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Operation Management

The document outlines decision analysis techniques for operations management, focusing on quantitative methods for making decisions under uncertainty and risk. It covers various decision-making criteria such as Maximax, Maximin, Minimax regret, and Hurwicz, as well as the use of Excel for decision analysis. Additionally, it introduces concepts like the Expected Value of Perfect Information and Sequential Decision Trees for analyzing complex decision scenarios.

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Galib Nayim
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33 views25 pages

Operation Management

The document outlines decision analysis techniques for operations management, focusing on quantitative methods for making decisions under uncertainty and risk. It covers various decision-making criteria such as Maximax, Maximin, Minimax regret, and Hurwicz, as well as the use of Excel for decision analysis. Additionally, it introduces concepts like the Expected Value of Perfect Information and Sequential Decision Trees for analyzing complex decision scenarios.

Uploaded by

Galib Nayim
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
You are on page 1/ 25

Operations Management: Creating

Value Along the Supply Chain


Second Canadian Edition
Russell, Taylor, Bayley, Castillo

Chapter 1 Supplement

Decision Analysis

© John Wiley and Sons, Inc.


Learning Objectives

Appropriately use a variety of quantitative decision analysis


techniques.

© John Wiley and Sons, Inc. 2


Lecture Outline

• Decision Analysis
• Decision Making without Probabilities
• Decision Analysis with Excel
• Decision Making with Probabilities
• Expected Value of Perfect Information
• Sequential Decision Trees

© John Wiley and Sons, Inc. 3


Decision Analysis

• Quantitative methods
o a set of tools for operations manager
• Decision analysis
o a set of quantitative decision-making techniques for decision
situations in which uncertainty exists
o Example of an uncertain situation
• demand for a product may vary between 0 and 200 units,
depending on the state of market

© John Wiley and Sons, Inc. 4


Decision Making Without Probabilities

• States of nature
o Events that may occur in the future
o Examples of states of nature:
• high or low demand for a product
• good or bad economic conditions
• Decision making under risk
o probabilities can be assigned to the occurrence of states of nature in
the future
• Decision making under uncertainty
o probabilities can NOT be assigned to the occurrence of states of
nature in the future
© John Wiley and Sons, Inc. 5
Payoff Table

• Payoff table
o method for organizing and illustrating payoffs from different
decisions given various states of nature
• Payoff
o outcome of a decision

Decision States of Nature: a States of Nature: b


1 Payoff 1a Payoff 1b
2 Payoff 2a Payoff 2b

© John Wiley and Sons, Inc. 6


Decision Making Criteria Under Uncertainty
(1 of 2)
• Maximax
o choose decision with the maximum of the maximum payoffs
• Maximin
o choose decision with the maximum of the minimum payoffs
• Minimax regret
o choose decision with the minimum of the maximum regrets for
each alternative

© John Wiley and Sons, Inc. 7


Decision Making Criteria Under Uncertainty
(2 of 2)
• Hurwicz
o choose decision in which decision payoffs are weighted by a
coefficient of optimism, alpha
o coefficient of optimism is a measure of a decision maker’s
optimism, from 0 (completely pessimistic) to 1 (completely
optimistic)
• Equal likelihood
o choose decision in which each state of nature is weighted
equally

© John Wiley and Sons, Inc. 8


Artic Textile Company

Decision States of Nature: Good Foreign States of Nature: Poor Foreign


Competitive Conditions Competitive Conditions
Expand $800,000 $500,000
Maintain status quo 1,300,000 −150,000
Sell now 320,000 320,000

© John Wiley and Sons, Inc. 9


Maximax Solution
Decision States of Nature: Good Foreign States of Nature: Poor Foreign
Competitive Conditions Competitive Conditions
Expand $800,000 $500,000
Maintain status quo 1,300,000 −150,000
Sell now 320,000 320,000

Expand: $800,000
Status quo: 1,300,000 ← Maximum
Sell: 320,000

Decision: Maintain status quo

© John Wiley and Sons, Inc. 10


Maximin Solution
Decision States of Nature: Good Foreign States of Nature: Poor Foreign
Competitive Conditions Competitive Conditions
Expand $800,000 $500,000
Maintain status quo 1,300,000 −150,000
Sell now 320,000 320,000

Expand: $500,000 ← Maximum


Status quo: −150,000
Sell: 320,000

Decision: Expand

© John Wiley and Sons, Inc. 11


Minimax Regret Solution

Good Competitive Conditions Poor Competitive Conditions


$1,300,000 − 800,000 = 500,000 $500,000 − 500,000 = 0
1,300,000 − 1,300,000 = 0 500,000 − (− 150,000) = 650,000
1,300,000 − 320,000 = 980,000 500,000 − 320, 000 = 180,000

Expand: $500,00 ← Minimum


Status quo: 650,000
Sell: 980,000

Decision: Expand

© John Wiley and Sons, Inc. 12


Hurwicz Criteria

Good Competitive Conditions Poor Competitive Conditions


$1,300,000 − 800,000 = 500,000 $500,000 − 500,000 = 0
1,300,000 − 1,300,000 = 0 500,000 − (− 150,000) = 650,000
1,300,000 − 320,000 = 980,000 500,000 − 320, 000 = 180,000

Expand: $800,000(0.3) + 500,000(0.7) = $590,000 ← Maximum


Status quo: 1,300,000(0.3) − 150,000(0.7) = 285,000
Sell: 320,000(0.3) + 320,000(0.7) = 320,000

Decision: Expand

© John Wiley and Sons, Inc. 13


Equal Likelihood Criteria
Good Competitive Conditions Poor Competitive Conditions
$1,300,000 − 800,000 = 500,000 $500,000 − 500,000 = 0
1,300,000 − 1,300,000 = 0 500,000 − (− 150,000) = 650,000
1,300,000 − 320,000 = 980,000 500,000 − 320, 000 = 180,000

Expand: $800,000(0.50) + 500,000(0.50) = $650,000 ← Maximum


Status quo: 1,300,000(0.50) − 150,000(0.50) = 575,000
Sell: 320,000(0.50) + 320,000(0.50) = 320,000

Decision: Expand
© John Wiley and Sons, Inc. 14
Decision Analysis with Excel

© John Wiley and Sons, Inc. 15


Decision Making with Probabilities (1 of 2)

• Risk involves assigning probabilities to states of nature


• Expected value
o a weighted average of decision outcomes in which each future
state of nature is assigned a probability of occurrence

© John Wiley and Sons, Inc. 16


Expected Value
n
EV(x) =  p(x i )x i
i=1

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

© John Wiley and Sons, Inc. 17


Decision Making with Probabilities (2 of 2)

Good Competitive Conditions Poor Competitive Conditions


$1,300,000 − 800,000 = 500,000 $500,000 − 500,000 = 0
1,300,000 − 1,300,000 = 0 500,000 − (− 150,000) = 650,000
1,300,000 − 320,000 = 980,000 500,000 − 320,000 = 180,000

EV (expand) = $800,000(0.70) + 500,000(0.30) = $710,000


EV (status quo) = 1,300,000(0.70) – 150,000(0.30) = 865,000 ←Maximum
EV (sell) = 320,000(0.70) + 320,000 (0.30) = 320,000

© John Wiley and Sons, Inc. 18


Decision Making with Probabilities: Excel

© John Wiley and Sons, Inc. 19


Expected Value of Perfect Information

• EVPI
o maximum value of perfect information to the decision maker
o maximum amount that would be paid to gain information that
would result in a decision better than the one made without
perfect information

© John Wiley and Sons, Inc. 20


EVPI
• Good conditions will exist 70% of the time
o choose maintain status quo with payoff of $1,300,000
• Poor conditions will exist 30% of the time
o choose expand with payoff of $500,000
• Expected value given perfect information
= $1,300,000 (0.70) + 500,000 (0.30)
= $1,060,000
• Recall that expected value without perfect information was
$865,000 (maintain status quo)
• EVPI = $1,060,000 − 865,000 = $195,000
© John Wiley and Sons, Inc. 21
Sequential Decision Trees

• A graphical method for analyzing decision situations that


require a sequence of decisions over time
• Decision tree consists of
o Square nodes - indicating decision points
o Circles nodes - indicating states of nature
o Arcs - connecting nodes

© John Wiley and Sons, Inc. 22


Evaluations at Nodes

• Compute EV at nodes 6 & 7


o EV(node 6) = 0.80($3,000,000) + 0.20($700,000) = $2,540,000
o EV(node 7) = 0.30($2,300,000) + 0.70($1,000,000) = $1,390,000
• Decision at node 4 is between
$2,540,000 for Expand and $450,000 for Sell land
• Choose Expand
• Repeat expected value calculations and decisions at remaining
nodes

© John Wiley and Sons, Inc. 23


Decision Tree Analysis

© John Wiley and Sons, Inc. 24


Copyright

© John Wiley & Sons, Inc. or the author, All rights reserved. Students and instructors who are
authorized users of this course are permitted to download these materials and use them in
connection with the course. No part of these materials should be reproduced, stored in a retrieval
system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording
or otherwise, except as permitted by law. Advice on how to obtain permission to reuse this material
is available at http://www.wiley.com/go/permissions.

© John Wiley and Sons, Inc. 25

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