Business Decision Process

Overview Steps in rational decision making Tests of rationality? Types of organizational decisions

Steps in “ Rational” Decision Making – in a Choice problem Define the problem Generate alternative solutions Identify criteria for choosing between solutions Weight the criteria Rate each alternative on each decision Compute the optimal decision

Are people rational? Decision makers forego best solution in favor of one that is acceptable or reasonable. They satisfice People often lack sufficient data on problem, alternatives and criteria. They have limited amount of working memory to store and process data. Yet, they make decisions using heuristics

Heuristics A heuristic is a “mental short-cut” in judgment and decision making They are essential for living in an uncertain world Rule of thumb Mechanisms to cope with in a complex world But can lead to faulty beliefs and suboptimal decisions

Example uses of heuristics One negative comment outweighs many positive comments (e.g. Online purchases) Information from direct perception given more importance than secondary data that has greater evidential value (my impressions of India) Case histories and anecdotes have greater impact than more informative abstract statistical data (e.g. Mitsubishi Montero safety tests)

Availability Heuristic What is readily available in memory influences the people’s judgments Which is more harmful health? –Speeding? –Smoking? People’s choice may be influenced by –Their closeness of victims of either –Vividness of their experience in dealing with either People tend to make judgments using retrievability of information

Problem #1 The following 10 corporations were ranked by Fortune magazine to be among the largest 500 US-based firms according to sales revenue for 2003 Group A: Reebok Intl, Hilton Hotels, Starbucks, RadioShack, Hershey Foods Group B: CoconoPhillips, American International Group, McKesson, Amerisource Bergen, The Altria Group Which group of companies has the largest total sales revenue?

Your answer to Problem #1 Correct answer : Group B You chose Group A, because of familiarity of the names of companies in Group A Availability heuristic and resulting bias

Problem #2 In four pages of a novel (about 2000) words, how many words would you expect to find the form _ _ _ _ ing (seven-letter words that end with ing)? Choices:

Problem #2 (contd) In four pages of a novel (about 2000) words, how many words would you expect to find the form _ _ _ _ _ n _ (seven-letter words with n in the sixth position)? Choices:

Retrievability Did you respond with higher number for Problem 2a than for 2b? Retrievability of 7-letter words ending with “ing” apparently easier than 7-letter words with “n” as the 6 th letter. Retrievability is exploited by business –‘Upscale’ retailers in the same mall –Multiple gas-stations at an intersection –Pharmacists in the same intersection (12 th Street and Main)

Problem #3 How would you respond to “Is marijuana use related to delinquency?” Typically, people start by recalling marijuana users who are delinquent Correct way to make a judgment is to use four sets of people

Problem #4 Mark is finishing his MBA at a prestigious university. He is very interested in the arts and at one time considered a career as a musician. Where is he more likely to take a job? a.In arts management b.With a consulting firm

Problem #4 Did you choose “A”? Your image of an arts management person might have influenced your decision You forgot the base-rate Proportionately more MBA’s work for consulting firms than Arts management

Problem #5 You have started buying stocks on the Internet, beginning with five different stocks. Each stock goes down soon after you purchase. As you prepare to make a sixth purchase, you reason that it should be more successful, since the last five were “lemons”. After all, the odds favor making at least one successful pick in six decisions. This thinking is a.Correct b.Incorrect

Problem #5 Answer : Incorrect Performance of 6 th stock is independent of the performance of other five stocks Gambler’s fallacy –Perceives higher chance of winning after a long streak of losses

Are people rational? Decision makers forego best solution in favor of one that is acceptable or reasonable. They satisfice People often lack sufficient data on problem, alternatives and criteria. They have limited amount of working memory to store and process data. Yet, they make decisions using heuristics

How to make decisions Herb Simon (1916 –2001) Researcher in cognitive psychology, computer science, public administration, economics and philosophy Won Nobel price for economics in 1978 for his work on decision-making in organizations

Simon’s 3-stage model Intelligence Design Choice

Stage 1 - Intelligence Gathering intelligence about the decision problem Requirements gathering and analyzing requirements E.g. : Wanting a solution to transport problem

Stage 2 - Design Create solutions Must have more than one alternative solutions Find or create or develop alternatives E.g. What choices do we have for solving the transportation problem?

Stage 3 - Choice Consider the alternatives and their attributes and make a choice Select a choice or alternative for implementation Eg. How to choose between various alternatives?

Evaluating decisions Is the problem solved? Are the objectives achieved? Is the solution acceptable by the users? Is there no conflict of interest? Do users perceive usefulness of the solution? Do the users use the solution?

Managerial Decisions The decision can be classified based on the level of the organization Decisions can be classified based on the context of the decision

Decisions categorized by Levels within an organization

Operational performance decisions Day-to-day decisions

Operational control decisions Related to effectiveness of Operations; monitoring and Correcting deviations

Management control decisions Decisions related to allocation of resources; analyzing buyer and supplier behavior

Strategic planning decisions Establishing broad policies Evaluating investment proposals