Learning Objectives

F-1: Explain the importance of following a systematic process to make operations and supply chain management decisions.

Decision analysis is the art and science of formal decision-making. It is often used to make decisions in many areas of business including operations, finance, marketing, and so forth, Decision analysis offers both individuals and organizations a framework, specific methodologies and tools to identify and analyze uncertain events, risk factors, and possible outcomes to reach optimal decisions.

F-2: Define the elements in the decision-making process.

Any decision-making situation comprises the following four elements: (1) the decision alternatives that can be taken to address the problem; (2) the states of nature, which consist of future events or conditions beyond the control of the decision maker; (3) the consequences of the decision made and the state of nature that occurs; and (4) the decision’s monetary or nonmonetary payoffs.

F-3: Appraise the different environments, or categories, under which decision are made.

Decisions can be made under a variety of different environments, including, first, decisions under certainty— situations where we know without a doubt what the state of nature is going to be. Second are decisions under uncertainty—in which there are not only multiple states of nature but they are also unpredictable and the decision maker cannot even make an educated guess about the chances, or probabilities, of their occurring. These are typically the most common types of decisions organizations face. Finally, the third category is decisions under risk—a scenario that falls between the two extremes of certainty and uncertainty. The decision maker, although not certain, is aware of the chances, or probabilities, of the various states of nature occurring.

F-4: Solve decision-making problems under certainty, uncertainty, and risk.

When you know with certainty what the state nature is going to be, simply choose the alternative in the matrix with the highest payoff for that state of nature. When you are uncertain about what the state of nature will be, the Laplace criterion, maximin criterion, maximax criterion, Hurwicz criterion, or minimax regret criterion can be used. Under conditions of risk, the expected value decision-making approach should be used.

F-5: Use decision trees and sensitivity analyses to make sequential decisions.

When sequential decisions need to be made, a decision tree should be used. Begin the tree with the initial decision to be made. Then expand it for different alternatives. After all possible states of nature, decisions, and payoffs have been placed on the tree, consider each decision path and its final payoff. In decision-making scenarios under uncertainty or risk, the values of the probabilities of the various states of nature and the payoffs associated with them are either unknown or estimates. Nevertheless, instead of single-point estimates, as a decision maker, you can use a range of values for the estimates to determine how “sensitive” an alternative is to changes in the values of these variables.

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