Quantitative analysis and pitfalls in decision making
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The document discusses quantitative analysis and common pitfalls in decision making. It begins by defining quantitative analysis as using mathematical tools and data manipulation to derive meaningful information that can aid managerial decision making. Examples are given of companies saving millions through quantitative analysis models. The steps of the quantitative analysis approach are then outlined, from defining the problem to implementing results. Common problems that can occur during these steps and in modeling are discussed. Finally, common pitfalls in decision making are presented, such as being anchored by initial estimates or continuing with past decisions due to sunk costs.
![How To Develop a Quantitative Analysis Model
Expenses can be represented as the sum of fixed and
variable costs and variable costs are the product of
unit costs times the number of units
Profit = Revenue – (Fixed cost + Variable cost)
Profit = (Selling price per unit)(number of units
sold) – [Fixed cost + (Variable costs per
unit)(Number of units sold)]
Profit = sX – [f + vX]
Profit = sX – f – vXwhere
s = selling price per unit v = variable cost per unit
f = fixed cost X = number of units sold
The parameters of this model
are f, v, and s as these are the
inputs inherent in the model
The decision variable of
interest is X](https://image.slidesharecdn.com/q5maxzsnr96ytjmcy38j-signature-631a916b893a0fe010735980969f13cdf7f1c06f7cdd008ad062f91880c85dfb-poli-150514023930-lva1-app6892/85/Quantitative-analysis-and-pitfalls-in-decision-making-16-320.jpg)
![Pritchett’s Precious Time Pieces
Profits = sX – f – vX
The company buys, sells, and repairs old clocks.
Rebuilt springs sell for $10 per unit. Fixed cost of
equipment to build springs is $1,000. Variable cost
for spring material is $5 per unit.
s = 10 f = 1,000 v = 5
Number of spring sets sold = X
If sales = 0, profits = –$1,000
If sales = 1,000, profits = [(10)(1,000) – 1,000 – (5)(1,000)]
= $4,000](https://image.slidesharecdn.com/q5maxzsnr96ytjmcy38j-signature-631a916b893a0fe010735980969f13cdf7f1c06f7cdd008ad062f91880c85dfb-poli-150514023930-lva1-app6892/85/Quantitative-analysis-and-pitfalls-in-decision-making-17-320.jpg)
Quantitative analysis and pitfalls in decision making
- 1. Quantitative Analysis for Decision Making and Pitfalls in Decision Making Report in DEM 723 Managerial Analysis and Decision Making
- 2. Introduction • Mathematical tools have been used for thousands of years • Quantitative analysis can be applied to a wide variety of problems • It’s not enough to just know the mathematics of a technique • One must understand the specific applicability of the technique, its limitations, and its assumptions
- 3. Examples of Quantitative Analyses • Taco Bell saved over $150 million using forecasting and scheduling quantitative analysis models • NBC television increased revenues by over $200 million by using quantitative analysis to develop better sales plans • Continental Airlines saved over $40 million using quantitative analysis models to quickly recover from weather delays and other disruptions
- 4. Meaningful Information Quantitative Analysis What is Quantitative Analysis? Quantitative analysis is a scientific approach to managerial decision making whereby raw data are processed and manipulated resulting in meaningful information Raw Data
- 5. What is Quantitative Analysis? Quantitative factors might be different investment alternatives, interest rates, inventory levels, demand, or labor cost Qualitative factors such as the weather, state and federal legislation, and technology breakthroughs should also be considered – Information may be difficult to quantify but can affect the decision-making process
- 6. Implementing the Results Analyzing the Results Testing the Solution Developing a Solution Acquiring Input Data Developing a Model The Quantitative Analysis Approach Defining the Problem
- 7. Defining the Problem Need to develop a clear and concise statement that gives direction and meaning to the following steps – This may be the most important and difficult step – It is essential to go beyond symptoms and identify true causes – May be necessary to concentrate on only a few of the problems – selecting the right problems is very important – Specific and measurable objectives may have to be developed
- 8. Developing a Model Quantitative analysis models are realistic, solvable, and understandable mathematical representations of a situation There are different types of models $ Advertising $Sales Schematic models Scale models
- 9. Developing a Model • Models generally contain variables (controllable and uncontrollable) and parameters • Controllable variables are generally the decision variables and are generally unknown • Parameters are known quantities that are a part of the problem
- 10. Acquiring Input Data Input data must be accurate – GIGO rule Data may come from a variety of sources such as company reports, company documents, interviews, on-site direct measurement, or statistical sampling Garbage In Process Garbage Out
- 11. Developing a Solution • The best (optimal) solution to a problem is found by manipulating the model variables until a solution is found that is practical and can be implemented • Common techniques are – Solving equations – Trial and error – trying various approaches and picking the best result – Complete enumeration – trying all possible values – Using an algorithm – a series of repeating steps to reach a solution
- 12. Testing the Solution Both input data and the model should be tested for accuracy before analysis and implementation – New data can be collected to test the model – Results should be logical, consistent, and represent the real situation
- 13. Analyzing the Results Determine the implications of the solution – Implementing results often requires change in an organization – The impact of actions or changes needs to be studied and understood before implementation Sensitivity analysis determines how much the results of the analysis will change if the model or input data changes Sensitive models should be very thoroughly tested
- 14. Implementing the Results Implementation incorporates the solution into the company – Implementation can be very difficult – People can resist changes – Many quantitative analysis efforts have failed because a good, workable solution was not properly implemented Changes occur over time, so even successful implementations must be monitored to determine if modifications are necessary
- 15. Modeling in the Real World Quantitative analysis models are used extensively by real organizations to solve real problems – In the real world, quantitative analysis models can be complex, expensive, and difficult to sell – Following the steps in the process is an important component of success
- 16. How To Develop a Quantitative Analysis Model Expenses can be represented as the sum of fixed and variable costs and variable costs are the product of unit costs times the number of units Profit = Revenue – (Fixed cost + Variable cost) Profit = (Selling price per unit)(number of units sold) – [Fixed cost + (Variable costs per unit)(Number of units sold)] Profit = sX – [f + vX] Profit = sX – f – vXwhere s = selling price per unit v = variable cost per unit f = fixed cost X = number of units sold The parameters of this model are f, v, and s as these are the inputs inherent in the model The decision variable of interest is X
- 17. Pritchett’s Precious Time Pieces Profits = sX – f – vX The company buys, sells, and repairs old clocks. Rebuilt springs sell for $10 per unit. Fixed cost of equipment to build springs is $1,000. Variable cost for spring material is $5 per unit. s = 10 f = 1,000 v = 5 Number of spring sets sold = X If sales = 0, profits = –$1,000 If sales = 1,000, profits = [(10)(1,000) – 1,000 – (5)(1,000)] = $4,000
- 18. Pritchett’s Precious Time Pieces 0 = sX – f – vX, or 0 = (s – v)X – f Companies are often interested in their break-even point (BEP). The BEP is the number of units sold that will result in $0 profit. Solving for X, we have f = (s – v)X X = f s – v BEP = Fixed cost (Selling price per unit) – (Variable cost per unit)
- 19. Pritchett’s Precious Time Pieces 0 = sX – f – vX, or 0 = (s – v)X – f Companies are often interested in their break-even point (BEP). The BEP is the number of units sold that will result in $0 profit. Solving for X, we have f = (s – v)X X = f s – v BEP = Fixed cost (Selling price per unit) – (Variable cost per unit)
- 20. Advantages of Mathematical Modeling 1. Models can accurately represent reality 2. Models can help a decision maker formulate problems 3. Models can give us insight and information 4. Models can save time and money in decision making and problem solving 5. A model may be the only way to solve large or complex problems in a timely fashion 6. A model can be used to communicate problems and solutions to others
- 21. Models Categorized by Risk • Mathematical models that do not involve risk are called deterministic models – We know all the values used in the model with complete certainty • Mathematical models that involve risk, chance, or uncertainty are called probabilistic models – Values used in the model are estimates based on probabilities
- 22. Possible Problems in the Quantitative Analysis Approach Defining the problem – Problems are not easily identified – Conflicting viewpoints – Impact on other departments – Beginning assumptions – Solution outdated Developing a model – Fitting the textbook models – Understanding the model
- 23. Possible Problems in the Quantitative Analysis Approach Acquiring input data – Using accounting data – Validity of data Developing a solution – Hard-to-understand mathematics – Only one answer is limiting Testing the solution Analyzing the results
- 24. Implementation – Not Just the Final Step Lack of commitment and resistance to change – Management may fear the use of formal analysis processes will reduce their decision-making power – Action-oriented managers may want “quick and dirty” techniques – Management support and user involvement are important
- 25. Implementation – Not Just the Final Step Lack of commitment by quantitative analysts – An analysts should be involved with the problem and care about the solution – Analysts should work with users and take their feelings into account
- 26. © 2008 Prentice-Hall, Inc. Common Pitfalls in Decision Making The road of decision-making is filled with numerous pitfalls and traps. These pitfalls are hard to discern since they are part of our normal decision making process. They include misconceptions in the decisions we make, a bias in favor of one option, falling prey to the status quo, and continuance with sunk decisions. The more complex the decision, the more likely you'll run into these pitfalls.
- 27. © 2008 Prentice-Hall, Inc. Common Pitfalls in Decision Making There’s a reason for the saying, “It’s lonely at the top.” Contrary to popular belief, the hallmark of effective leadership doesn’t solely rely on the decisions a leader makes but rather how he or she sets the conditions for followers to live and learn, read and react, and decide for themselves as information becomes available. Without the right information, decision-making, and therefore, progress, doesn’t happen. This is why it’s so important for leaders to set the “organizational guardrails” that foster a single, uniformed direction.
- 28. © 2008 Prentice-Hall, Inc. Common Pitfalls in Decision Making 1. Anchors prejudice your decision by introducing an estimate or idea before you have time to analyze the decision. For example, suppose you and I need to negotiate billing rates for my services. If you reviewed my web site, you clearly saw what my billing rates were. This information will force or anchor you to seek rates that are close to what you already know. Anchors influence your decision by leaving an impression. Remedy: They are hard to avoid. You can reduce the influence of anchors by not exposing yourself to information that influences your decision until you've had time to think on your own.
- 29. © 2008 Prentice-Hall, Inc. Common Pitfalls in Decision Making 2. Sunk decisions are another common pitfall. Here you are trapped into a past decision because you don't want to admit that you were wrong. So you continue to throw more resources into the bad decision. Technology type projects often lend themselves to sunk cost decision making Remedy: To avoid sunk decisions, seek out advice from people who are not involved in the project and recognize that failure is a normal part of decision making.
- 30. © 2008 Prentice-Hall, Inc. Common Pitfalls in Decision Making 3. Status quo where you make decisions that tend to not rock the boat. This bias approach to decision making is common in organizations where change is hard to accept. Additionally, if you break away from the status quo, you open yourself up to more responsibility and criticism. Remedy: Remember that status quo is not your only alternative and status quo rarely remains the same over time. Ask yourself if the status quo weren't around would you still make the same decision in favor of the status quo?
- 31. © 2008 Prentice-Hall, Inc. Common Pitfalls in Decision Making 4. Lack of clear guidance. If leaders don’t set parameters early on, the propensity for uncertainty to develop only worsens. More so, the one-off conversations and random interruptions prevent any real work from getting done because people are unsure of their decision-making authority. Remedy: Consider the opposite perspective. The advantage to such looming uncertainty is that it affords the very opportunity to create certainty by setting the direction. The mindset that it’s better to beg for forgiveness than to ask for permission. If you’re taking incoming mortar rounds, there is no wrong answer for what direction to move in, just so long as you move.
- 32. © 2008 Prentice-Hall, Inc. Common Pitfalls in Decision Making 5. Unclear purpose. Not understanding the why behind a decision is akin to driving without a map. You want to know where you’re going so you can determine the best route to get there. Otherwise, you’re just wasting gas. Remedy: Identify who or what a decision is for. Is it something that benefits the organization, the team or the individual? Will the decision impact a greater audience or just you? If it’s the latter, be sure to remove as much emotion as possible from your decision by looking at the positive outcomes it will yield (you can always find something positive).
- 33. © 2008 Prentice-Hall, Inc. Common Pitfalls in Decision Making 6. Define the meeting .One way to make sure you don’t walk away from the next meeting with your eyes crossed is to know the type of meeting that will take place. Informative: These are meetings where updates, status reports and lessons learned are shared to build the “knowledge bridge” to the next milestone and to close the gap between silos and business functions. Remember, knowledge is not power, but sharing it is. Collaborative: Once the proverbial ship has sailed (an initiative is underway), it’s time to figure out the best route to get there, and this happens through group participation. Collaborative meetings help flush out what decisions need to be made in an effort to collectively solve a business challenge. Decisive: The ship's captain reels in all the swimmers from the water and says, “Don’t swim. Fix the boat instead.” In other words, decision-making meetings offer feedback to ensure your efforts are aligned with organizational priorities and ready to navigate into uncharted territory.
- 34. © 2008 Prentice-Hall, Inc. Common Pitfalls in Decision Making 7. Lack of autonomy. While decisions should be based upon their collective benefit for all (at least, in an organizational setting), how you go about making that decision should be your own. In other words, relying on other peoples’ input as a basis for your own decision-making is dependent, whereas gathering input to broaden your knowledge base so you can make your own choice is independent. The copy-and-paste approach works short term until that co-worker leaves, along with your ability to solve problems. Remedy: For the next week, record how many times you conferred with somebody over a decision and why. Were you looking for an alternative perspective to help broaden yours so you could make a more informed decision? Or were you secretly hoping for that person to make the decision for you?
- 35. © 2008 Prentice-Hall, Inc. Common Pitfalls in Decision Making 8. Wrong people, wrong place. Integral to decision-making is having the power (defined as credibility and knowledge) to grab the gavel and say, “This decision makes sense. Let's do it.” Many meetings go through an iteractive process simply because the wrong people are in the room. Remedy: If you require strategic decisions then you need strategic leaders. The stated outcome of a meeting determines who should be present so the meeting’s objective can be achieved.
- 36. © 2008 Prentice-Hall, Inc. The more a leader can set the conditions for his or her people to make decisions the more time he or she can dedicate to strategy and business growth. Try to be aware of these pitfalls in making decisions. And remember, the more assumptions you make in your decisions, the more likely you'll be confronted with these pitfalls.
- 37. © 2008 Prentice-Hall, Inc. Final Thought “People at operations are in the best position to decide on the most effective and efficient use of resources to obtain the best value for money.”