The Decision Analysis Approach to Decision Making in Business

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  • 0:00 Decision Analysis
  • 1:03 Value & Payoffs
  • 2:33 Uncertainty & States of Nature
  • 3:58 Lesson Summary
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Lesson Transcript
Instructor: Natalie Boyd

Natalie is a teacher and holds an MA in English Education and is in progress on her PhD in psychology.

How do you know what the best decision for your business is? What are the costs and benefits associated with each option? In this lesson, we'll examine decision analysis, including what it is and how to use value and uncertainty in your analysis.

Decision Analysis

Keegan owns a company that makes furniture. He's worried about rising costs, though, and wants to know whether he should keep their furniture factory where it is or move to a neighboring state. The move might decrease costs, but Keegan's not sure.

There are many ways that Keegan can decide whether to move his factory or not. He could go with his gut reaction, use a rule of thumb to make a simple calculation on whether the move will save money, or even make the decision based on the fact that traditionally, the factory has been where it is and should just stay there.

But, Keegan wants to make a smart, informed decision. Decision analysis is the process of evaluating options to make decisions. It involves complex analysis to figure out the long- and short-term benefits and drawbacks of different decisions. By engaging in decision analysis, Keegan can examine the possibilities of moving or staying put in-depth.

To help Keegan out, let's look at the different elements used in decision analysis.

Value and Payoffs

Keegan's ready to use decision analysis to help him figure out whether to move his factory or not. But he still needs some help. He's not sure exactly what to do first.

The analysis part of decision analysis involves comparing outcomes for decision alternatives based on value and uncertainty. What does this mean? Decision alternatives are just what they sound like: the different options available. In Keegan's case, he can decide to keep the factory where it is, move it to a neighboring state, or even move it across the country or around the world.

For Keegan to analyze which decision alternative is the best option, he has to compare each one based on its value. Value in business decision analysis is about money. How much will it cost Keegan to move? How much will Keegan save if he does move? How much will he save if he stays where he is? All of these questions are focusing on value.

Of course, Keegan can't know exactly what each decision will cost or save him, so he has to guess. A payoff is the future value of a decision. Keegan can estimate a decision's payoff by examining things like taxes in different states, approximating the cost of moving, analyzing how much it costs to run a factory in different locations, and other factors. His goal when it comes to value is to get as close as possible to the payoff amount for each possible decision. Then, he'll know which decision will be best for him in the long run.

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