Chapter 1: Foundations of Decision Making

Introduction

The ability of businesses to achieve their goals, to sustain their existence and to compete with rivals depends on their ability to make consistent and correct decisions. To this end, it is effective to know the current conditions, to obtain information about the factors that may affect the decision, to access data, the situation of the possible alternatives, the separation of sufficient time to the decision-making process, the capabilities, leadership characteristics and experiences of the managers or decision makers. On the other hand, the use of mathematical and statistical techniques also helps to make the right decision.

The Concept of Decision Making

The concept of decision making is to choose the most appropriate one among the available alternatives, in other words to make the best choice. A good decision is a decision based on logic, which takes into account all possible alternatives, and examines all available information about the future.

However managers often have to make decisions before they can be sure which events will occur in the future. Therefore, because of the uncertainty of future events, a good decision may result in an undesirable outcome. Otherwise, a decision not based on logic, not considering all alternatives and not examining all available information is a bad decision.

Some decisions are easy to make while some are more difficult. There might be many reasons. Some of these reasons are information, uncertanity, scarce sources, phychological factors, number of alternatives, cost of making errors.

• Information: If there is not enough information in making a decision, it becomes difficult to decide.
• Uncertanity: If there is uncertainty situations in making a decision, it becomes difficult to decide.
• Scaerce Sources: If there is scarce source about the decision problem, it becomes difficult to decide.
• Number of Alternatives: As the number of alternatives increases, it is difficult to decide which the best option is.
• The Cost of Alternatives: As the cost of making errors increases, you may have to think more about choosing the best alternative.

Common Chracteristics of Decision Making

There are some common characteristics of decision making. These are “decision maker”, “objective”, “alternatives (strategies/actions)”, “events (states of nature)”, “outcomes (pay-off)” and “payoff table/pay off matrices” .

Decision Maker (DM): the person who chooses the appropriate alternatives and is responsible for the results of this choice.

Objective: Decision making problems have two objectives: maximization and minimization. E.g. selecting the alternative that makes the maximum profit or the number of customers; selecting the alternatives that makes the minimum cost or transportation time.

Alternatives/Strategies/Actions: these are the alternatives that the decision maker will choose from.

Events/States of Nature: that are likely to occur in the future but are unpredictable. Events are environmental factors that influence the choice of the decision maker. However, they are uncontrollable.

Outcomes/Pay-Offs: These are the values of alternatives and events. Outcomes are usually numeric values.

Pay-off Table / Pay-off Matrix: The outcomes of all alternatives and events are indicated by a matrix called “pay-off matrix”. When m indicate alternatives and n indicate events, m x n size matrix is obtained.

S ₁ , S ₂ , S ₃ , ... , S _m denote the alternatives and N ₁ , N ₂ , N ₃ , ... , N _n denote the events in the pay-off matrix in Figure 1.4. Combinations of each strategy and event are indicated by O _ij notation. When alternative i is taken and event j occurs, the outcomes of this situation is indicated by O _ij , i=1, 2, ..., m and j = 1, 2, ..., n . The pay-off table should be drawn in order to solve the decision problems with different decision making methods.

Decision Making Process

The steps of the decision making process are as follows :

• Define decision problem
• Establish objectives
• List all the possible decision alternatives
• Identify the possible outcomes for each decision alternative
• Identify the pay-off matrix for each combination of alternatives and events
• Select the most appropriate decision making method and apply this method
• Determine the best alternative and make your decision

1. Step: Define decision problem: Defining a decision problem includes a good understanding of management assumptions, organizational boundaries and the desired conditions for the problem. In order to identify the problem, all information about it should be collected, factors and causes associated with the problem should be determined.
2. Step: Establish objectives: It is necessary to develop specific and measurable objectives for the problem. For example, a problem is defined as inadequate health care delivery in a hospital. We need a numerical and concrete objective to analyze and solve this problem. Therefore, the objective of this problem may be to increase the number of hospital beds or to reduce the average number of days of stay in hospital.
3. Step: List all possible decision alternatives: It is important that the decision maker adds all possible alternatives to the list. If an important decision alternative is forgotten to be added to the list, wrong decisions can be made.
4. Step: Identify the possible outcomes for each decision alternative: Some of decision makers are optimistic and some are pessimistic. Optimistic ones may tend to ignore the outcomes that they think will not happen. However, what needs to be done here is to make a logical decision considering all the possibilities.
5. Step: Identify the pay-off matrix for each combination of alternatives and events: When a specific alternative is selected, it is possible to know which outcome to be taken for each event. This will make it easier for the decision maker to make a correct choice.
6. Step: Select the most appropriate decision making method and apply this method: The selection of appropriate method and tool depends on the nature of the decision problem and the preference of decision-makers. The decision maker’s expertise and experience will help choosing the appropriate method.
7. Step: Determine the best alternative and make your decision: In this last step, according to the outcomes of the events, the most appropriate alternative is selected. It is considered as the decision that gives the best solution according to the determined objective. Then, the decisionmaking process ends.

Summarizing the decision making process; we can say that the decision is to choose from various alternatives. The decision makers pass through all the stages mentioned above in the decision-making process. A systematic approach to decision making may help ensure that all aspects of decision making are taken into account correctly.

Types of Decision Making

Decision environments vary according to the level of knowledge of the decision maker. There are three different decision-making environments according to the level of knowledge or information of the decision-maker regarding events or states of nature.

a. Decision Making Under Certainty
b. Decision Making Under Risk
c. Decision Making Under Uncertainty

Decision Making Under Certainty

In decision making under certainty , the decision maker knows outcomes of events for each decision alternative. In this case, because the decision maker knows everything about the problem, it is easier to make the best decision. The decision matrix includes the outcomes of only one event according to different alternatives. If the decision making objective is maximized, decision maker selects the alternative with the maximum value from all alternatives. If the decision making objective is minimized, decision maker selects the alternative with the minimum value from all alternatives.

Decision Making Under Uncertainty

When the decision maker has no information about the probabilities of occurrence and outcomes of the events, the decision making environment is called “ decision making under uncertainty ”.

Decision Making Under Risk

Decision makers have information about the probability of occurrence of each events. The probability value can be known precisely or predicted. These possibilities can be obtained from the personal opinions of the decision maker, from the statistical records held in the enterprise, from expert opinions, from market research.