Lesson 1

Decision Making, Problem

Solving and Decision Analysis
 Expected Learning Outcomes

1. Describe/Illustrate the Decision-making and

problem solving process
2. Demonstrate understanding of the different
decision-making models ad decision styles
3. Describe the types of decision-making
environments
4. Make decisions under uncertainty
5. Use probability values to make decisions
under risk
 Recall:
Steps in Decision Making

1. Clearly define the problem

2. List all possible alternatives
3. Identify all possible outcomes for each
alternative
4. Identify the payoff for each alternative
and outcome combination
5. Use a decision modeling technique to
choose an alternative
6. Evaluate the effectiveness
 Problem Definition
Problem is a discrepancy (difference)
between an existing and a desired state.
Example:
“The manager has resigned, and we need
another manager”
Here the phrase “manager has resigned”
reflects the current state while “need
another manager” represents a desired
state.
 Identifying Decision Criteria
The word criteria, is defined as “a
standard by which something can be
judged”.
A decision criteria therefore, is the
•basis of a decision,
•It outlines the relevant and important
factors for a decision.
•and implicitly, it also defines what is not
important.
 Decision Criteria: Example
In the above-cited scenario, the decision
criteria may include the following factors:
❑ Relevant qualifications
❑ Leadership skills
❑ Communication skills
❑ Planning and analytical skills
❑ Professional experience
Allocating Weights to Criteria

❑ The next step in the decision making

process is prioritization.
❑ Prioritization is achieved by assigning
quantitative weights to each criteria
element.
❑ The weightage defines the relative
significance of each element.
Allocating Weights: Example
 Developing Alternatives

❑ Involves defining the possible

alternatives (or choices) that would
resolve the problem.
❑ In our case, the alternatives would be a
list of candidates or job applicants.
 Analyzing Alternatives
❑ Alternatives are rated and analyzed
on the basis of the criteria
❑ The rating can be based on a specified
scale, say 1 – 5 etc.
❑ Rating may be subjective in nature
and thus,may depend on the judgment
of the individual(s)
Criteria Rating: Example
Analyzing and Assessment:
Example
 Selecting an alternative
❑ Involves choosing the best alternative,
based on the above rating and analysis
❑ Generally implies selecting the
alternative with the highest score.
 Implementing the Alternative

❑ Putting the decision into action

❑ Involves clear communication of the
decision to all concerned and obtaining
their commitment
Evaluation
❑ Evaluation forms an integral part of
any process
❑ Involves evaluation of the outcome
based on the desired goal and criteria
❑ Involves assessing the effectiveness
and efficiency of the outcome (or the
entire process)
❑ In case of any undesired results, each
step of the process is carefully
reviewed to trace the root causes
Decision-making Models
Model
“A simplified representation or description
of a system or complex entity”
Examples
❑ A model of a building
❑ A globe (Earth model)
Rational/Bounded Rational
Rational and Bounded Rational Models are
cognitive models that describe how
managers make rational decisions
The Rational Model

1. Define and
diagnose the
2. Set goals
problem
7. Follow up
and control
3. Search for
External and alternative
internal
6. Implement solutions
Environ. forces
the solution
selected 5. Choose 4. Compare
among
and evaluate
alternative
solution
solutions
Rational Model: Assumptions
❑ Clear and unambiguous problem
❑ Single, well-defined goal
❑ All alternatives are known
❑ Clear preferences (ranking criteria)
❑ Constant/stable preferences
❑ No time or cost constraints
❑ Decision will maximize payoff
Rational Model: Criticism
❑ Not all decisions made on rational
basis
❑ Most problems, goals and preferences
are not clear or well defined
❑ Not practical to know all possible
alternatives
❑ Time and cost constraints exist in all
practical problems
❑ Result not maximized in most cases
Bounded Rational: Assumptions
❑ Limited set of criteria
❑ Self-interest influences ratings
❑ Limited no. of alternatives
❑ Alternatives are assessed one at a
time till a satisficing (or good
enough) alternative is found
❑ Politics influences acceptance and
commitment of decision
Intuition
An unconscious process of making
decisions on the basis of experience and
judgment
Intuition
❑ Involves gut feeling
❑ May also have rational basis
❑ The “feeling” arises from past
experience and knowledge
❑ Involves quicker response
❑ Does not involve systematic analysis
Decision Types
Effective managers make various kinds of
decisions. In general, these decisions are
either
❑ Programmed decisions
❑ Non-programmed decisions
Programmed Decisions
❑ A decision that is repetitive and routine
❑ A definite method for its solution can
be established
❑ Does not have to be treated a new
each time it occurs
❑ Procedures are often already laid out
❑ Examples: pricing standard customer
orders, determining billing dates,
recording office supplies etc.
Non-programmed Decisions
❑ A decision that is novel (new or
unique) or Ill structured
❑ No established methods exist, because
it has never occurred before or because
❑ It is too complex
Non-programmed Decisions
❑ Are “tough” decisions that involve risk
and uncertainty and
❑ call for entrepreneurial abilities
❑ Such decisions draw heavily on the
analytical abilities of the manager
❑ Examples: Moving into a new market,
investing in a new unproven
technology, changing strategic
direction
Decision Styles
❑ Decision-making, though a rational
process does include some subjective
elements
❑ Thus in real organizational settings, the
quality of decision does depend on the
ability, style and approach of the
manager
Decision Styles: Directive
Directive
❑ Represents low tolerance for
ambiguity and uncertainty
❑ Reflects rational thinking of the
manager
❑ Such decision styles are more suitable
for routine procedural tasks
Decision Styles: Analytic
Analytic
❑ Analytical style is also a rational style
of thinking
❑ Involves a very high tolerance for
ambiguity and uncertainty
❑ Such managers generally seek detailed
information before making a decision
Decision Styles: Behavioural
Behavioural
❑ Represents a creative way of thinking
❑ Involves a low tolerance for
ambiguity or uncertainty
❑ Managers with a behavioural style
introduce “new” ways of doing things
Decision Styles: Conceptual
Conceptual
❑ Conceptual style also reflects a
creative and intuitive way of thinking
❑ Conceptual style managers have a very
broad vision and generally look at
numerous alternatives for
decision-making
❑ Focused on the long run and often
result in creative outcomes or
alternatives
Vroom and Yetton Model
Vroom and Yetton have identified five
decision styles for managers, and are
classified as follows:
Autocratic
AI
The decision is made individually, using
the information available to the individual
only
Vroom and Yetton Model
AII
❑ The manager obtains information from
subordinates and himself makes the
decision
❑ May or may not share with
subordinates, the purpose of questions
or the nature of problem
❑ Subordinates do not play any role in
problem definition or selection of
alternatives
Vroom and Yetton Model
Consultative
CI
❑ The manager shares the problem with
relevant subordinates individually
❑ Getting their input individually and
not as a group. The manager then
makes the decision independently,
and may or may not be influenced by
the subordinates’ suggestions
Vroom and Yetton Model
CII
❑ The problem is shared to subordinates
in a group
❑ Their ideas and suggestions are sought
in a group meeting
❑ The decision is then made by the
manager which
❑ May or may not reflect the
subordinates’ influence
Vroom and Yetton Model
Group Consensus
GI
❑ The problem is shared to subordinates
as a group
❑ Alternatives are generated and
evaluated collectively
❑ Effort is made to reach a consensus
Vroom and Yetton Model
GI (Contd.)
❑ The decision is made collectively and
the manager functions as a coordinator
❑ Does not “press” the group in adopting
the manager’s “solution”
❑ The manager is willing to accept and
implement the decision of the group
Group Decision-making
The factors requiring group decisions
include:
❑ Involving sensitive issues
❑ High cost alternatives
❑ Involving very high risk factor
❑ Strategic impact
Group Decisions: Advantages
❑ Acceptance of group members
❑ Coordination is easier
❑ Communication is easier
❑ Existence of large alternatives
❑ More information can be processed
❑ Diversity of experience and
perspectives
Group Decisions: Disadvantages
❑ Take longer time
❑ Group can be indecisive
❑ Groups can compromise
❑ Groups can be dominated
❑ Groups can “play games”
❑ Victim to Groupthink
Situational Factors for
Individual Decision-making
❑ Short time
❑ Unimportant to group
❑ Manager can take decision
❑ Dominate the decision
❑ Destructive conflict
❑ Members hesitant
Situational Factors for
Individual Decision-making

❑ Confidential data
❑ Incapability of members
❑ Manager’s dominance
❑ Indirect effect on group members
Situational Factors for
Group Decision-making

❑ Need for innovation and creativity

❑ Data collection
❑ Importance of acceptance
❑ Importance of solution
❑ Complex problem
❑ Democratic process
Situational Factors for
Group Decision-making

❑ Risk taking solution needed

❑ Better understanding
❑ Whole responsibility
❑ Feedback required
Improving Group Decision-making

❑ Brainstorming
❑ Nominal group techniques
❑ Electronic meeting
What is involved in making a good
decision?

• Decision theory is an analytic and systematic

approach to the study of decision making

• A good decision is one that is based on logic,

considers all available data and possible
alternatives, and uses appropriate quantitative
approaches.
 Steps in Decision Making

1. Clearly define the problem

2. List all possible alternatives
3. Identify all possible outcomes for each
alternative
4. Identify the payoff for each alternative
and outcome combination
5. Use a decision modeling technique to
choose an alternative
6. Evaluate the effectiveness
 Example 1:
A Lumber Company

1. Decision: Whether or not to make and sell

storage sheds
2. Alternatives:
• Build a large plant
• Build a small plant
• Do nothing
3. Outcomes: Demand for sheds will be high,
moderate, or low
4. Payoffs

Outcomes (Demand)
Alternatives High Moderate Low
Large plant 200,000 100,000 -120,000
Small plant 90,000 50,000 -20,000
No plant 0 0 0

5. Apply a decision modeling method

 Types of Decision Modeling
Environments

Type 1: Decision making under certainty

Type 2: Decision making under uncertainty

Type 3: Decision making under risk

 Decision Making Under Certainty

• The consequence of every alternative is

known
• Usually there is only one outcome for each
alternative
• This seldom occurs in reality
Decision Making Under Uncertainty

• Probabilities of the possible outcomes

are not known
• Decision making methods:
1. Maximax
2. Maximin
3. Criterion of realism
4. Equally likely
5. Minimax regret
 Maximax Criterion
• The optimistic approach
• Assume the best payoff will occur for each
alternative
Outcomes (Demand)
Alternatives High Moderate Low
Large plant 200,000 100,000 -120,000
Small plant 90,000 50,000 -20,000
No plant 0 0 0

Decision:
Choose the large plant (best payoff)
 Maximin Criterion
• The pessimistic approach
• Assume the worst payoff will occur for each
alternative
Outcomes (Demand)
Alternatives High Moderate Low
Large plant 200,000 100,000 -120,000
Small plant 90,000 50,000 -20,000
No plant 0 0 0

Decision:
Choose large plant (worst payoff)
 Criterion of Realism
• Uses the coefficient of realism (α) to estimate
the decision maker’s optimism
• 0<α<1

(α )(max payoff for alternative)

+ (1- α) (min payoff for alternative)
= Realism payoff for alternative
 Suppose α = 0.45
Alternatives Realism Payoff
Large plant 24,000
Small plant 29,500
No plant 0

Decision:
Choose small plant
Note:
Check computation refer to pay off table in slide 6.
Use formula in slide 12.
 Equally Likely Criterion
Assumes all outcomes equally likely and uses
the average payoff

Average Payoff
Alternatives
Large plant 60,000
Small plant 40,000
No plant 0
Decision:
Chose the large plant
 Minimax Regret Criterion
• Regret or opportunity loss measures much
better we could have done
Regret = (best payoff) – (actual payoff)
Outcomes (Demand)
Alternatives High Moderate Low
Large plant 200,000 100,000 -120,000
Small plant 90,000 50,000 -20,000
No plant 0 0 0
The best payoff for each outcome is highlighted
 Regret Values
Outcomes (Demand) Max
Alternatives High Moderate Low Regret
Large plant 0 0 120,000 120,000
Small plant 110,000 50,000 20,000 110,000
No plant 200,000 100,000 0 200,000

We want to minimize the amount of regret

we might experience, so decision is
chose small plant
Decision Making Under Risk
• Where probabilities of outcomes are available

• Expected Monetary Value (EMV) uses the

probabilities to calculate the average payoff for
each alternative

EMV (for alternative i) =

∑(probability of outcome)(payoff of outcome)
 Expected Monetary Value (EMV) Method

Outcomes (Demand)
Alternatives High Moderate Low EMV
Large plant 200,000 100,000 -120,000 86,000
Small plant 90,000 50,000 -20,000 48,000
No plant 0 0 0 0

Probability
0.3 0.5 0.2
of outcome
Decision:
Chose the large plant
 Expected Opportunity Loss
(EOL)
• How much regret do we expect based on the
probabilities?

EOL (for alternative i) =

∑(probability of outcome)(regret of outcome)
 Regret (Opportunity Loss) Values
Outcomes (Demand)
Alternatives High Moderate Low EOL
Large plant 0 0 120,000 24,000
Small plant 110,000 50,000 20,000 62,000
No plant 200,000 100,000 0 110,000

Probability
0.3 0.5 0.2
of outcome
Decision:
Chose the large plant
 Perfect Information

• Perfect Information would tell us with

certainty which outcome is going to occur
• Having perfect information before making a
decision would allow choosing the best payoff
for the outcome
 Expected Value With
Perfect Information (EVwPI)
The expected payoff of having perfect
information before making a decision

EVwPI = ∑ (probability of outcome)

( best payoff of outcome)
 Expected Value of
Perfect Information (EVPI)
• The amount by which perfect information
would increase our expected payoff
• Provides an upper bound on what to pay for
additional information
EVPI = EVwPI – EMV
EVwPI = Expected value with perfect information
EMV = the best EMV without perfect information
Payoffs in blue would be chosen based on
perfect information (knowing demand level)

Demand
Alternatives High Moderate Low
Large plant 200,000 100,000 -120,000
Small plant 90,000 50,000 -20,000
No plant 0 0 0

Probability 0.3 0.5 0.2

EVwPI = 110,000
 Expected Value of Perfect
Information
EVPI = EVwPI – EMV
= 110,000 - 86,000 = 24,000

• The “perfect information” increases the

expected value by 24,000
• Would it be worth 30,000 to obtain this
perfect information for demand?
 Sensitivity Analysis
■ Sensitivity analysis examines how our decision
might change with different input data
■ For the Lumber example

P = probability of a favorable market(high)

(1 – P) = probability of an unfavorable market(low)
The Lumber Company’Payoffs

Outcomes (Demand)
Alternatives High Moderate Low
Large plant 200,000 100,000 -120,000
Small plant 90,000 50,000 -20,000
No plant 0 0 0
 Sensitivity Analysis

EMV(Large Plant) = P200,000P – P120,000)(1 – P)

= P200,000P – P120,000 + P120,000P
= P320,000P – P120,000
EMV(Small Plant) = P100,000P – P20,000)(1 – P)
= P100,000P – P20,000 + P20,000P
= P120,000P – P20,000
EMV(Do Nothing) = P0P + 0(1 – P)
= P0
 Sensitivity Analysis

EMV Values
P300,000

P200,000

Point 2 EMV (large plant)

P100,000

Point 1 EMV (small plant)

0
EMV (do nothing)
–P100,000 .167 .5
Values of P
–P200,000

Figure 3.1
 Sensitivity Analysis

Point 1:
EMV(do nothing) = EMV(small plant)

0=P120,000P-P20,000

Point 2:
EMV(small plant) = EMV(large plant)
P120,000P- P20,000=P320,000P - P120,000
 Sensitivity Analysis
BEST RANGE OF P
ALTERNATIVE VALUES
Do nothing Less than 0.167
EMV Values Construct a small plant 0.167 – 0.5
P300,000
Construct a large plant Greater than 0.5
P200,000

Point 2 EMV (large plant)

P100,000

Point 1 EMV (small plant)

0
EMV (do nothing)
–P100,000 .167 .5 1
Values of P
–P200,000

Figure 3.1
 Challenge !

What kind of decision maker are

you?
•To answer this question, take the decision style
inventory.
•Share your result to our FB group.
•Make a short reflection of your decision style.
• We’re all experienced decision makers.
• We make hundreds of decisions a day,
often without really thinking about it.
• But in reality, the decision-making process
is complex, and many different factors
influence the decisions we make.
• Our family, our values and emotions,
advertising, and societal pressure can all
influence our choices.
• Another factor that can influence the way we
make decisions is habit.
• We tend to make decisions in a certain way.
It’s called our “decision-making style.”
• Take this questionnaire to discover your own
decision-making style.

(This questionnaire is an adaptation of the General

Decision Making Style questionnaire developed by
Scott and Bruce, 1995)
 DIRECTIONS

Rate each statement as a 1, 2, or 3:

1 : This statement is false.
2 : This statement is sometimes true.
It depends on the situation.
3 : This statement is true.
1. I make sure that I have all the facts before I make a decision.
2. When I make a decision, I do what feels right.
3. I often ask other people to help me make important decisions.
4. I don’t like making decisions, so I try to avoid it.
5. I make decisions quickly.
6. I make decisions in a slow, logical way.
7. When I make a decision, I rely on my instincts
8. I don’t make big decisions without talking to other people first.
9. I usually won’t make an important decision until I’m forced to do so.
10. I don’t think too much about the decisions that I make.
11. Making decisions requires careful thought.
12. A decision doesn’t need to make sense – it just needs to feel right.
13. When I need to make an important decision, I like to have someone
point me in the right direction.
14. I try to put off making important decisions because thinking about
them makes me feel uneasy.
15. When I need to make an important decision, I just do what seems
natural at the moment.
16 I consider all of my options before making a decision.
17. I rely on my inner feelings when making decisions.
18. When I make a decision, I rely on other people’s advice.
19. I usually make important decisions at the last minute.
20. I often make impulsive decisions.
 SCORING

•Within each box, indicate the number (1,

2, or 3) that you assigned to the statements
on the questionnaire.
•Then add those numbers up to get a total.
 INTERPRETATION OF RESULTS

Take a look at your total scores.

•If A is your highest number, you’re systematic.
•If B is your highest number, you’re intuitive.
•If C is your highest number, you’re dependent.
•If D is your highest number, you’re avoidant.
•If E is your highest number, you’re spontaneous.
•If you have equally high scores in more than one
area, it means that you regularly use more than one
decision-making style.
• A – Systematic
You make decisions slowly and carefully. You make
sure that you have all the facts before you
proceed. You carefully consider all of your
options in order to make the best choice.

• B – Intuitive
When you need to make a decision, you tend to
rely on your feelings. You make decisions based
on “hunches” and instinct. You do what feels
right at the moment.
• C – Dependent
You find it hard to make decisions without other
people’s support. When you need to make an
important decision, you ask other people for
advice and direction. You’re uncomfortable
making decisions alone.

• D – Avoidant
You don’t like making important decisions. They
make you feel uneasy and uncomfortable. So you
try to avoid making decisions as much as
possible. You only make important decisions
when you’re pressured to do so.
• E – Spontaneous
You make important decisions quickly and
easily. You’re often impulsive. You don’t
spend much time thinking or worrying about
your decisions. You just make a choice and see
what happens.
 One style isn’t better than another. They each have
their strengths and weaknesses, and they each
work well in different situations.
•For instance, the systematic approach would work
well if you have a big decision to make and a lot of
time to make it.
•In an emergency situation, it might be better to be
intuitive or spontaneous.
•If you don’t know much about a certain decision
that you need to make, it might be good to be
dependent and rely on the opinions of others.
•And sometimes it might be best to avoid making a
decision altogether.
• It’s OK to favor one of these styles more than the
others.
• But if you rely exclusively on one decision-making
style, you could end up making some bad
decisions.
• For instance, it’s fine to be spontaneous
sometimes – but it’s not the best way to go about
making a major life decision.
• And it’s fine to avoid decisions now and then, but
you’re going to run into problems if you avoid
them all.
• Skilled decision-makers are able to use more than
one style.
• They’re able to be flexible, and use the style that
best fits the situation.