UNIVERSITY OF SAINT LOUIS

Tuguegarao City

SCHOOL OF ACCOUNTANCY, BUSINESS and HOSPITALITY

Second Semester
A.Y. 2023-2024

COURSE LEARNING MODULE

OMGT 1013 – Operations Management and Total Quality Management

Prepared by:

GLADYS T. TUMBALI, DBM

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 COURSE LEARNING MODULE
OMGT 1013 (Operations Management and Total Quality Management)
AY 2023-2024

Lesson 3 and 4: Decision Making

Topic: Decision Making

Learning Outcomes: After reading this module, you are expected to:

1. Determine the different criteria in making a decision;

2. Determine the favorable payoff using the different criteria;
3. Make a decision using quantitative techniques.

LEARNING CONTENT

Introduction:

Operations managers make many choices as they deal with various decision areas (see the Operations
as a Competitive Weapon). Although the specifics of each situation vary, decision making generally involves
the same basic steps:

(1) recognize and clearly define the problem;

(2) collect the information needed to analyze possible alternatives, and

(3) choose and implement the most feasible alternative.

Sometimes hard thinking in a quiet room is sufficient.

Lesson Proper:

DECISION ENVIRONMENT
Operation management’s decision environments are classified according to degree of certainty present:

BASIC CATEGORIES:

1) CERTAINTY
- Environment in which relevant parameters have known values.
- Means that relevant parameters such as cost, capacity, and demand have known values
- The decision maker knows which state of nature will occur
- E.g. profit/unit is P50. You have an order for 200 units. How much profit will you make? (profits and total
demand are known)

2) RISK
- Environment in which certain future events have probable outcomes
- Means that certain parameters have probabilistic outcomes

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- The decision maker does not know which state of nature will occur but can estimate the probability that any
one state will occur.
- E.g profit/ unit is P50. Based on previous experience there is a 50% chance of an order for 100 units and a
50% chance of an order for 200 units. What is expected profit? (demand outcome are probabilistic)

3) UNCERTAINTY
- Environment in which it is impossible to assess the likelihood of various future events
- Means that it is impossible to assess the likelihood of various future events
- The decision maker lacks sufficient information even to estimate the probabilities of the possible states of
nature
- E.g. profit is to P50/unit. The probabilities of potential demand are unknown.

NOTE: These three decision environments require different analysis techniques. Some techniques are better
suited for one category than for others.

DECISION THEORY
Decision theory is a general approach to decision making when the outcomes associated with
alternatives are often in doubt. It helps operations managers with decisions on process, capacity, location, and
inventory because such decisions are about an uncertain future. Decision theory can also be used by
managers in other functional areas. With decision theory, a manager makes choices using the following
process.

The decision theory is suitable for a wide range of operations management decisions, e.g. capacity
planning, product and service design, equipment selection and location planning and inventory, because these
are about an uncertain future. It is a general approach to decision making when the outcomes associated with
alternatives are often in doubt.

Elements A set of possible future conditions exist that will have a

bearing on the results of the decision.
of
Decision
Making A list of alternatives for the manager to choose from.

A known payoff for each alternative under each possible

future condition.

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 Process of Decision Making

1. List the feasible alternatives

One alternative that should always be considered as a basis for reference is to do nothing or to
maintain Status Quo.
Example.: where to locate a new retail store in a certain part of the city

2. List the events (chance events or states of nature) that have an impact on the outcome of the choice
but aren’t under the managers’ control

States of Nature- possible future conditions; these events must be mutually exclusive and
exhaustive- they don’t overlap and that they cover all eventualities.
Examples.:
- Number of contracts awarded will be one, two or three
- Competitors will or will not introduce a new product
- Demand experienced by the new facility could be: low, medium or high

3. Calculate/determine/estimate the payoff for each alternative in each event.

Note: Typically the payoff is in terms of total profit or total cost. These payoffs can be entered into a
payoff table
Payoff table- shows the expected payoffs for each alternative under the various possible states
of nature
- helpful in choosing among alternatives because they facilitate comparison of alternatives

POSSIBLE FUTURE DEMAND (in millions)

Alternatives Low Moderate High

Small Facility P10 P10 P10

Medium Facility 7 12 12
Large Facility -4 2 16

 Payoffs are in terms of present values which represent equivalent current peso values of expected future.
income

4. Estimate the likelihood of each event using past data, executive opinion and other forecasting methods.
Express it as probability, making sure that the probabilities sum to 1.0; develop probability estimates
from past data if the past is considered a good indicator of the future.

5. Select a decision rule or criterion to evaluate the alternatives and select the best alternative
Examples: choosing the alternative with the lowest expected cost

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 The following are the Three (3) Decision Environments

A. DECISION MAKING UNDER CERTAINTY

 manager knows which event will definitely occur under each alternative
 decision rule is to pick the alternative with the best payoff for the known event
 the best alternative is the highest payoff if the payoffs are expressed as profit, if the payoffs
are expressed as costs, the best alternative is the one having the lowest payoff
 the decision is usually relatively straight forward: simply choose the alternative that has the best
payoff under state of nature

Example:
A manager is deciding whether to build a small or a large facility. Much depends on the future demand
that the facility must serve and demand may be small or large. The manager knows which certainty the payoffs
that will result under each alternative. The payoffs, in thousands (P 000), are the present values of future
revenues minus costs for each alternative in each event.

Possible Future Demand

Alternative Low High

Small Facility 200 270

Large Facility 160 800

Question: If you would make the decision, which is the best choice if the future demand will be low?

Answer: The best choice is the one with the highest payoffs. So the decision would be:

If the manager knows the future demand will be low, the company should build a small facility and
enjoy a payoff of P200 000.

B. DECISION MAKING UNDER UNCERTAINTY

 no information is available on how likely the various states of nature are.

4 Decision rules or criteria

A. Maximin - It maximizes the minimum payoffs given the various decisions that are possible.

-Its rule is a very conservative one that takes a pessimistic view on the various states of nature.

B. Maximax - It maximizes the maximum payoffs for the different decisions starting with the identification of the
maximum payoffs of each alternative decision (optimistic view).

C. Laplace – determines the average payoff for each alternative and chooses the alternative with the best
average.

D. Minimax Regret – determine the worst regret for each alternative and choose the alternative with the “best
worst”
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 Example #1 (same problem given in certainty) Profit Payoffs
Required: Determine the best alternative for each decision rule

Solution:

a. Maximin

1. Select the column with minimum payoff.

2. Choose the highest amount.

Alternative Payoffs Worst Payoffs (000)

Small Facility P 200
Large Facility P 160

Decision: The manager would build a small facility if demand would be low with a payoff of P200,000.

b. Maximax

1. Select the column with the highest payoff.

2. Choose the highest amount.

Alternative Payoffs Best Payoffs (000)

Small Facility P270
Large Facility P800

Decision: The manager would build a large facility if demand would be high with a payoff of P800,000.

NOTE: In stating your decisions for maximax criterion and minimin/maximin criterion, always
include the three elements in your decision.

The Three (3) ELEMENTS are the following:

•Small Facility
Alternative
•Large Facility
•low demand
State of nature
•high demand
•P800,000
Payoff
•P200,000

c. Laplace

With two events, we just get the average.

Alternative Payoffs Weighted Payoffs

Small Facility 200 + 270/2 = 235
Large Facility 160 + 800/2 = 480

Decision: The manager would build a large facility with a payoff of P480,000.

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d. Minimax Regret

1. Determine the largest element in both columns ( in BOLD)

2. Subtract every element from the largest payoff in both columns.
3. Select the largest amount in each row. ( in colored BOLD)
4. Identify the minimum regret.

Alternative Payoffs Low Demand High Demand Maximum Demand

Small Facility P 200-200=0 P 800-270=530 P 530
Large Facility P 200-160=40 P 800-800=0 P 40

The column on the right shows the worst regret for each alternative. To minimize the maximum regret,
pick a large facility. The biggest regret is associated with having only a small facility and high demand.

Decision: The manager would build a large facility with a minimum regret of P 40,000.

NOTE: In stating your decisions for laplace criterion and minimax regret criterion, only two (2)
elements are included in your decision. These are the alternative and the payoff.

Example #2 (same problem given in certainty) Cost Payoffs

Required: Determine the best alternative for each decision rule

Solution:

a. Maximin

1. Select the column with highest payoff.

2. Identify the lowest amount.

Alternative Payoffs Worst Payoffs (000)

Small Facility P270
Large Facility P800

Decision: The manager would build a small facility if demand would be high with a payoff of P270,000.

b. Minimin

1. Select the column with lowest payoff.

2. Identify the lowest amount.

Alternative Payoffs Best Payoffs (000)

Small Facility P 200
Large Facility P 160

Decision: The manager would build a large facility if demand would be low with a payoff of P160,000.

c. Laplace

With two events, we just get the average.

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 Alternative Payoffs Weighted Payoffs (000)
Small Facility P200 + 270 = P235
Large Facility P160 + 800 = P480

Decision: The manager would build a small facility with a payoff of P235,000.

d. Minimax Regret

1. Determine the lowest element in both columns. (in BOLD)

2. Subtract every element from the lowest payoff in both columns.
3. Select the largest amount in each row.
4. Identify the lowest payoff.

Alternative Payoffs Low Demand High Demand Maximum Demand

Small Facility 200-160=40 270-270=0 40
Large Facility 160-160=0 800-270=530 530

Decision: The manager would build a small facility with a minimum regret of P40,000.

Note: Payoff is:

Profit – choose the column with the lowest payoffs then pick out the highest amount in
the column.
Maximin
Cost – Choose the column with the highest payoffs then select the lowest amount in the
column

Maximax Profit – Choose the column with the highest payoffs then select the highest in the
column.

Minimin Cost – Choose the column with the lowest payoffs then select the lowest in the
column.
Profit – get the average in each row and select the highest payoff.
Laplace
Cost – get the average in each row and select the lowest payoff.

Profit – Subtract highest PO in each column to each PO in each row, select the
highest in each row then select the lowest.
Minimax Regret
Cost – subtract lowest PO to each PO in each row, select the highest in each
row, and select the lowest.

C. DECISION MAKING UNDER RISK

- The manager or decision maker has estimates of the probabilities of the various states of nature or is
willing to make them
- The manager can list the events and estimate their probabilities; the manager has less information than
with decision making under certainty but more information than with decision making under uncertainty
- Widely used approach under this is the Expected Monetary Value Criterion.

Expected Monetary Value (EMV)

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- The best expected value among the alternatives
- Sum of the payoffs for an alternative where each payoff is weighted by the probability for the relevant
state of nature or the expected value for an alternative is found by weighing each payoff with its
associated probability and then adding the weighted payoff scores- the alternative with the best
expected value (highest for profit and lowest for cost) is chosen.

EMV Criterion

- Determine the expected payoff of each alternative and choose the alternative that has the best
expected payoff
Note: This EMV approach is most appropriate when a decision maker is neither risk- averse nor risk-
seeking, but is risk- neutral.
The expected value is what the average payoff would be if the decision would be repeated time
after time.
The rule should not be used if the manager is inclined to avoid risk. This approach provides an
indication of the long run, average payoff that is, the expected value amount is not an actual payoff but
an expected or average amount that would be approximated if a large number of identical decision,
were to be made.

Example 1
Possible Future Demand (000)
Alternative Low High
Small Faculty 200 270
Large Faculty 160 800
Do Nothing 0 0
Which is the best alternative if the probability of small demand is estimated to be .40 and the
probability of large demand is estimated to be .6?

Solution: The expected value for each alternative is:

Alternative Expected Value

Small Facility .4(200) +.6(270) = 242

Large Facility .4(160) + .6(800) = 544

Choose a large facility because its expected value is the highest at P544,000

Example 2

Using the expected monetary value criterion, identify the best alternative for previous payoff table for
these probabilities: low= .30, moderate= .50 and high= .20

Solution:

EV small= .30(P10) + .50(P10) + .2(P10) = P10

EV medium=. 30(P7) + .50(P12) + .2(P12) = P10.50

EV large= .30(-4) + .50(P2) + .2(P16) = P3

Choose the medium facility because it has the highest expected value
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 *** END of LESSON***

REFERENCES

Textbooks

Stevenson, William J. (2018). Operations management thirteenth edition. McGraw Hill Education, 2 Penn
Plaza, New York, NY 10121.

Collier, David Alan, et.al.(2020). Operations Management and Total Quality Management. Cengage Learning
Asia Pte. Ltd.

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