The Nature of Decision Making

Making effective decisions, as well as recognizing when a bad decision has been made and quickly responding to mistakes, is a key ingredient in organizational effectiveness.Some experts believe that decision making is the most basic and fundamental of all managerial activities.Decision making is most closely linked with the Planning function. However, it is also part of Organizing, Leading and Controlling.

What is Decision Making?

• Decision making is the act of choosing one alternative from among a set of alternatives.

• We have to first decide that a decision has to be made and then secondly identify a set of feasible alternatives before we select one.

Decision-Making Process

• Decision-Making Process includes:

recognizing and defining the nature of a decision situation

identifying alternatives

choosing the ‘best’ [most effective] alternative and

putting it into practice.

Decision-Making Process. . .(continued)

Sometimes effective decisions must be made to:

• Optimize some set of factors such as profits, sales, employee welfare and market share or

• Minimize loss, expenses or employee turnover or• Select best method for going out of business,

laying off employees, or terminating a strategic alliance.

Decision-Making Process. . .(continued)

Managers make decisions about both problems (undesirable situations) and opportunities (desirable situations).

Cutting costs by 10%

Learning that the company has earned higher-than-projected profits

It may take a long time before a manager can know for sure if the right decision was made.

Types of Decisions

• Programmed decision is one that is fairly structured or recurs with some frequency (or both).

• Nonprogrammed decision is one that is unstructured and occurs much less often than a programmed decision.

Programmed Decisions. . .

Many decisions regarding basic operating systems and procedures and standard organizational transactions fall into this category.

McDonald’s employees are trained to make the Big Mac according to specific procedures.

Starbucks, and many other organizations, use programmed decisions to purchase new supplies [coffee beans, cups and napkins].

Nonprogrammed Decisions. . .

Most of the decisions made by top managers involving strategy and organization design are nonprogrammed.

Decisions about mergers, acquisitions and takeovers, new facilities, new products, labor contracts and legal issues are nonprogrammed decisions.

Managers faced with nonprogrammed decisions must treat each one as unique, investing great amounts of time, energy and resources into exploring the situation from all views.Intuition and experience are major factors in these decisions.

Decision-Making Conditions

• Decision Making Under Certainty

• Decision Making Under Risk

• Decision Making Under Uncertainty

Decision Making Under Certainty

A state of certainty exists when a decision maker knows, with reasonable certainty, what the alternatives are and what conditions are associated with each alternative.

Very few organizational decisions, however, are made under these conditions.

The complex and turbulent environment in which businesses exist rarely allows for such decisions.

Decision Making Under Risk

A state of risk exists when a decision maker makes decisions under a condition in which the availability of each alternative and its potential payoffs and costs are all associated with probability estimate.

Decisions such as these are based on past experiences, relevant information, the advice of others and one’s own judgment.Decision is ‘calculated’ on the basis of which alternative has the highest probability of working effectively. [union negotiations, Porsche’s SUV focus vs high-performance sports cars]

Decision Making Under Uncertainty

A state of uncertainty exists when a decision maker does not know all of the alternatives, the risks associated with each, or the consequences each alternative is likely to have.Most of the major decision making in today’s organizations is done under these conditions.To make effective decisions under these conditions, managers must secure as much relevant information as possible and approach the situation from a logical and rational view. Intuition, judgment and experience always play major roles in the decision-making process under these conditions.

See Figure 9.1, page 279.

A View of Decision-Making Conditions

Certainty Risk Uncertainty

Level of ambiguity and chances of making a bad decision

Lower Moderate Higher

The decisionmaker faces

conditions of:

Rational Perspectives on Decision Making

Keys to Decision Making

Classical

Decision

Model

Rational

Decision

Making

Classical Decision Model

• An approach to decision making that tells managers how they should make decisions.

• Approach assumes that managers are logical and rational.

• Approach assumes that managers’ decisions will be in the best interests of the organization.

• Conditions suggested in this approach rarely, if ever, exist.

See Figure 9.2, page 281.

Obtain complete and perfect information.

Eliminate uncertainty. Evaluate everything

rationally and logically…

The Classical Model of Decision Making

When faced with adecision situation,

managers should…

…and end up with adecision that best

serves the interestsof the organization.

Rational Decision Making

Consists of six (6) steps that keep the decision maker focused on facts and logic and help guard against inappropriate assumptions and pitfalls.

Designed to help the manager approach a decision rationally and logically.

Rational Decision Making. . .(continued)

1) Recognizing and defining the decision situation

a) Need to ‘define’ precisely what the problem is.

b) Manager must develop a complete understanding of the problem.

c) Manager must carefully analyze and consider the situation.

Rational Decision Making. . .(continued)

2) Identifying alternativesa) Managers must realize that their alternatives may

be limited by legal, moral and ethical norms, authority constraints, available technology, economic considerations and unofficial social norms.

Rational Decision Making. . .(continued)

3) Evaluating alternativesa) Each alternative must pass successfully through three

stages before it may be worthy of consideration as a solution.

1. Feasibility – Is it financially possible? Is it legally possible? Are there limited human, material and/or informational resources available?

2. Satisfactory – Does the alternative satisfy the conditions of the decision situation? [50% increase in sales]

3. Affordability – How will this alternative affect other parts of the organization? What financial and non-financial costs are associated?

b) The manager must put ‘price tags’ on the consequences of each alternative.

c) Even an alternative that is both feasible and satisfactory must be rejected if the consequences are too expensive for the total system.

Rational Decision Making. . .(continued)

4) Selecting an alternativea) Choosing the best alternative is the real test of

decision making.

b) Optimization is the goal because a decision is likely to affect several individuals or departments.

c) Finding multiple acceptable alternatives may be possible; selecting one and rejecting the others may not be necessary.

Rational Decision Making. . .(continued)

5) Implementing the chosen alternativea) Managers must consider people’s resistance to

change when implementing decisions.

b) For some decisions, implementation is easy; for others, very difficult or time consuming.

c) Operational plans are very useful in implementing alternatives.

d) Managers must also recognize that even when all of the alternatives and their consequences have been evaluated as precisely as possible, unanticipated consequences are still likely.

Rational Decision Making. . .(continued)

6) Following up and evaluating the resultsa) Managers must evaluate the effectiveness of their

decisions – did the chosen alternative serve its original purpose?

b) If the implemented alternative appears not to be working, the manager has several choices:

1. Another previously identified alternative might be adopted or

2. Recognize that the situation was not correctly defined and start the process all over again or

3. Decide that the alternative has not been given enough time to work or should be implemented in a different way.

[See Figure 9.3 and Table 9.1 ]

Figure 9.3: Evaluating Alternatives in the Decision-Making Process

Behavioral Aspects of Decision Making

• Sometimes decision making must reflect subjective considerations (tastes, etc.)

• Other behavioral aspects include: political forces, intuition, escalation of commitment, risk propensity and ethics.

Behavioral Aspects. . . (continued)

The Administrative Model of Decision MakingHerbert A Simon, a Nobel Prize winner in Economics,

developed the model to describe how decisions are often made rather than to prescribe how they should be made.

Argues that decision makers have incomplete and imperfect information, are constrained by ‘bounded rationality’ and tend to ‘satisfice’ when making decisions.

Bounded rationality suggests that decision makers are limited by their values and unconscious reflexes, skills and habits. [American vs foreign automakers]

Behavioral Aspects. . . (continued)

Satisficing is the tendency to search for alternatives only until one is found that meets some minimum standard of sufficiency.

Rather than conducting an exhaustive search for the best possible alternative, decision makers tend to search only until they identify an alternative that meets some minimum standard of sufficiency.

...and end up with a decision that may or

may not serve the interests of the organization.

The Administrative Model of Decision Making

Use incomplete andimperfect Information.

Are constrained by bounded rationality. Tend to satisfice…

When faced with a decision situation

managers actually…

Behavioral Aspects. . . (continued)

The Classical and Administrative Models paint quite a different picture of decision making. However, each may be used to better understand how managers make decisions.

The Classical Model attempts to explain how managers can at least attempt to be more rational and logical in their approach to decisions.

The Administrative Model can be used by managers to develop a better understanding of their inherent biases and limitations.

Behavioral Forces Influencing Decisions

Political Forces in Decision Making

Coalition - an informal alliance of individuals or groups formed to achieve a common goal [stockholders,

directors, parliament blocs, etc]

Impact of a coalition may be positive or negative.

Managers must recognize when to use coalitions, how to assess if they are acting in the best interest of the organization and how to control their negative effects.

Behavioral Forces Influencing Decisions

Intuition – is an innate belief about something, without conscious consideration.

Deciding to do something because it ‘feels right’ or one has a ‘hunch’.

Feeling is based on years of experience and practice in making decisions in similar situations; may help managers make occasional decisions without going through an a-to-z process.

Behavioral Forces Influencing Decisions

Escalation of Commitment – occurs when a decision maker stays with a decision even when it appears to be wrong. [Pan Am holdings]

Decision makers must guard against sticking too long with an incorrect decision.

However, managers should not ‘bail out’ of a seemingly incorrect decision too soon.

Behavioral Forces Influencing Decisions

Risk Propensity – the extent to which a decision maker is willing to gamble when making a decision.

Organizational culture is a prime ingredient in encouraging different levels of risk.

Behavioral Forces Influencing Decisions

Ethics

Managerial ethics involves a wide variety of decisions:Relationships of the firm to its employees [closing a dept to save money]

Relationships of the employees to the firm

Relationships of the firm to other economic agents