Operations Management
For Competitive Advantage
1
ninth edition
Decision Trees
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Used for complex decision problems
characterized by uncertainities
Two main symbols:
Box = Decision
Circle = Random event
Expected profit values calculated
Select decision with highest exp. profit
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©The McGraw-Hill Companies, Inc., 2001
Operations Management
For Competitive Advantage
2
ninth edition
An Example
A glass factory specializing in crystal is experiencing a
substantial backlog, and the firm's management is considering
three courses of action:
A) Arrange for subcontracting,
B) Construct new facilities.
C) Do nothing (no change)
The correct choice depends largely upon demand, which may
be low, medium, or high. By consensus, management
estimates the respective demand probabilities as .10, .50, and
.40.
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©The McGraw-Hill Companies, Inc., 2001
Operations Management
For Competitive Advantage
3
ninth edition
The Payoff Table
The management also estimates the profits when
choosing from the three alternatives (A, B, and C) under
the differing probable levels of demand. These costs, in
thousands of dollars are presented in the table below:
A
B
C
0.1
Low
10
-120
20
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0.5
Medium
50
25
40
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0.4
High
90
200
60
©The McGraw-Hill Companies, Inc., 2001
Operations Management
For Competitive Advantage
ninth edition
4
Step 1: Draw the decisions
A
B
C
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©The McGraw-Hill Companies, Inc., 2001
Operations Management
For Competitive Advantage
5
ninth edition
Step 2: Draw the random events
High demand (.4)
Medium demand (.5)
Low demand (.1)
A
High demand (.4)
B
Medium demand (.5)
Low demand (.1)
$90k
$50k
$10k
$200k
$25k
-$120k
C
High demand (.4)
Medium demand (.5)
Low demand (.1)
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$60k
$40k
$20k
©The McGraw-Hill Companies, Inc., 2001
Operations Management
For Competitive Advantage
6
ninth edition
Step 3: Calculate exp. values
$90k
$50k
$10k
High demand (.4)
Medium demand (.5)
$62k
Low demand (.1)
A
EVA=.4(90)+.5(50)+.1(10)=$62k
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©The McGraw-Hill Companies, Inc., 2001
Operations Management
For Competitive Advantage
7
ninth edition
Step 4: Select best alternative
High demand (.4)
Medium demand (.5)
$62k
A
B
$80.5k
Low demand (.1)
High demand (.4)
Medium demand (.5)
Low demand (.1)
$90k
$50k
$10k
$200k
$25k
-$120k
C
High demand (.4)
$46k
Medium demand (.5)
Low demand (.1)
$60k
$40k
$20k
Alternative B generates the greatest expected profit, so our
choice is B or to construct a new facility.
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©The McGraw-Hill Companies, Inc., 2001
Operations Management
For Competitive Advantage
8
ninth edition
Other views and criteria
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Sensitivity analysis for the estimated
probabilities
Can we “buy” better information? EVPI
Risk Aversion, Utilities
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©The McGraw-Hill Companies, Inc., 2001