How to Make an Influence Diagram-Step by Step(with Influence Chart)

What is Influence Diagram?

Influence Diagram is a simple diagram to show outputs and how they are calculated from inputs, it is a useful tool for complex, unstructured problems.

Influence Chart Principles

Built from output to input
Identify input data and decisions as they arise
A variable should appear only once
Decompose outcome measure into independent variables that directly determine it
Repeat decomposition for each variable, in turn, until no variable left

Conventions on types of variables

Objectives — hexagon
Variables — circle
Fixed parameters — triangle
Random parameters — double circle (I am not familiar with this one yet, if someone can explain to me, please comment below thanks!)
Decisions — box

Hand-on practice

This is a case from my first assignment of Decision Modeling course, I will show you how to make an influence diagram step by step

Case:
The Great Threads Company sells hand-knit sweaters. Great Threads is planning to print a catalog of its products and undertake a direct mail campaign. The cost of printing the brochure is $20,000 plus $0.10 a catalog. The cost of mailing each catalog is $0.15. In addition, the company will include direct reply envelopes in its mailings. If a customer places an order upon receiving the catalog, he/she will use the direct reply envelope to mail it back, and it costs the company extra $0.20 in postage for each direct mail envelope used by a respondent. If a customer does not place an order, the direct reply envelope will not be used, and no extra cost is incurred for the company. The average value of a customer order is $40, and the company’s variable cost per order averages around 80% of the order’s value. The company plans to mail 100,000 catalogs, and it expects the response rate (percentage of customers that mails back an order) to be at 5%. It wants to develop a spreadsheet model to analyze its profit.

**Step1: Identify the outcome, the thing we want to know, and decompose into independent variables that directly determine it.**

Profit = Revenue - Cost

Step2: Repeat decomposition for each variable, in turn, until no variable left

I started from the side of Revenue.

Revenue = Order Value($40) * Number of response(Variable)
Number of response = Response Rate(5%) * Number of catalogs(plans to mail 100,000 catalogs) (Stop here! No more variable left)

Then, decomposition the side of cost

Cost = Total order cost + Total catalog cost + Fixed cost($20,000)

Total order cost = Cost of goods +Total envelope cost
Total catalog cost = [Printing cost($0.10/ per catalog) + Mailing cost($0.15/ per catalog)]* Number of catalogs(plans to mail 100,000 catalogs)

Cost of goods = Order value * Number of response(already decompose above) * Cost percentage(80% of the order’s value)
Total envelope cost = Number of response(already decompose above) * Envelope cost($0.20 in postage)

There is no any variable left! We Just made our first nice and clear Influence Diagram!

Let’s make the spreadsheet for this case!

↑Click the link to learn about Spreadsheet Engineering.