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INTRODUCTION TO PRODUCTION AND OPERATIONS MANAGEMENT:The Decision Process

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Production and Operations Management ­MGT613
VU
Lesson 06
The Decision Process
Decision Process is more or less the fundamental process of Management. Whether a person works in a
manufacturing organization or a services side organization, he or she would be asked to carry out the
decision process. Normally the decision making process involves the following six important steps
1. Specify Objectives and the Criteria for decision making
2. Develop Alternatives
3. Analyze and compare alternatives.
4. Select the best alternative.
5. Implement the chosen Alternative
6. Monitor the results to ensure the desired results are achieved.
Operations Manager identifies the criteria by which the proposed solutions will be judged. The common
criteria often relates to costs, profits, return on investment, productivity, risk, company image, impact on
demand, or similar variables. The management is interested that the Operations Manager should be able
to focus on parameters that will increase or decrease? Ideally the aim is that
1. Costs should decrease and Profits should increase
2. Return on Investment should increase along with increase in Productivity.
3. Risk should decrease along with increase in Company image.
4. Demand should increase for the product or service.
5. Monitor the results to ensure the desired results are achieved.
The Decision Process Example
The CEO of ABC Corporation has asked you (the VP Operations) to help the BOD reach a decision
whether to introduce a new automobile model. The new model would have the following effects on
important decision making process. Certain Parameters will increase and decrease?
Costs decrease by 15 %
Profits increase by 2%
Return on Investment stays the same
Productivity decreases by 5%
Risk increases by 5 %
Company image may increase or decrease
Demand may increase or decrease for the product or service.
Solution
·Based on the above data, a Risk Averse Manager would forego the new project, A Risk taker would go
for it. These factors alone do not present the overall big picture, most of the times in practical situations,
the decision is based upon important factors like ROI, Productivity, Utilization of available resources,
Profits and Costs in line with organizations operational and organizational strategy and the mapping of
the organization with respect to its competitors and competitive environment..
Causes of Poor Decisions
·Unforeseeable and uncertain circumstances , which in reality refers to a mistake or error in the decision
making, remedial action is to have a STEERING COMMETIEE ( comprising of senior management) to
review the whole process and monitor the decision steps.
Decision Environments
·There are three degrees of Certainty, Risk and Uncertainty.
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Production and Operations Management ­MGT613
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1. Certainty: Means that the relevant parameter such as costs, capacity and demand have known
values.
2. Risk means that certain parameters have probabilistic outcomes.
3. Uncertainty means that the certain parameters have various possible future events.
Decision Environments often represent the same three scenarios of Certainty, Risk and Uncertainty. Let
us consider the example where we are making a ball bearing which is to be used in ceiling fan and our
marketing department comes with up three scenarios with different set of numbers. It costs us Rs 40 per
unit to manufacture the ball bearing. The marketing department has through its market research noted
that our organization can have a sale price of Rs. 90 per unit.
·Certainty: Profit per unit is Rs. 50. You have an order for 2000 units. The decision is under certainty as
the Means that the relevant parameter such as costs, capacity and demand have known values.
·Risk There is a 25 % chance of demand of 2000 units, 50% chance of demand of 1000 units and 25 %
chance of an order of 500 units.
·Uncertainty .There is no available data of demand forecasts means that the certain parameters
necessary for decision making are absent.
DECISION THEORY
No discussion in Production Operation Management is complete without making a reference to
Decision Theory. Decision Theory is in fact a general approach to decision making.
Decision theory consists of the following three elements.
1. A set of possible outcomes exist that will have a bearing on the results of the decision.
2. A list of alternatives to choose from.
3. A known payoff for each alternative under each possible future condition.
An operations manager would need to develop an understanding of decision theory knowledge and
needs to employ the following.
1. Identify a set of possible future conditions called state of nature which includes the low, high,
medium demand pattern and a working on the competitor's introduction of new product.
2. Develop a list of alternatives, one of which may be to do nothing.
3. Determine or estimate the payoff associated with each alternative for every possible future
condition.
4. If possible estimate the likely hood of each possible future condition.
5. Evaluate alternatives according to some decision criterion e.g. maximize expected profit and
select the best alternatives to choose from.
PAY OFF TABLE
·Payoff table summarizes the information of a decision and captures the expected payoffs under various
possible states of nature.
·Let us consider an example, we are setting up a pharmaceutical factory and our state of nature indicates
that If we built a small facility the return remains the same whether the demand is low or high, the
medium facility indicates a constant return on moderate and high. If we build a large facility chances are
that the return would only be good if we have a high demand or return.
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Production and Operations Management ­MGT613
VU
Alternatives Possible Future Demands
Low
Moderate
High
Small
Rs. 10 M
Rs. 10 M
Rs. 10 M
Facility
Medium
Rs. 5 M
Rs. 8 M
Rs. 12 M
Large
Rs. 1 M
Rs. 2 M
Rs. 15 M
The states of nature are very important, for our decision making.
Decision Making under Certainty
Decision making under certainly is always simple but never available to the managers.
Alternatives
Possible Future Demands
Low
Moderate
High
Small Facility
Rs. 10 M
Rs. 10 M
Rs. 10 M
Medium
Rs. 5 M
Rs. 8 M
Rs. 12 M
Large
Rs. 1 M
Rs. 2 M
Rs. 15 M
Decision Making under Certainty
·It is known with certainty that the demand will be low, moderate and high.
·In the example, we just select the best or highest payoff for all the states of nature.
Decision Making under Uncertainty
·In the absence of clear information, An Operations Manager would need to carryout decision making
under uncertainty. This is the usual pattern when managers working at assembly plants, services, oil
refineries or chemical processing plant end up facing a dilemma to evaluate the alternative of payoffs..
1. Maximin
2. Maximax
3. Minimax Regret
4. Laplace
MAXIMIN
Maximin determines the worst payoff for each alternative; the operations manager chooses the best
worst alternative. Meaning the least (best) of the worst.
It is a pessimistic approach.
Ensures a guaranteed minimum.
MAXIMAX
Maximax determines
the best possible outcome
Choose the Alternative with the best possible payoff.
It does not take into account any other alternative then the best payoff.
An optimistic approach.
Go for it strategy.
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Production and Operations Management ­MGT613
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LAPLACE
Determines the Average payoff for each alternative
And chooses the alternative with the best average.
This is a cautious approach
Laplace approach treats the states of nature as equally likely.
Example to calculate Maximin, Maximax and Laplace
Alternatives
Possible Future Demands
Low
Moderate
High
Small Facility
Rs. 10 M
Rs. 10 M
Rs. 10 M
Medium
Rs. 5 M
Rs. 8 M
Rs. 12 M
Large
Rs. 1 M
Rs. 2 M
Rs. 15 M
Example to calculate Maximin, Maximax and Laplace
Maximin , the worst payoff for alternatives
Pick the Minimum (Least) of the maximum
Small Facility Rs 10 M since the payoff table shows that
­Small Facility
Rs. 10 M
­Medium
Rs. 12 M
­ Large
Rs. 15 M
Example to calculate Maximin, Maximax and Laplace
Laplace , the best payoff of the average for each alternatives
Small Facility Rs 10 M since the payoff table shows that
­Small Facility
Rs. 30/3= Rs. 10 M
­Medium
Rs. 25/3= Rs. 8.33 M
­ Large
Rs. 18/3= Rs. 6 M
Decision Making under Uncertainty
Minimax Regret
Determines the worst regret for each alternative
Chooses the alternative with the best worst.
This approach seeks to minimize the difference between payoff that is realized and best payoff for
each state of nature.
Example to calculate Minimax Regret
·Minimax Regret ,
·Step I ; Construct the Table of Opportunity Losses or Regrets.
­Subtract the column entries by subtracting the entry from that of the highest column value
­Repeat the process for all columns
·Step II. Select the maximum regret value of each row ( alternative
meaning small, medium and large
scale)
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Production and Operations Management ­MGT613
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Example to calculate Minimax Regret
Alternatives
Possible Future Demands
Low
Moderate
High
Small Facility
Rs. 10-10=0
Rs. 10-10=0
10-15=-5
Medium
Rs. 5-10=
Rs. 8-10=
Rs. 12-15=
-5 M
-2 M
-3 M
Large
Rs.1-10=
Rs. 2-10=
Rs. 15-15=
-9 M
-8 M
0M
EXPECTED MONETARY VALUE CRITERION
Decision Making under Risk
The area between the certainty and uncertainty is known as Risk.
Expected Monetary Value Criterion (EMV)which refers to the best expected value among the
alternatives
We use the payoff table with probabilities low =0.3, moderate =0.5 and highest=0.2.These
probabilities must add to 1,mutually exclusive and collectively exhaustive)
·EXPECTED MONETARY VALUE CRITERION
·EV small
= 0.3(10)+0.5(10)+0.2(10)
=
Rs. 10 M
·EV medium= 0.3(5)+0.5(8)+0.2(12)
=
Rs. 7.9 M
·EV large  = 0.3(1)+0.5(2)+0.2(15)
=
Rs. 4.3 M
We select the smallest facility as it has the highest value
Expected Value of Perfect Information
In certain situations, it is possible to ascertain which state of nature ( level of demand) will
occur with certainty. E.g. If you want to construct a restaurant or trauma centre on a motorway
highway chances are you would get a great ROI.
Expected value of perfect information = Expected payoff under certainty -Expected payoff
under risk
Visual tool for analyzing Decision Problems
Two visual tools used for analyzing decision problems include
Decision Trees
Graphical Sensitivity Analysis
Decision Trees
A schematic representation of the alternatives and their possible consequences is presented graphically.
You can refer.
The diagram resembles a tree.
Extremely suitable for analyzing and evaluating situations which involve sequential decisions.
Decision Trees
Suppose the Pakistani government decides to operate a gas field. Initially the government had
information that it can exploit 1 million cubic feet of gas but later studies indicate potential
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Production and Operations Management ­MGT613
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reserves of additional 10 million cubic feet. As an operations manager you may be ask to
prepare a feasibility report to either expand or make a new facility using the new reserves.
Decision Trees
Low Demand = 0.4 Rs. 20
Do Nothing Rs. 20
Reduce capacity
Build small
- Rs 30
High
Expand = Rs 50
Demand =
0.6
Do Nothing = Rs. 15
Low Demand=0.4
Build Large
Reduce Prices Rs. 45
High Demand= 0.6
Rs. 60/unit
Decision Trees
The tree is read from left to right
Square nodes represent decisions
Circular nodes represent chance events.
Branches leaving square nodes represent alternatives.
Branches leaving the circular nodes represent the chance events ( states of nature)
Decision Trees Analysis
·Step I. Analyze the decisions from Right to left
·Step II. Determine which alternative would be selected for each possible second decision.
­For a small facility with high demand there are three alternatives , select the highest payoff and
multiply it with the probable outcome. Put a double slash on the alternatives which have lower value.
­Follow the same procedure for small facility with high demand
·Step III . Repeat the steps for both low and demand pattern for the larger facility.
·Step IV. Determine the product of chance probabilities
·Step V. Determine the expected value of each initial alternative.
·Step VI. Select the choice which has a larger expected value than the small facility.
Decision Tree Example Solution
Option I: Build Small Facility
Low Demand = 0.4 X Rs. 20= Rs. 8
High Demand=0.6 X Rs. 50= Rs. 30
Option II: Build Large Facility
Low Demand = 0.4 X Rs. 45= Rs. 18
High Demand=0.6 X Rs. 60= Rs. 54
Option III: Determine the Expected Value of each initial alternative
Build Small Facility = Rs. 8+ Rs. 30= Rs. 38
Build Large Facility=Rs. 18+Rs. 36= Rs. 54
Select the Larger Facility as it has a larger expected value than the small facility
Sensitivity Analysis
Determining the range of probability for which an alternative has the best expected payoff.
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Production and Operations Management ­MGT613
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A graphical solution
Makes use of Algebra
Prime importance
CONCLUSION
Decision Making is a critical responsibility that stays with a manager throughout his active professional
life. It goes without saying that, at the start of the service, the decision making involves low impact
financial impact but with the passage of time, the decision making becomes more critical and highly
finance focused. This very aspect gives the field of decision making a competitive edge over other
important tools available to an operations manager. The related field of game theory is often used in
conjunction with decision theory.
PAYOFF TABLE HOMEWORK
The following table shows profit payoffs. Calculate the results for the five rules and indicate for each
rule the best and worst decision alternatives. All Cost and Revenue numbers in Rs. 000. d1,d2, d3 and
d4 represent decision options and s1,s2,s3 and s4 show states of nature.
0.30 0.25 0.10 0.35
S1  S2  S3  S4  MAXIMIN MAXIMAX LAPLACE  EXPECTED
MINIMAX
MONETARY REGRET
VALUE
d1
50
-20
75
60
d2
80
30
100
-10
d3
25
35
10
45
d4
55
65
-15
40
The following table shows cost payoffs. Calculate the results for the five rules and indicate for each
rule the best and worst decision alternatives.
0.40 0.15 0.10 0.35
S1  S2  S3  S4  MAXIMIN MAXIMAX LAPLACE  EXPECTED
MINIMAX
MONETARY REGRET
VALUE
d1
40
20
75
60
d2
30
70
90
10
d3
60
55
5
85
d4
40
100
15
35
30
Table of Contents:
  1. INTRODUCTION TO PRODUCTION AND OPERATIONS MANAGEMENT
  2. INTRODUCTION TO PRODUCTION AND OPERATIONS MANAGEMENT:Decision Making
  3. INTRODUCTION TO PRODUCTION AND OPERATIONS MANAGEMENT:Strategy
  4. INTRODUCTION TO PRODUCTION AND OPERATIONS MANAGEMENT:Service Delivery System
  5. INTRODUCTION TO PRODUCTION AND OPERATIONS MANAGEMENT:Productivity
  6. INTRODUCTION TO PRODUCTION AND OPERATIONS MANAGEMENT:The Decision Process
  7. INTRODUCTION TO PRODUCTION AND OPERATIONS MANAGEMENT:Demand Management
  8. Roadmap to the Lecture:Fundamental Types of Forecasts, Finer Classification of Forecasts
  9. Time Series Forecasts:Techniques for Averaging, Simple Moving Average Solution
  10. The formula for the moving average is:Exponential Smoothing Model, Common Nonlinear Trends
  11. The formula for the moving average is:Major factors in design strategy
  12. The formula for the moving average is:Standardization, Mass Customization
  13. The formula for the moving average is:DESIGN STRATEGIES
  14. The formula for the moving average is:Measuring Reliability, AVAILABILITY
  15. The formula for the moving average is:Learning Objectives, Capacity Planning
  16. The formula for the moving average is:Efficiency and Utilization, Evaluating Alternatives
  17. The formula for the moving average is:Evaluating Alternatives, Financial Analysis
  18. PROCESS SELECTION:Types of Operation, Intermittent Processing
  19. PROCESS SELECTION:Basic Layout Types, Advantages of Product Layout
  20. PROCESS SELECTION:Cellular Layouts, Facilities Layouts, Importance of Layout Decisions
  21. DESIGN OF WORK SYSTEMS:Job Design, Specialization, Methods Analysis
  22. LOCATION PLANNING AND ANALYSIS:MANAGING GLOBAL OPERATIONS, Regional Factors
  23. MANAGEMENT OF QUALITY:Dimensions of Quality, Examples of Service Quality
  24. SERVICE QUALITY:Moments of Truth, Perceived Service Quality, Service Gap Analysis
  25. TOTAL QUALITY MANAGEMENT:Determinants of Quality, Responsibility for Quality
  26. TQM QUALITY:Six Sigma Team, PROCESS IMPROVEMENT
  27. QUALITY CONTROL & QUALITY ASSURANCE:INSPECTION, Control Chart
  28. ACCEPTANCE SAMPLING:CHOOSING A PLAN, CONSUMER’S AND PRODUCER’S RISK
  29. AGGREGATE PLANNING:Demand and Capacity Options
  30. AGGREGATE PLANNING:Aggregate Planning Relationships, Master Scheduling
  31. INVENTORY MANAGEMENT:Objective of Inventory Control, Inventory Counting Systems
  32. INVENTORY MANAGEMENT:ABC Classification System, Cycle Counting
  33. INVENTORY MANAGEMENT:Economic Production Quantity Assumptions
  34. INVENTORY MANAGEMENT:Independent and Dependent Demand
  35. INVENTORY MANAGEMENT:Capacity Planning, Manufacturing Resource Planning
  36. JUST IN TIME PRODUCTION SYSTEMS:Organizational and Operational Strategies
  37. JUST IN TIME PRODUCTION SYSTEMS:Operational Benefits, Kanban Formula
  38. JUST IN TIME PRODUCTION SYSTEMS:Secondary Goals, Tiered Supplier Network
  39. SUPPLY CHAIN MANAGEMENT:Logistics, Distribution Requirements Planning
  40. SUPPLY CHAIN MANAGEMENT:Supply Chain Benefits and Drawbacks
  41. SCHEDULING:High-Volume Systems, Load Chart, Hungarian Method
  42. SEQUENCING:Assumptions to Priority Rules, Scheduling Service Operations
  43. PROJECT MANAGEMENT:Project Life Cycle, Work Breakdown Structure
  44. PROJECT MANAGEMENT:Computing Algorithm, Project Crashing, Risk Management
  45. Waiting Lines:Queuing Analysis, System Characteristics, Priority Model