Discovering Knowledge

CSC-426
Business Intelligence
&
Analytics
Lecture 11

Dr. Humera Farooq

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Lecture 11

Model-Based Decision
Making: Optimization and Multi-
Criteria Systems

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Contents
• Basic concepts of analytical decision modeling
• Basic concepts of optimization
• Sensitivity analysis, what-if analysis, and goal seeking
• Key issues of multi-criteria decision making

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Learning Objectives
• Understand the basic concepts of analytical
decision modeling
• Describe how prescriptive models interact with
data and the user
• Understand some different, well-known model
classes
• Understand how to structure decision making with
a few alternatives

(Continued…)
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Learning Objectives
• Explain the basic concepts of optimization and
when to use them
• Describe how to handle multiple goals
• Explain what is meant by sensitivity analysis,
what-if analysis, and goal seeking
• Describe the key issues of multi-criteria
decision making

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Analytical Decision Modeling

• It compares the expected costs and consequences of
decision options by synthesizing information from
multiple sources and applying mathematical
techniques, usually with computer software.
• Work as a prescriptive model that prescribes how a
new software system should be developed.
• Prescriptive models are used as guidelines or
frameworks to organize and structure how software
development activities should be performed

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Major Modeling Issues

• Problem identification and environmental analysis
(information collection)

• Variable identification
– Influence diagrams, cognitive maps

• Forecasting/predicting
– More information leads to better prediction

• Multiple models: can include several models, each

of which represents a different part of the
decision-making problem
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Categories of Models

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Model Categories
Static and Dynamic Models
• Static Analysis
– Single snapshot of the situation
– Single interval
– Steady state
• Dynamic Analysis
– Dynamic models
– Evaluate scenarios that change over time
– Time dependent
– Represents trends and patterns over time
– More realistic: Extends static models

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Model Categories
Current Trends in Modeling
 Development of Model/Solution Libraries

 Web-based modeling (optimization/simulation/…)

 Multidimensional analysis (modeling)

 Influence Diagrams

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Structure of Mathematical Models

for Decision Support
 Non-Quantitative Models (Qualitative)
 Quantitative Models: Mathematically links decision
variables, uncontrollable variables, and result
variables

ables
Vari
dent Uncontrollable
epen Variables
Ind Dependent Variable
Decision Mathematical Result
Variables Relationships Variables

Intermediate
Variables

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Examples - Components of Models

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Modeling and Decision Making -

Under Certainty, Uncertainty, and Risk
• Certainty
– Assume complete knowledge
– All potential outcomes are known
– May yield optimal solution
• Uncertainty
– Several outcomes for each decision
– Probability of each outcome is unknown
– Knowledge would lead to less uncertainty
• Risk analysis (probabilistic decision making)
– Probability of each of several outcomes occurring
– Level of uncertainty => Risk (expected value)

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Modeling and Decision Making -

Under Certainty, Uncertainty, and Risk

The Zones of Decision Making

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Decision Modeling with Spreadsheets

• Spreadsheet
– Most popular end-user modeling tool
– Flexible and easy to use
– Powerful functions (add-in functions)
– Programmability (via macros)
– What-if analysis and goal seeking
– Simple database management
– Seamless integration of model and data
– Incorporates both static and dynamic models
– Examples: Microsoft Excel, Lotus 1-2-3
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Optimization
via Mathematical Programming
• Mathematical Programming
A family of tools designed to help solve managerial
problems in which the decision maker must allocate
scarce resources among competing activities to optimize a
measurable goal

• Optimal solution: The best possible solution to a

modeled problem
– Linear programming (LP): A mathematical model for the
optimal solution of resource allocation problems. All the
relationships are linear.

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Common Optimization Models

• Product-mix problems (how many of each
product to produce for max profit)
• Transportation (minimize cost of shipments)
• Assignment (best matching of objects)
• Investment (maximizing rate of return)
• Network optimization models for planning and
scheduling
• Replacement (capital budgeting), …
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Multiple Goals, Sensitivity Analysis, What-If

Analysis, and Goal Seeking
• Multiple Goals
– Simple-goal vs. multiple goals
– Vast majority of managerial problems has multiple
goals (objectives) to achieve
• Attaining simultaneous goals
– Methods of handling multiple goals
• Utility theory
• Goal programming
• Expression of goals as constraints, using LP
• A points system
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Multiple Goals, Sensitivity Analysis, What-If

Analysis, and Goal Seeking
• Certain difficulties may arise when analyzing
multiple goals
– Difficult to obtain a single organizational goal
– The importance of goals change over time
– Goals and sub-goals are viewed differently
– Goals change in response to other changes
– Dynamics of groups of decision makers
– Assessing the importance (priorities)
–…
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Multiple Goals, Sensitivity Analysis, What-If

Analysis, and Goal Seeking
• Sensitivity analysis
– It is the process of assessing the impact of change
in inputs on outputs
– Helps to …
• eliminate (or reduce) variables
• revise models to eliminate too-large sensitivities
• adding details about sensitive variables or scenarios
• obtain better estimates of sensitive variables
• alter a real-world system to reduce sensitivities
• …
– Can be automatic or trial and error
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Multiple Goals, Sensitivity Analysis, What-If

Analysis, and Goal Seeking
• What-if analysis
– Assesses solutions based on changes in variables or
assumptions (scenario analysis)
– What if we change our capacity at the milling
station by 40% [what would be the impact]
• Goal seeking
– Backwards approach, starts with the goal and
determines values of inputs needed
– Example is break-even point determination
• In-order to break even (profit = 0), how many products
do we have to sell each month
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Decision Analysis with Decision Tables and Decision

Trees
• Decision Tables – a tabular representation of
the decision situation (alternatives)
• Investment Example
– Goal: maximize the yield after one year
– Yield depends on the status of the economy (the
state of nature)
• Solid growth
• Stagnation
• Inflation

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Decision Table -
Investment Example: Possible Situations

1. If solid growth in the economy, bonds yield 12%;

stocks 15%; time deposits 6.5%
2. If stagnation, bonds yield 6%; stocks 3%; time
deposits 6.5%
3. If inflation, bonds yield 3%; stocks lose 2%; time
deposits yield 6.5%

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Decision Table
Investment Example: Treating Uncertainty

• Optimistic approach
• Pessimistic approach
• Treating Risk/Uncertainty:
– Use known probabilities
– Expected values

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Decision Trees
• Graphical representation of relationships
• Multiple criteria approach
• Demonstrates complex relationships
• Cumbersome, if many alternatives exists
• Tools include
– Mind Tools Ltd., mindtools.com
– TreeAge Software Inc., treeage.com
– Palisade Corp., palisade.com

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Decision Trees – An Example

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Multi-Criteria Decision Making with Pairwise

Comparisons
• Having more than one criterion makes
decision-making process complicated

• Usually some type of weighing algorithm is

used to analyze such problems

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End of the Chapter

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