Module 3: Risk and Reward - Organizational Decision-Making PDF

RMI 2302 Module 3:Risk and Reward - Organizational Decision- Making 1  Recognize why it is important to Module 3: Risk understand how organizations make decisions. and Reward -...

RMI 2302 Module 3:Risk and Reward - Organizational Decision- Making 1  Recognize why it is important to Module 3: Risk understand how organizations make decisions. and Reward - Recall the single-stage decision-making Organizational process including: The steps of the decision-making process Decision Making How profit matrices/payoff tables are used Learning Types of decision criteria Identify why expected value is the most Objectives common decision criteria used by organizations. 2  Theory that provides a formal analytic framework for decision- What is making under conditions of uncertainty. Decision Used to determine optimal strategies where a decision-maker Theory? is faced with several alternatives and an uncertain, or risky, pattern of future events. 3  1.Determine all the possible future outcomes (states of the world). Steps of 2.Determine all of the future choices (decisions) the organization can Decision- make. 3.Combine the outcomes and Making choices into a matrix (payoff table). Process 4.Select the choice from the menu determined in Step 2 that fulfills some decision criteria. 4  1. Identify courses of action in the One-Stage face of possible events. Decision- 2. Develop pay-off regret table. This represents the matrix of the Making conditional values associated Problems with all the possible combinations of the acts and the (Let’s keep it events. simple) 3. Choose a course of action in accordance with some principle. 5  LaPrade Manufacturing has to decide how many shirts to Decision- manufacture. Making Profit per shirt is $30. Loss per unsold shirt is $10. Example The annual demand for shirts is between 240 and 312 copies. 6  Possible Events (D = Demand. We have no control over this.) Step #1: D0 = 240 shirts D2 = 288 shirts Determine All demanded demanded Possible D1 = 262 shirts D3 = 312 shirts Future demanded demanded Outcomes 7  Possible Courses of Action (Q= Supply. What we provide.) Step #2: Q0 = make 240 shirts Q2 = make 264 shirts Determine All Q1 = make 288 shirts Q3 = make 312 shirts Future Choices 8  Possible Choices (Quantity Supplied) S0=240 S1=264 S2=288 S3=312 Step 3: Create Possible D0=240 7200 6960 6720 6480 Outcomes (Quantity D1=264 7200 7920 7680 7440 a Pay-off Table Demanded) D2=288 D3=312 7200 7200 7920 7920 8640 8640 8400 9360 (Combining Example of Calculations: Outcomes and Total Profit = 240 shirts made X $30 profit per shirt = $7,200 Choices) Total Profit = (240 shirts made X $30 profit per shirt) – (24 unsold shirts X $10 loss per unsold shirt) = $7,200 - $240 = $6,960 9  There are other decision criteria but Step #4: Select we will focus on: Maximax Criterion the Choice Maximin Criterion LaPlace Criterion 10  Optimistic Criterion – Look at the maximum payoff for each choice and pick the highest one. Possible Choices (Quantity Supplied) S0=240 S1=264 S2=288 S3=312 Maximax Possible Outcomes D0=240 7200 6960 6720 6480 Criterion (Quantity D1=264 7200 7920 7680 7440 Demanded) D2=288 7200 7920 8640 8400 D3=312 7200 7920 8640 9360 In this case, the company would make 312 shirts. If the team wins all games, the company makes $9,360. 11  Pessimistic Criterion – Look at the minimum payoff for each choice and pick the highest one. Possible Choices (Quantity Supplied) S0=240 S1=264 S2=288 S3=312 Maximin Possible Outcomes D0=240 7200 6960 6720 6480 Criterion (Quantity D1=264 7200 7920 7680 7440 Demanded) D2=288 7200 7920 8640 8400 D3=312 7200 7920 8640 9360 In this case, the company would make 240 shirts. Regardless of how many games the team wins, the company makes $7,200. 12  Since don’t know probabilities, take the average of outcomes and pick the highest one. Possible Choices (Quantity Supplied) S0=240 S1=264 S2=288 S3=312 Laplace Possible Outcomes D0=240 D1=264 7200 7200 6960 7920 6720 7680 6480 7440 Criterion (Quantity Demanded) D2=288 D3=312 7200 7200 7920 7920 8640 8640 8400 9360 Average 7200 7680 7920 7920 Though two quantity options have the same average, the company would make 288 shirts as this option has lower volatility (safer choice). 13  What if we know a little more? We Step #4: Select know (or can estimate) the probabilities of each outcome the Choice occurring? Different choices: Revisited Maximum Likelihood Expected Value 14  What changes if we know something about the probability of each outcome? Possible Choices Prob. (Quantity Supplied) S0=240 S1=264 S2=288 S3=312 Possible D0=240.25 7200 6960 6720 6480 Maximum Outcomes (Quantity D1=264 Demanded).20 7200 7920 7680 7440 Likelihood D2=288.40 7200 7920 8640 8400 D3=312.15 7200 7920 8640 9360 Find the outcome that has the highest probability of occurring, pick the quantity that maximizes the profit with that outcome. 15  What changes if we know something about the probability of each outcome? Possible Choices Prob. (Quantity Supplied) S0=240 S1=264 S2=288 S3=312 Possible D0=240.25 7200 6960 6720 6480 Expected Outcomes (Quantity D1=264 Demanded).20 7200 7920 7680 7440 Value D2=288.40 7200 7920 8640 8400 D3=312.15 7200 7920 8640 9360 EV 7200 7680 7968 7872 Calculate EV for each supply option and select the one with the highest EV where EV is equal to the sum over all of the possible outcomes, of the probability of each outcome occurring times the outcome. 16