da the master discipline informs 05-01-06 v4
TRANSCRIPT
Suite 202855 Oak Grove AvenueMenlo Park, CA 94025Phone (650) 470-0188www.smartorg.com
SMARTORG SM Value-Based Management Systems
Decision AnalysisThe Master Discipline
INFORMS Conference on O.R. PracticeMiami, May 1, 2006
INFORMS 05-01-06 2 © 2000-2006
Decision Analysis is the Discipline concerned with decision-making — both solving problems and maintaining decision health.
• Philosophy– What are decisions and why should we make them?– How do we deal with an uncertain world?– What is a good decision?– What organizational culture promotes good decisions?
• Processes & Practices– What are the steps to reach a good decision?– What are the steps to capturing uncertainty well?– What are the design principles for organizations and their
processes?
• Tools– Decision Theory– Influence Diagrams– Computer Applications
INFORMS 05-01-06 3 © 2000-2006
Decision Analysis = Decision Engineering
• Would you design a bridge by guessing the size of various structural members?
• Would you build a chemical plant by asking an “expert” to guess the size of various process elements?
• Would you like the pilot of your aircraft to fly through fog without instruments?
• They why do people expect executives to use “gut feel” to make decisions?
• Decisions need to be engineered just like bridges and chemical plants
– There are sound engineering procedures for arriving at good decisions
– They need to involve the right people and to guide and motivate excellent implementation
– This discipline is called Decision Analysis
INFORMS 05-01-06 4 © 2000-2006
Decision Analysis is for developing clarity of actionwhen you don’t “know” what to do.
• If you have long experience that you are sure is applicable, make the decision and get on with it! – But remember people like Gladwell (2005) in “Blink” have
demonstrated many cases where intuition goes wrong.– Beware – Often people apply inappropriate operational habits to
strategic situations.
• If you have “inner knowing” of what to do – then do it!
• But when you don’t “know”, or when you want to reassure yourself that your experience is correct, or if you want to delegate to others or to explain to your superiors (who may not “know” or accept your “knowing), then decision analysis is appropriate.– I once had a very interesting lunch with a minister who was frustrated
that people wanted god to balance their checkbooks!
INFORMS 05-01-06 5 © 2000-2006
Many organizations and academics confuse operational strength with strategic intelligence.
In 1982 Peters and Waterman, writing In Search of Excellence, missed the mark on strategy by confusing operational and strategic excellence.
INFORMS 05-01-06 6 © 2000-2006
The skills required for effective operational management are counterproductive in strategic management.
• Focuses on the important issues
• Considers long time horizons
• Treats uncertainty strategically
• Chooses among significantly different alternatives
• Attends to detail and follow-through
• Concerns itself withnear-term performance
• Treats uncertainty statistically
• Avoids new alternatives— “Just do it!”
Strategic Management Operational Management
INFORMS 05-01-06 7 © 2000-2006
We boiled down key areas of the decision analysis into nine principles for designing a Smart Organization.
SmartOrganiza-
tion
Achieve Purpose
Mobili
ze R
esou
rces
Understand Environment
Continual Learning
ValueCreationCulture
CreatingAlternatives
SystemsThinking
Alignment &Empowerment
EmbracingUncertainty
DisciplinedDecision Making
Outside-InStrategic
Perspective
OpenInformation
Flow
David and Jim Matheson, The Smart Organization: Creating Value Through Strategic R&D, Harvard Business School Press, 1998.
INFORMS 05-01-06 8 © 2000-2006
The keystone is a Value Creation Culture – it is the driver of Value-Based Management.
INFORMS 05-01-06 9 © 2000-2006
We can test to see if the principles are operational.
It’s Smart. . . It’s Not Smart. . .
to aim always at value creation
to divert attention to other goals
to know what you do not know and to know what you cannot influence
to pretend you know or try to control outcomes you cannot influence
to take charge of your own destiny
to allow your competitors or fate to determine your future
to coordinate everyone effectively
to micromanage, or not manage at all
to know where you stand to believe provincial illusions
to aggressively inform and be informed
to build power by withholding information
to know the full implications of actions and events
to be myopic
to create valuable options to do the first thing you think of
Principle
1. Value Creation Culture
4. Embracing Uncertainty
7. Disciplined Decision-Making
9. Alignment and Empowerment
5. Outside-In Perspective
8. Open Information Flow
6. Systems Thinking
2. Creating Alternatives
3. Continual Learning
to anticipate and benefit from change
to get stuck where you are
Operational Testfor Principle
Value creation is a compelling argument for change
Uncertainty is understood, communicated, and managed
People have rapid, unrestrict-ed access to information
Systematic decision processes are used routinely
Meaningful information is available from the outside
A common understanding of strategies for value creation coordinates the organization
People understand complex cause-and-effect relationships
Multiple alternatives are created and evaluated
Improvements are continually identified and acted upon
INFORMS 05-01-06 10 © 2000-2006
Analysis of over 500 IQ tests revealed that smarter companies perform better – the discipline is worth it!
0%5%
10%15%20%25%30%35%40%45%50%
<90 90 - 110 >110
Freq
uenc
y of
the
top
quar
tile
perf
orm
ance
Company IQLow Medium High
INFORMS 05-01-06 11 © 2000-2006
Strategic Decisions need to be declared and bounded
• People and organizations can go through life on their momentum– Often their decisions are just “reactions” to the impacts of others– They often blame others for their misfortunes
• Today’s American auto companies are a great example– They blame high oil prices for lack of sales of profitable SUVs.– They blame overcapacity for many high costs, pensions, etc. – They blame Toyota for tying up suppliers for hybrid components– They should blame themselves for acting so dumb!
• We need to put a boundary around a piece of reality that we are focusing our decision attention upon.– Assessments of alternatives, uncertainties, and values penetrate this
boundary– The boundary needs to be tested and revised (reframed)– If a problem is technically difficult, modifying the boundary often
simplifies it.
INFORMS 05-01-06 12 © 2000-2006
A poster for
Teens
from the
Decision Education Foundation
INFORMS 05-01-06 13 © 2000-2006
A high-quality decision produces personal and organizational commitment to the best prospects for creating value.
AppropriateFrame
Creative,Doable
Alternatives
Meaningful,Reliable
InformationClear Values and Trade- offs
Logically CorrectReasoning
Commitmentto
Action
Elements ofDecisionQuality
These links also specify good design principles for each decision.
INFORMS 05-01-06 14 © 2000-2006
Measurement of decision quality can be used to guide a decision process.
DecisionQuality
1Appropriate
Frame
2Creative,Doable
Alternatives
3Meaningful, Reliable
Information
4Clear Values
andTradeoffs
5LogicallyCorrect
Reasoning
6Commitment
to Action
0% 100%
One hundred percent is the point at which additional improvement efforts would not be worth their cost.
Initial and Final Steering
CommitteeAssessments
INFORMS 05-01-06 15 © 2000-2006
The decision process needs to be designed to the needs of the organization and the decision being make.
INFORMS 05-01-06 16 © 2000-2006
Process design must address both organizational and analytical complexities. Narrow analysts often overlook organizational side.
High
Low
Low HighAnalytical Complexity
Organizational Complexity
• Uncertainty• Dynamics• Many interrelated factors• Many alternatives• Multiple interrelated decision criteria
DecideNow
TechnicalDecisionAnalysis
• Many parties in conflict
• Individual and organizational differences:
- Values, desires, and motivation
- Initial convictions- Frames of reference- Personalities and
competencies- Power and resources
• Group dynamics
FacilitativeLeadership
DialogDecisionProcess
INFORMS 05-01-06 17 © 2000-2006
For large organizational decision problems the Dialogue Decision Process (DDP) has been effective. It is carried out in weeks or months.
Dec
isio
n Te
amSt
rate
gy T
eam
Wor
king
Gro
up
• Alternatives• Improved
Information• Values
PlanEvaluatedAlternatives
• Frame• Challenges• Understanding
1. Assess Business Situation
2. DevelopAlternatives, Information, and Values
3. Evaluate Risk and Return of Alternatives
5. Plan for Action
6. ImplementDecisionand Manage Transition
0. DesignProcess
4. DecideAmong Alternatives
In other environments, simplified and software enabled processes provide better solutions.A good process is engineered to achieve decision quality in its organizational setting
INFORMS 05-01-06 18 © 2000-2006
For repetitive decision classes, such as product development, value-based management systems provide process guidance through web-based delivery. It is carried out in hours or days.
The definition part of the process sets up the project and its evaluation.
Next, the team needs to provide the information on the project.
This information drives a cash flow and uncertainty analysis of the opportunity.
The results are sent to the portfolio and incorporated into a PowerPoint deck for presentation.
Project Guidelines—a message from the portfolio team to all the projects—orients team members to your objectives and supports consistency across projects.
Web-based productivity tools: coach on call is an email help function, files keeps a library of documents for the project.
INFORMS 05-01-06 19 © 2000-2006
Strategy Table
The analytical side of decision analysis furnishes a powerful common set of tools.
DecisionStructure Deterministic
AnalysisProbabilistic
Analysis AppraisalInitialSituation
Iteration
InfluenceDiagram
12345
DeterministicModelA B C
DeterministicSensitivity
DecisionTree
ProbabilityDistributions
Value ofInformation
Decision Spiders
INFORMS 05-01-06 20 © 2000-2006
A Decision Hierarchy clearly shows what is being decided now.
Example: Manufacturing Plant Modernization
• Continue manufacturing
Policy Decisions
Take asgiven
• Plant configuration and location
• Technological stretch• Product range• Quality and cost position• Marketing strategy
Strategic Decisions Focus on in
this analysis
• Product design• Manufacturing operations• Marketing plans
Tactical Decisions
Decide Later
Example: Manufacturing Plant Modernization
• Continue manufacturing
Policy Decisions
Take asgiven• Continue
manufacturing
Policy Decisions
Take asgiven
• Plant configuration and location
• Technological stretch• Product range• Quality and cost position• Marketing strategy
Strategic Decisions Focus on in
this analysis
• Product design• Manufacturing operations• Marketing plans
Tactical Decisions
Decide Later
• Product design• Manufacturing operations• Marketing plans
Tactical Decisions
Decide Later
INFORMS 05-01-06 21 © 2000-2006
The Decision Hierarchy Determines Decision Columns in a Strategy Table
Decision Hierarchy
Tactics
Policies
Strategic Decisions
• Plant• Technology• Products• Quality• Marketing
Strategic Decisions (one column for each)
Strategy Table
Plant
Option 1
Option 2
Option 3
• • •
Technology
Option 1
Option 2
Option 3
• • •
Products
• • •
Quality
• • •
Marketing
• • •
Listing the options helps illustrate the scope chosen for decision-making; options will be combined later into strategic alternatives.
Decision Hierarchy
Tactics
Policies
Strategic Decisions
• Plant• Technology• Products• Quality• Marketing
Strategic Decisions (one column for each)
Strategy Table
Plant
Option 1
Option 2
Option 3
• • •
Technology
Option 1
Option 2
Option 3
• • •
Products
• • •
Quality
• • •
Marketing
• • •
Listing the options helps illustrate the scope chosen for decision-making; options will be combined later into strategic alternatives.
INFORMS 05-01-06 22 © 2000-2006
A Strategy Table reduces and many strategy possibilities into a few for evaluation.
Current
Close #1;build domesticgreenfield
Close #1;build foreigngreenfield
State of art
Proven
Current
Full line
One basicline andspecialties
Value-addedspecialtiesonly
Quality and cost leadership
Improved quality;deferredcostreduction
Minimalqualityimprovements
Sellquality and influence market growth
Sellquality
Current
PlantConfigurationand Location
TechnologicalStretch
ProductRange
Quality and CostPosition
MarketingStrategy
Aggressive Modernization
ModerateModernization
Consolidation
Run Out
StrategyAlternatives
Close #1
Current
Close #1;build domesticgreenfield
Close #1;build foreigngreenfield
State of art
Proven
Current
Full line
One basicline andspecialties
Value-addedspecialtiesonly
Quality and cost leadership
Improved quality;deferredcostreduction
Minimalqualityimprovements
Sellquality and influence market growth
Sellquality
Current
PlantConfigurationand Location
TechnologicalStretch
ProductRange
Quality and CostPosition
MarketingStrategy
Aggressive Modernization
ModerateModernization
Consolidation
Run Out
StrategyAlternatives
Close #1
INFORMS 05-01-06 23 © 2000-2006
Influence diagrams identify important variables and relationships in a decision problem.
VariableCosts
FixedCosts
Profit
Revenue Costs
MarketShare
Market Size
MarketPrice
ResultDecisionUncertaintyRelationship
Key
Product Features
INFORMS 05-01-06 24 © 2000-2006
Influence diagrams are useful at several points in the decision process.
Market Share
Market Size
Sales
• Structuring how information will be assessed
A B C12345
• Specifying relationships for the spreadsheet evaluation model
Project Team
– Uncertainties
– Information needs
• Identifying key factors that need to be considered
– Sources of value
– Decisions
An effective influence diagram saves time by ensuring that the evaluation “begins with the end in mind.”
INFORMS 05-01-06 25 © 2000-2006
Influence diagrams also identify information sources and show how this knowledge will be integrated.
Profits
Revenue Costs
Competitors
Price Sales Volume
CapitalInvestment
Labor Cost
DistributionCost
ProductionCost
Raw Materials
Costs
ManufacturingAutomation
ProcurementHuman Resources
SalesManufacturingMarketing
Project PlanningFinance
INFORMS 05-01-06 26 © 2000-2006
Case Study — HDTV
Determining the Best Strategy in an Uncertain World
INFORMS 05-01-06 27 © 2000-2006
TV product strategy was complicated by many uncertainties and involved internal and outside actors.
• A high-definition picture needs a big screen—but large CRTs are inherently too expensive for most consumers.– What display technologies should we pursue to enable mass
penetration?
• We are promising a revolutionary jump in picture quality—but we don’t know what consumers perceive as picture quality, or what they are willing to pay for it.
• What will happen to U.S. standards, and how will that affect Europe?
• The Japanese are already announcing HDTV broadcasts. How long will the EC support us in the face of strong pressure from Japan Inc.
To make any HDTV initiative work, broadcasters, equipment makers, and software creators must all make enormous coordinated investments—and the consumers must buy. Will they?
INFORMS 05-01-06 28 © 2000-2006
An influence diagram depicted a complex situation in a manageable from.
INFORMS 05-01-06 29 © 2000-2006
A Strategy Table assembled the major decisions components into a set of internally consistent strategies.
StrategyTheme Platform
IntroductionsFeature
Introductions
Feature Development
Capability
Display Development
Alliances and Cooperation
Key Decisions
Aggressive Analog
Evolutionary Improvement
Info Age
VCR—The Shortest Road
Conventional Plus
•••
Improved conventional (1995); HD
analog (2001)
HD analog (1995)
Improved conventional
(1993); HD digital (2003)
HD digital (1998)
Reserve all for HDTV introduction
Sequential annual introduction in conventional standard 16:9
aspect ratio (1992); CD audio (1993);
Comb filter (1994); 100Hz progressive
scan (1995)
Sequential annual introduction
conventional TV; CD audio (1992);
Comb filter (1993); 100Hz progressive scan (1994); 16:9
aspect ratio (1995)
Lead (develop IC
design capability)
Follow (purchase ICs)
Negotiate for exclusive IC rights with supplier
Co-develop key ICs with
competitor
Focus on large CRT
Emphasize projection LCD
Switch resources to digital mirror
device projection
Concentrate on large flat panel
advances
Take leadership of EC/industry HD
project
Strong role in conventional
standard council
Join USHDTV consortium
Passive participation
Manufacturing
Enhance large CRT capability
and quality control
Source initially from alliance
partner
Build pilot LCD projection plant
•••
These are not just platitudes in boxes. Each executive should know what it takes to execute it.
INFORMS 05-01-06 30 © 2000-2006
A Strategic Business Model showed the value results of scenarios depicted by the Influence Diagram.
INFORMS 05-01-06 31 © 2000-2006
Careful debiasing procedures were used to assess ranges of uncertainties and full probability distributions.
Value for Sensitivity Analysis Definition
Low
.1 .2 .3 .4 .6 .7 .8 .9
.8 Probability of Being “In the Range”
Low Base High
0 .5 1.0
• There is only a 10 percent probability that the variable will be less than or equal to this value– What would have caused a value this low?
• There is only a 10 percent probability that the variable will be greater than this value.– What would have caused a value this high?
• There is a 50 percent probability that the variable will be less than or equal to this value.– Would you bet above or below this value?
High
Base Case
INFORMS 05-01-06 32 © 2000-2006
Sensitivity “tornado diagram” identified the uncertainties key to value – there can be only a few.
–900 –600 –300 0 300 600 900
Change in NPV—Evolutionary High-End TV Strategy ($ millions)
Videophile Segment Size in 2000 Low High
Japanese 2nd-GenerationCost Advantage Yes None
36" 16:9 TV Cost High Low
New Broadcast Standard(when and what) None Terrestrial 16:9 (1995)
and analog HD (2001)
Proportion of TV > 30 inches Low High
Development Costs With government funding
Impact of Earlier TV Replacement Low High
Distribution Markup Low High
Programming Availability Response High Low
INFORMS 05-01-06 33 © 2000-2006
Aggressive Analog was dominated. Info Age a had higher upside but more risk than Evolutionary Improvement.
Rather than trying to reach a decision, the search began for a better alternative.
Cum
ulat
ive
Prob
abili
ty
1.0
.9
.8
.7
.6
.5
.4
.3
.2
.1
0
–2Net Present Value ($ billions)
AggressiveAnalog
EvolutionaryImprovement
InfoAge
–1 0 1 2 3 4 5
INFORMS 05-01-06 34 © 2000-2006
Based on an understanding of the original three alternatives, the team constructed a new hybrid strategy “Sooner and Later.”
Focusing on feature leadership in conventional TV, dropping analog HDTV, and devoting some resources to a cooperative, slower, digital development was the best approach.
Cum
ulat
ive
Prob
abili
ty
1.0
.9
.8
.7
.6
.5
.4
.3
.2
.1
0
–2Net Present Value ($ billions)
AggressiveAnalog
EvolutionaryImprovement
InfoAge
Soonerand Later
–1 0 1 2 3 4 5
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The company committed to action as a result of a shared understanding of the business.
• Customer needs• Our capabilities• Competition
SharedUnderstanding of
Our Business
Information and entertainment will merge—we should slow down and develop a digitalHDTV.
If we don’t offer an alternative ASAP, theJapanese will destroy us.
These HDTV sets will be so expensive no one will ever buy one.
Before After
! !!
INFORMS 05-01-06 36 © 2000-2006
In this problem, like many corporate problems, risk attitude was not an issue.
• People continually confuse uncertainty and risk attitude
• The first order of business is to focus on value creation and the drivers of uncertainty in achieving high value. – This often leads to better strategies, and near stochastic dominance– In a learning situation, it is often better to proceed for a while to get
more information (and creativity) rather then tweaking a strategy
• If risk attitude seems important, it is usually tested by sensitivity to risk tolerance (exponential utility - which has constant risk tolerance)– In 50 years of professional practice, I have only seen one case in the
corporate domain that needed to go beyond exponential utility.
INFORMS 05-01-06 37 © 2000-2006
Decision Analysis in the Twenty-First CenturyA paradigm shift!
According to Thomas Friedman, the World is now “Flat.”
INFORMS 05-01-06 38 © 2000-2006
Today’s trends are forcing the evolution of decision analysis methods and delivery systems.
• Organizations are once again into decentralization and empowerment– Agile organizations push responsibility as low as possible
• Executives and managers are much better trained and familiar with decision analysis and similar approaches.– In the 60’s and 70’s most had no clue about decision analysis
• Everyone is looking for instant gratification, and they expect high-speed decision analysis– They are used to having information at their fingertips, and
participating in global teams– They want their strategic decisions made quickly, so they can move
on to operational effectiveness.
• By making the process of strategy creation and decision operational, we play into their new mindset– Strategy and operational thinking are very different.– But the process of creating strategy is an operational process.
INFORMS 05-01-06 39 © 2000-2006
Where does the decision analysis profession stop?
1. Decision Analyst - responsible for processing numbers
2. Decision Facilitator - responsible for meetings
3. Decision Consultant - responsible for attaining commitment
4. Decision Engineer - responsible for process, systems and organizational design
5. Decision Change Agent - responsible for personal, organizational, and cultural change necessary for routine, high quality decision making
INFORMS 05-01-06 40 © 2000-2006
The Ten Commandments of Decision Analysis
1. Decision Analysis is the One Master Discipline – do not follow false fads.
2. Work for the Decision-Maker and serve the organization he/she represents.
3. Construct a monetary value measure – nobody puts “scores” in the bank.
4. Beware of rates of return – nobody puts ratios in the bank either.
5. Have no regret – do not covet the pie you did not get or the other guy’s pie.
6. Beware of difference lotteries – they never happen.
7. Beware of triage – often “no brainers” have the biggest improvement potential.
8. If the problem is technically hard, change your frame – avoid “constraints”
9. Start simple and iterate – use the simplest model that gives decision clarity.
10.Change with the times and join in the new paradigm – the world is now flat!
INFORMS 05-01-06 41 © 2000-2006
Coming Attractions!
• SmartOrg Software Demonstration– Tuesday 3:00 PM– Decision Advisor® — Create and Analyze Value-Based Models– Portfolio Navigator™ — Deploy over the web
• Free Software Trials– Come to SmartOrg Exhibit Booth
INFORMS 05-01-06 42 © 2000-2006
Selected References• Friedman, Thomas L. 2005. The World Is Flat: A Brief History of the
Twenty-first Century, Farrar, Straus and Giroux
• Howard, Ronald A. and James E. Matheson eds. 1983 Readings on the Principles and Applications of Decision Analysis, Strategic Decisions Group.
• Howard, Ronald A. and James E. Matheson 1981. Influence Diagrams, Reprinted in Decision Analysis, Vol 2, No 3, Sept 2005, pp 127-143.
• Matheson, David and Jim Matheson, 1998. The Smart Organization: Creating Value Through Strategic R&D, Harvard Business School Press.
• Matheson, David and James E. Matheson, 2001. Smart Organizations Perform Better in Research • Technology Management, July-August 2001, pp 49-54.
• McNamee, Peter and John Celona, 2001. Decision Analysis for the Professional, Third Edition, SmartOrg, Inc.
• Spetzler, Carl S. and Carl-Axel S. Staël van Holstein. 1975. Probability Encoding in Decision Analysis, Management Science 22, pp 340-358.