judgment. Judgment typically
incorporates basic knowledge, experience, and common
sense.
The appropriateness of a given type of analysis depends on:
a.The significant or long lasting decisions,
b.The time availability and the cost of analysis, and
c. The degree of complexity of the decision.
 The significant or long lasting decisions deserve more
considerations than routine ones. Plant investment, which is a
long-range decision, may deserve more thorough analysis.
The time availability and the cost of analysis also influence the
amount of analysis. The degree of complexity of the decision
increases when many variables are involved, variables are
highly independent and the data describing the variables are
uncertain.
Complete Extreme
Certainty Uncertainty

Objective Subjective
Information Information

Large Small
Samples Samples
Framework of Decision-Making
 An analytical and scientific framework for decision implies the following systematic
steps;
• Defining the problem.
• Establish the decision criteria.
• Formulation of a model.
• Generating alternatives .
• Evaluation of the alternatives.
• Implementation and monitoring.
DEFINING THE PROBLEM
 Defining the problem enables to identify the relevant variables and the cause of
the problem. Careful definition of the problem is crucial. Finding the root cause of
a problem needs some questioning and detective work. If a problem defined is too
narrow, relevant variable may be omitted. If it is broader, many tangible aspects
may be included which leads to the complex relationships.
ESTABLISH THE DECISION CRITERIA
 Establish the decision criterion is important because the criterion reflects the goals
and purpose of the work efforts. For many years profits served as a convenient
and accepted goal for many organizations based on economic theory. Nowadays
organization will have multiple goals such as employee welfare, high productivity,
stability, market share, growth, industrial leadership and other social objectives.
FORMULATION OF A MODEL
 Formulation of a model lies at the heart of the scientific decision-making process.
Model describes the essence of a problem or relationship by abstracting relevant
variables from the real world situation. Models are used to simplify or approximate
reality, so the relationships can be expressed in tangible form and studied in
isolation.
GENERATING ALTERNATIVES
 Alternatives are generated by varying the values of the parameters. Mathematical
and statistical models are particularly suitable for generating alternatives because
they can be easily modified. The model builder can experiment with a model by
substituting different values for controllable and uncontrollable variable.
EVALUATION OF THE ALTERNATIVES
 Evaluation of the alternatives is relatively objective in an analytical
decision process because the criteria for evaluating the alternatives
have been precisely defined. The best alternative is the one that most
closely satisfies the criteria. Some models like LPP model
automatically seek out a maximizing or minimizing solution.
IMPLEMENTATION AND MONITORING
 Implementation and monitoring are essential for completing the
managerial action. The best course of action or the solution to a
problem determined through a model is implemented in the business
world. Other managers have to be convinced of the merit of the
solution.
Decision Methodology
 The kind and amount of information available helps to determine
which analytical methods are most appropriate for modeling a given
decision.
Risk &
Complete Extreme
Uncertainty
Certainty Uncertainty

 This illustrates some useful quantitative methods that are classified

according to the amount of certainty that exists with respect to the
decision variables and possible outcomes. These analytical
techniques often serve as the basis for formulating models, which
help to reach operational decisions.
 The degree of certainty is classified as complete certainty, risk
and uncertainty and extreme uncertainty.
Complete Certainty methods
 Under complete certainty conditions, all relevant information about the decision
variables and outcomes is known or assumed to be known. Following are some of
the methods used:
Algebra:
 This basic mathematical logic is very useful for both certainty and uncertainty
analysis. With valid assumptions, algebra provides deterministic solutions such as
break-even analysis and benefit cost analysis.
Calculus:
 The branch of mathematics provides a useful tool for determining optimal value
where functions such as inventory costs, are to be maximized or minimized.
Mathematical programming:
 Programming techniques have found extensive applications in making a product mix
decisions; minimizing transportation costs, planning and scheduling production and
other areas.
Risks and uncertainty Methods
 In risk and uncertainty situations, information about the decision
variables or the outcomes is probabilistic. Following are some of the
useful approaches:
Statistical analysis:
 Objective and subjective probabilities with the use of probability and probability
distribution, Estimation and tests of hypothesis, Bayesian statistics, Decision
theory, Correlation and regression technique for forecasting demand and
Analysis of variance are some of the techniques used for decision-making.

Queuing theory:
The analysis of queues in terms of
waiting-time length and mean
waiting time is useful in analyzing
service systems, maintenance
activities, and shop floor control
activities
Simulation
 Simulation duplicates the essence of an activity. Computer simulations
are valuable tools for the analysis of investment outcomes, production
processes, scheduling and maintenance activities.

Heuristic methods
 Heuristic methods involve set of rules, which facilitate solutions of
scheduling, layout and distribution problems when applied in a
consistent manner.

Network analysis techniques

 Network approaches include decision trees, CPM and PERT methods.
They are helpful in identifying alternative course of action and
controlling the project activities.
Utility theory
 Utility theory or preference theory allows decision-makers to incorporate
their own experience and values into a relatively formalized decision
structure.
Extreme Uncertainty Methods
 Under extreme uncertainty, no information is available to assess the
likelihood of alternative outcomes.
Following are some of strategies to solve this:
1. Game theory: Game theory helps decision-makers to choose course of
action when there is no information about what conditions will prevail.
2. Coin flip: Flipping a coin is sometimes used in situation where the
decision-makers are wholly indifferent.
Decision-Making Under Uncertainty
 No information is available on how likely the various states of nature are under
those conditions.
Four possible decision criteria are :
1. Maximin,
2. Maximax ,
3. Laplace and
4. Minimax regret.
Maximin
 Determine the worst possible pay-off for each alternative, and
choose the alternative that has the “best worst.” The Maximin
approach is essentially a pessimistic one because it takes into
account only the worst possible outcome for each alternative. The
actual outcome may not be as bad as that, but this approach
establishes a “guaranteed minimum.
Maximax
 Determine the best possible pay-off, and choose the alternative with that
payoff. The Maximax approach is an optimistic, “go for it” strategy; it
does not take into account any pay-off other than the best .
Minimax regret:
 Determine the worst regret for each alternative, and choose the
alternative with the “best worst.” This approach seeks to minimize the
difference between the payoff that is realized and the best pay-off for
each state of nature.
Laplace
 Determine the average pay-off for each alternative, and choose the
alternative with the best average. The Laplace approach treats the
states of nature as equally likely.
Decision Support System
Decision support system (DSS) is
computer-based systems designed
to aid decision-makers of any stage
of the decision process in the
development of alternatives and
evaluation of possible course of
action. Their purpose is to provide
the information and analytical
support that enables managers to
better control and guide the decision
process.
Economic Models ( Break Even Analysis)
• Break-even Analysis - One of the techniques to study the total cost, total revenue and output
relationship is known as Break -even Analysis. ‘A Break-even Analysis indicates at what level of
output, cost and revenue are in equilibrium’. In other words, it determines the level of operations in
an enterprise where the undertaking neither gains a profit nor incurs a loss.
• Break-even chart (BEC)- It is a graph showing the variation in total costs at different levels of
output (cost line) as well as the variation in the total revenues at various levels of output .
• Break-even point- It is that point of activity (sales volume) where total revenues and total
expenses are equal. It is point of zero profit, i.e. stage of no profit and no loss. BEP can be used to
study the impact of variations in volume of sales and cost of production on profits.
• Angle of incidence- It is an angle at which total revenue line intersects total cost line. The
magnitude, of this angle indicates the level of profit. Larger the angle of incidence, higher will be
the profits per unit increase in sales and vice versa.
• Margin of safety- It is excess of budgeted or actual sales over the break-even sales volume i.e.
margin of safety = (actual sales minus sales at BEP)/actual sales. A high margin of safety would
mean that even with a lean period, where sales go down, the company would not come in loss
area. A small margin of safety means a small reduction in sale would take company to cross BEP
and come in red zone.
CALCULATION OF BEP
 Relationship between costs and activity level (AL) is also assumed to be linear.
For every elemental cost, actual cost figures at different activity levels are
plotted, and by ‘least square analysis’ a ‘line of best fit’ is obtained. This would
give a fixed cost component and a variable cost component for the elemental
cost.
 This analysis is carried out for all elemental costs. The total cost function would
give total fixed cost and total variable cost for the company. The Break-even
Point is that volume where the fixed and variable costs are covered. But no
profit exists. Thus at BEP, the total revenues equal to the total costs.
 Profit volume ratio (PVR)- is defined as
the ratio between Contribution Margin
and Sales Revenue.
i.e. Profit Volume Ratio (f) = Contribution ⋅
Margin /Sales. Revenue

 Margin of safety (MOS)-is defined as the

ratio between Operating Profit and
Contribution Margin. It signifies the
fractional reduction in the current
activity level required to reach the
break-even point.
Sales turnover (STO)- is defined as
ratio between Sales Revenue and the
Capital Employed. It represents the
number of times capital employed is
turned over to reach the sales revenue
level that is called Operating
management performance [OMP].

IMPROVING OMP- A company

interested in improving its OMP will have
to improve its operating profit.
Following any of the strategies given
below or a combination of them can do
this: (a) By reducing variable costs (b) By
reducing fixed costs (c) By increasing
sales price (d) By increasing the activity
level
A) Reduction in variable costs will bring
down BEP, increase PV ratio and
increase margin of safety. To achieve a
required Targeted Profit (Z), variable cost
would have to be controlled at V=SR –
(F+Z )
B) A reduction in fixed costs will bring down
BEP and increase margin of safety. It will
have no effect on PV ratio. To achieve a
required TP by controlling fixed cost
alone, the fixed cost would have to be
controlled as F=(SR – V) – Z

C. An increase in selling price will

bring BEP down, it will increase PV
ratio and it will also increase the
margin of safety. To get the targeted
profit level the increase required in
selling price is given by
Statistical Models
 Most business decisions are made with only limited or incomplete information.
Statistical theory can help to control error associated with the amount of data used
in the decision process. Decision makers utilize probabilities, which are the most
basic measures of uncertainty. Probabilities attach a quantitative value (between 0
and 1) to the occurrence of an event. Events are called independent if the
occurrence of one in no way affects any other one. Mutually exclusive events
automatically preclude each other, such as classifying an item as good or defective.
Following are the rules for applying probabilities.
There are three types of probabilities:
(a)Classical probabilities are based upon equally likely outcomes that can be
calculated prior to an event on the basis of mathematical logic.
(b)Empirical probabilities are based upon observed data and express the relative
frequency of an event in the long run.
(c)Subjective probabilities are based upon personal experience or judgment and are
sometimes used to analyze one-time occurrences
Decision Tree
 A decision tree is a schematic representation of
the alternatives available to a decision maker
and their possible consequences. The term gets
its name from the tree like appearance of the
diagram (see Figure 2.8 below). Although tree
diagrams can be used in place of a pay-off table,
they are particularly useful for analyzing
situations that involve sequential decisions.
 A decision tree is composed of a number of
nodes that have branches emanating from them
(see Figure 2.8 below). Square nodes denote
decision points, and circular nodes denote
chance events. Read the tree from left to right.
Branches leaving square nodes represent
alternatives; branches leaving circular nodes
represent chance events (i.e., the possible
states of nature).
THANK YOU! 