MM 5010 Strategic Decision Making and Negotiation INDIVIDUAL SUMMARY ASSIGNMENT

Chapter 3,5,67

29111311

Haidir Afesina (FEZI)

MBA Executive 46

MASTER OF BUSINESS ADMINISTRATION SCHOOL OF BUSINESS AND MANAGEMENT INSTITUT TEKNOLOGI BANDUNG 2013

Main Ideas Businesspeople make decisions daily, but few companies implement the kind of quality decisionmaking process that produces solid results. That is unfortunate since bad decisions are costly. Over the long term, the basis for any organizations success is its leaders ability to make the right decisions consistently. In fact, making the right decisions is seldom easy. Situations change and choices confound. Faulty perceptions and biases can block clear thinking and undermine the ability to weigh alternatives rationally. People who are in the process of deciding cannot always trust their own perceptions and thought processes. To enable the decision maker to gain an increased understanding of his or her decision problem, the chapter explores how decision analysis can be used to support decision makers who have multiple objectives. Simple Multiattribute Rating Technique (SMART) is the technique that uses to analyze the problem. Its simplicity and transparency can be easily applied and understood by decision makers from any backgrounds. Decision makers are often required to choose between several alternatives or options where each option exhibits a range of attributes. A key component for selecting the best alternative is obtaining the attribute weights. In SMART analysis the direct rating method of selecting raw weights is normally used as it is cognitively simpler and therefore is assumed to yield more consistent and accurate judgments from the decision maker. Requirement in Implementing Ideas Two basic terms used in the analysis: 1. Objective It is an indication of the preferred direction of movement i.e. minimize or maximize. 2. Attribute It is used to measure performance in relation to an objective. SMART main stages are: 1. 2. 3. 4. 5. 6. 7. 8. Identify decision maker(s) Identify alternative courses of action Identify the relevant attributes Assess the performance of the alternatives on each attribute Determine a weight for each attribute For each alternative, take a weighted average of the values assigned to that alternative Make a provisional decision Perform sensitivity analysis 1 of 10

Implementation After identify the decision maker, and alternative course of action as the first two stages, then the relevant attributes can be identify by using value tree by: 1. Addressing the attributes that represent the general concerns of the decision maker. 2. Decompose them to a level where they can be assessed. The 5 criteria that can be used to judge the tree, whether the value tree is an accurate and useful representation of the decision makers concerns: 1. Completeness i.e. all the attributes of concern have been included 2. Operationally i.e. all attributes are specific enough to evaluate 3. Decomposability i.e. each attribute is independent from other attributes 4. Absence of redundancy i.e. no duplicate of attributes 5. Minimum size i.e. attributes should not be decomposed beyond the level where they can be evaluated Stage 4 is to find out how well the options perform on each of the lowest-level attributes in the value tree, which are of concern to the owner. Two alternative approaches the performance on each attribute: 1. Direct rating Use direct numerical ratio judgments of relative attribute importance. Rank attributes from most preferred to least preferred. Then assigning values by giving the best option for attribute a value of 100, and 0 for the least appealing attribute. Therefore it is subjective. 2. Value functions Using a value functions to assign values. Measure the relative strength of preference and combine the values for the different attributes in order to gain a view of the overall benefits that each option has to offer in order to make a decision. Multiplying each value by its weight and summing the results can obtain the aggregate value for each option. Then the decision maker should choose option that is has the largest aggregate value and therefore performed best on the attribute, which was considered to be most important. 2 of 10

Stage 5 is using swing weights in order to avoid the problem if the options perform very similarly on a particular attribute, so that the range between worst and best is small. Thus the attribute is unlikely to be important in the decision, regardless consider being an important attribute per se by the decision maker. These are derived by asking the decision maker to compare a change (or swing) from the least preferred to the most-preferred value on one attribute to a similar change in another attribute. Stage 6 is aggregating the benefits using the additive model. 1. Normalizing weights Measure of how well each office performs on each attribute 2. Calculating aggregate benefits for each attribute Weights the attributes that allow us to compare the values among them. Each value is multiplied by the weight attached to that attribute. The resulting products are then summed and divided by 100 to obtain the overall value of aggregate benefits. Stage 7 is about making provisional decision. Decision makers often have difficulty in making trade-off judgments between costs and benefits. Trading benefits against cost can be applied if decision maker had difficulties in judging the costbenefit trade-off. However, if decision maker had not found this to be a problem, then have treated cost as just another attribute by allocated values between 0 and 100 and determined its swing weights. Stage 8 is sensitivity analysis. It examines how robust the choice of an alternative changes in the figures used in the analysis. In addition, it shows how the value of benefits for the different options varies with changes in the weight X on Y. Sensitivity analysis only allows the decision makers to investigate the effect of changing one weight at a time.

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Theoretical Considerations The axioms of the method are number of assumptions about the decision makers preferences. In technical terms, assume that mutual preference independence exists between the attributes. An analogy can be made with an attempt to answer a mathematical problem by using mental arithmetic. The axioms are decidability, transitivity, summation, solvability, finite upper and lower bounds for value. Conflict between intuitive and analytic results Sometimes the problem was too large and complex to handle as a whole so that preferences were not reflected in his holistic judgments. An analogy can be made with an attempt to answer a mathematical problem by using mental arithmetic rather than a calculator. In other words, the larger the problem, the less reliable holistic judgments may be. Alternatively, discrepancies between holistic and analytic results may result when the axioms are not acceptable to the decision maker. Thus, it is sometimes irrational. Nevertheless, any conflict between holistic and analytic rankings should be examined, since it may suggest that an important element of the problem has not been captured by the analysis. Variants of SMART Keeney (1992) has proposed value-focused thinking, which essentially involves a reversal of these two stages. 1. Determine your values that is what objectives (and hence what attributes) are important 2. Create alternatives that might help you to achieve these objectives. This approach is worth considering for major strategic or life-changing decisions where there is a need to think deeply about what you want to achieve in life or what the fundamental values of an organization are. Lessons Learned 1. 2. 3. 4. The limitations of human decision-making, so that the needed of tool for decision maker in order to take a decision that compared with intuitive. The conditions for a robust value tree, The idea of swing weight comparison as the basis for quantifying attribute importance, The need for sensitivity analysis that shows how different assumption about future would affect the recommended decision.

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Chapter 5. INTRODUCTION TO PROBABILITY Main Ideas Many problems the decision maker is not sure what will happen if a particular course of actions are chosen. Thus the concept of probability can be used to provide a measure of uncertainty. In most practical problems the probabilities used will be subjective, but they must still conform to the underlying axioms of probability theory. Numbers offer a much more precise way of measuring uncertainty, and most people will be familiar with the use of odds. Probabilities are measured on a scale that runs from 0 to 1. If the probability of an outcome occurring is zero then this implies that the outcome is impossible. At the opposite extreme, if it is considered that an outcome is certain to occur then this will be represented by a probability of 1 and the greater the chances of the event occurring, the closer its probability will be to 1. Requirement in Implementing The Ideas The terminologies are: 1. 2. 3. 4. 5. 6. Outcome i.e. each of the every possible thing that can happen Event i.e. one or more possible outcomes. Complementary of an event A i.e. all outcomes that are not part of event A Mutually exclusive i.e. events that cannot occur together Exhaustive events i.e. every possible event. Payoff i.e. quantitative measure of the value to the decision maker of the outcome, often the monetary value The approaches to accessing the probability of uncertain event: 1. Classical i.e. based on prior knowledge

2. Relative frequency i.e. based on observed data

3. Subjective i.e. individual judgment about particular event will occur. The first two methods lead to what are often referred to as objective probabilities. Since subjective is personal judgment, so it can be vary and valid only for certain of person, even though the decision is strongly back up with historical data. That is why sensitivity analysis is needed to reveal the probability calculations. 5 of 10

The rules of probability: 1. Addition rule p(A or B) = p(A)+(B) - p(A and B) If A and B are mutually exclusive (unions), then p(A or B) = 0, so p(A or B) = p(A)+P(B) If A and B are exhaustive, then p(A or B) = p(A) + p(B)=1 2. 3. Marginal probabilities i.e. the probability of the occurrence on single event Conditional probability i.e. used to find the probability of an event given that one of its possible causes has occurred. The conditional probability of A given that B has occurred 4. Independent events i.e. if the probability of one event is unchanged if the other has occurred. So two events A and B are independent if and only if p(A) = p(A|B). Thus the probability of one event is not affected by the occurrence of the other event. If affected then it is called dependent events. 5. The multiplication rule If A and B are independent: p(A and B) = p(A)p(B) If A and B are dependent: p(A and B) = p(A)p(BA) Implementation 1. Probability trees Device that can be proven to be particularly useful when awkward problems needed to be solved. 2. Probability distributions It is complete statement of all the possible events and their probabilities. Continuous (probability density function/pdf) A random variable is continuous if it can assume an uncountable number of values. After the first value is defined, any number can be the next one. Discrete (probability mass function/pmf) A random variable is discrete if it can assume a countable number of values. After the first value is defined the second value, and any value thereafter are known. Cumulative distribution function (cdf) It is the probability that the variable takes a value less than or equal to x. 3. Expected value It is an average value that will result if a process is repeated a large number of times. In other words, it measures the center of probability distribution (center of mass) 6 of 10

Chapter 6. DECISION MAKING UNDER UNCERTAINTY Main Ideas The ways of nding the right decision are as many as the number of people who have to make them. Nevertheless, the basic idea is the same for many of them: a decision is usually made as a combination of experiences from solving similar cases, the results of recent researches and personal judgment. In many decisions the consequences of the alternative courses of action cannot be predicted with certainty. The decision is not made repeatedly, and the decision make may only have one opportunity to choose the best course of action. Managers often must make decisions in environments that are fraught with uncertainty. If things go wrong then there will be no chance of recovering losses in future repetitions of the decision. In these circumstances some people might prefer the least risky course of action, and therefore the chapter discuss how decision makers attitude to risk can be assessed and incorporated into a decision model. The methods are maximin criterion, expected monetary value (EMV) and utility. Requirement in Implementing The Ideas 1. Maximin criterion It is the decision criterion for the total pessimist. It focuses only on the worst that can happen. The procedures are: 2. Identify the minimum payoff from any outcome for each alternative Find the maximum of these maximum payoffs and choose the alternative EMV (Expected Monetary Value)

It is choosing the decision that lead to the greater potential payoff from any possible scenarios. However, the limitations are that the decision maker has linear value function for money and focuses only on one attribute i.e. money. Though, EMV criterion is widely used in practice. 3. Utility It is designed to provide guidance on how to choose between alternative courses of action under conditions of uncertainty. The attitude to risk of a decision maker can be assessed by eliciting a utility function. Utility function can be also derived for attributes other than money. The shapes of the utility functions are risk averse, risk seeker, and risk neutral. In decision theory, an expected utility is only a certainty equivalent, that is, a single certain figure that is equivalent in preference to the uncertain situations. The optimal decision is the one that maximizes the expected quality. 7 of 10

Implementation Deriving the multi-attribute utility function Assuming that mutual utility independence does exist, derive the multi-attribute utility function as follows: 1. Derive single-attribute utility functions for overrun time and project cost. 2. Combine the single-attribute functions to obtain a multi-attribute utility function so that we can compare the alternative courses of action in terms of their performance over both attributes 3. Perform consistency checks, to see if the multi-attribute utility function really does represent the decision makers preferences, and sensitivity analysis to examine the effect. According to behavioral decision research, choices involving statements about gains tend to produce risk-averse response. When mutual utility independence exists in a decision problem it enables single attribute utility functions to be assessed separately for each attribute. The implications of research for utility assessment are: 1. 2. 3. It is clear that utility assessment requires effort and commitment from the decision maker. Fact that different elicitation methods are likely to generate different assessments means that the use of several methods is advisable Since the utility assessments appear to be very sensitive to both the values used and the context in which the questions are framed it is a good idea to phrase the actual utility questions in terms which are closely related to the values which appear in the original decision problem The axioms of Utility It is suggested that a rational decision maker should select the course of action, which maximizes expected utility. This will be true if the decision makers preferences conform to the following axioms: (1) The complete ordering axiom, (2) The transitivity axiom, (3) The continuity axiom, (4) The substitution axiom, (5) Unequal probability axiom, (6) Compound Lottery axiom. 8 of 10

Chapter 7. DECISION TREES AND INFLUENCE DIAGRAMS Main Ideas The need for a good decision support technique arises. It should be able to process those huge amounts of data and to help experts to make their decisions easier and more reliably. This lead to a basic introduction of the influence diagram and the relationships between decision trees, influence diagrams and fault trees. Both of decision tree and influence diagrams are common way of structuring the decision problem. On decision trees, the probabilities on the branches emanating from a chance node must sum to 1.0. Decision trees often need to make arbitrary assumptions about when the planning period, which is relevant to a decision, ends. In a decision tree several of the possible events emanating from a chance node are combined into an event labeled all other events before probabilities are elicited from the decision maker. According to behavioral decision research, this is likely to lead to an underestimate of the probability of all other events occurring. Sometimes three point approximations (like the Extended PearsonTukey approximation) are used to incorporate outcomes, which have a continuous probability distribution, into decision trees. It is inadvisable to use such approximations when the continuous probability distribution has more than one peak influence diagrams must contain no circles of influence where the sequences of arrows form loops. Requirement in Implementing The Ideas Decision Trees It is formalism for expressing such mappings and consists of tests or attribute nodes linked to two or more sub trees and leaf or decision nodes labeled with a class which means the decision. A decision node, represented by a square, indicates a decision to be made. The branches represent the possible decisions. An event node, represented by a circle, indicates a random event. The branches represent the possible outcomes of the random event Decision tree consists of a set of policies. A policy is a plan of action stating which option is to be chosen at each decision node that might be reached under that policy. The technique for determining the optimal policy in a decision tree is known as the rollback method. To apply this method, we analyze the tree from right to left by considering the later decisions first. Influence Diagrams It is a graphical structure for modeling uncertain variables and decisions and explicitly revealing probabilistic dependence and the flow of information. Designed as a knowledge representation to 9 of 10

bridge the gap between analysis and formulation. The advantage of starting with influence diagrams is that their graphic representation is more appealing to the intuition of decision makers who may be unfamiliar with decision technologies. In addition, influence diagrams are more easily revised and altered as the decision maker iterates with the decision analyst. Implementation Influence diagrams are excellent for displaying a decision`s structure, but thy hide many details. On the other hand, a decision tree reveals more of the decision diagram surface details. Some common mistakes such as influence diagrams should not be confused with flow charts, which are sequential in nature and building influence diagrams with many chance nodes pointing to a primary decision node. The phases of decision analysis are: 1. The decision analyst constructs a (provisional) representation of the problem 2. Iterative feedback to the decision maker, if disagree then back to first stage, if agree go to the third stage 3. Decision analyst elicits subjective probabilities and utilities from the decision maker 4. Decision analyst combines probabilities and utilities using normative decision theory 5. Normative decision theory specifies optimal decisions Eliciting Decision Tree Representation Subjective probabilities must be assessed for the events and utilities must be assigned to the end points in the decision tree. Procedure for turning an influence diagram into a decision tree: 1. 2. 3. 4. 5. 6. Identify a node with no arrows pointing into it (since there can be no loops at least one node will be such). If there is a choice between a decision node and an event node, choose the decision node. Place the node at the beginning of the tree and remove the node from the influence diagram. For the now-reduced diagram, choose another node with no arrows pointing into it. If there is a choice a decision node should be chosen. Place this node next in the tree and remove it from the influence diagram. Repeat the above procedure until all the nodes have been removed from the influence diagram.

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