Chapter 3

Foundation Of
Decision
Analysis
GREGORY S. PARNELL and STEVEN
N. TANI
3 4

1 2

Review By: Anantya Khrisna Seta

 Foundation Of Decision Analysis Content
01 Introduction & History

02 Five Rule : Theoretical Foundation Of Decision Analysis

03 Scope Of Decision Analysis

04 Taxonomy Of Decision Analysis Practice

05 Valued- Focused Thinking

 Introduction & History

Decision analysis is a branch of operations research and management science (OR/MS)

that aids decision-makers in dealing with complicated choices, major uncertainties,
various stakeholders, and significant (potentially contradictory) implications.
Introduction & History
3
1980s – 1990s
Decision analysis has
expanded to include new
2 areas, including
environmental
1960s – 1970s management, healthcare,
and public policy.
Decision analysis has
1 become increasingly
popular in businesses,
governments, and
1940s – 1950s militaries.
Frank Ramsey, Leonard Savage,
and Howard Raiffa developed
new theories and methods to
help individuals and
organizations make better
decisions.
 Five Rule : Theoretical Foundation Of Decision
Analysis
Decision analysis is based on the four axioms of
rational behavior established by John von Neumann
and Oskar Morgenstern in the 1940s.
The Probability Rule The Order Rule

Leonard J. Savage and Ronald A. Howard have

formulated alternative sets of axioms that lead to
decision making based on expected utility. decision The Equivalence
theory starts with five rules of behavior. Rule

The Substitution
The Choice Rule
Rule
 Five Rule : Theoretical Foundation Of Decision
Analysis
1. The Probability Rule: This rule states that when making a decision, decision-makers must consider the probabilities of
various outcomes. Each possible outcome must be assigned a probability, and the expected value of each option must
be calculated using these probabilities. The option with the greatest expected value should be selected.
2. The Order Rule: According to this rule, the order in which options are evaluated can influence the decision outcome. As
a result, decision-makers must evaluate all options consistently and objectively, avoiding being swayed by irrelevant
factors such as the order in which options are presented.
3. The Equivalence Rule : This rule states that different options that produce the same result should be treated as
equivalent, even if they differ in other ways. Decision-makers must prioritize the outcome of each option over other
considerations such as cost or effort required to achieve the outcome.
4. The Substitution Rule : This rule states that options with equivalent outcomes can be substituted for one another.
Decision-makers can switch from one option to another as long as the outcome remains the same. This enables
decision-makers to compare options that are not directly comparable and choose the best one for their needs.
5. The Choice Rule : according to this rule, The best option is the one that maximizes the decision-utility, maker's or
satisfaction. When making a decision, decision-makers must consider their personal preferences and values and select
the option that provides the greatest overall utility. This rule reflects the notion that decision-making is ultimately
subjective, with no single "correct" decision for all individuals or situations.
Scope Of Decision Analysis
Taxonomy Of Decision Analysis Practice
 Taxonomy Of Decision Analysis Practice

TAXONOMY DIVISION: SINGLE OR MULTIPLE OBJECTIVES

Decisions with a single goal or objective have one
clear goal or objective, and the decision maker's
goal is to maximize or minimize a single outcome.
For instance, selecting the investment option with
the highest expected return on investment.

Multiple-objective decisions involve multiple

competing objectives that cannot all be met at the
same time. Choosing a location for a new factory
that minimizes costs, maximizes customer access,
and minimizes environmental impact, for example.
In this case, the decision maker must make trade-
offs in order to find a solution that balances these
goals.
 Taxonomy Of Decision Analysis Practice

TAXONOMY DIVISION: ADDRESSING VALUE TRADEOFFS

AND RISK PREFERENCE SEPARATELY OR TOGETHER?
A multidimensional value function is a mathematical
representation of a decision maker's preferences across
multiple dimensions or criteria. A multidimensional
utility function is similar to a value function but takes
into account the decision maker's level of satisfaction
or happiness with the outcome.

Both are important tools in decision analysis, allowing

decision makers to systematically evaluate and
compare options across multiple criteria and
dimensions, taking into account their subjective
preferences and satisfaction with the outcomes.
 Taxonomy Of Decision Analysis Practice
TAXONOMY DIVISION: NONMONETARY OR MONETARY VALUE
METRIC?
Metrics that may be stated in terms of a particular currency or
financial unit, such as dollars, euros, or yen, are referred to as
monetary value metrics. When making decisions that have
financial costs or advantages, such as investment decisions or
pricing decisions, these measures are frequently employed.
Examples of financial value measurements are cost-benefit
ratio, return on investment, and net present value.
Non-monetary value metrics, on the other hand, are those that
are difficult to express in monetary terms. These metrics are
frequently used when making decisions involving non-financial
factors such as social or environmental consequences.
Environmental impact, social responsibility, and employee
satisfaction are examples of non-monetary value metrics.
 Value Focused Thinking

Value-focused thinking ( VFT ) is a decision-making strategy that focuses on creating

or optimizing value. Identifying the values that are important to the decision-maker,
generating options, evaluating each option based on its impact on these values, and
selecting the option that best satisfies the values are all part of this approach. The
goal is to make informed and effective decisions that prioritize and balance multiple
objectives or goals that are in conflict.
 FOUR MAJOR VFT IDEAS
1. Start With Values : The first major idea of VFT is that we should begin by identifying the
values that are important to us. Values are the things that we care about and strive for. We
can make decisions that are aligned with what is important to us if we begin with our
values.
2. Generate Better Alternatives : Values can be used to generate better alternatives, which
is the second major idea of VFT. By focusing on our values, we can generate new and
innovative solutions that are more likely to succeed. This keeps us from falling into the
trap of only considering the same old options we've always used.
3. Create Decision Opportunities: The third major concept of VFT is that we can create
decision opportunities by breaking down our decisions into smaller, more manageable
parts. This allows us to identify the specific decisions that must be made and focus on
them one at a time. This keeps us from becoming overwhelmed by the complexities of our
decisions.
4. Use values to evaluate alternatives: The fourth major idea of VFT is that we should
evaluate alternatives using our values. This allows us to identify the option that is most
likely to achieve our goals and is in line with our values. We can make more informed and
effective decisions if we use our values as a guide.
Benefit Of Value-Focused Thinking
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