Fundamentals of Decision Making Chapter 08

Fundamentals of Decision Making Learning Goals Explain certainty, risk, and uncertainty and how they affect decision making Describe the characteristics of routine, adaptive, and innovative decisions Discuss the rational and bounded rationality models of managerial decision making Explain the features of political managerial decision making

Decision making includes: defining problems, gathering information, generating alternatives, and choosing a course of action We’ve got lots of challenges ahead of us. I spend about 75% of my time solving problems of one sort or another. The other 25% is really wonderful, though. Watching people grow, develop, achieve, and do good things and seeing the company succeed is very rewarding and lots of fun. David Hoover Chairman, CEO and President Ball Corporation

Summary of Decision-Making Conditions Certainty Uncertainty Objective probabilities Subjective probabilities Risk Clear Intuition and judgment

Decision-Making Conditions: What is Certainty? The condition under which individuals are: fully informed about a problem, alternative solutions are known, and the results of each solution are known Both the problem and alternative solutions are totally known and well defined Exception for most managers

What is Risk? The condition under which individuals can: define a problem, specify the probability of certain events, identify alternative solutions, and state the probability of each solution leading to a result Probability: the percentage of times that a specific result would occur if an individual were to make the same decision a large number of times

What is Risk? (cont’d) Objective probability: the likelihood that a specific result will occur, based on hard facts and numbers Subjective probability: the likelihood that a specific result will occur, based on personal judgment

What is Uncertainty? Condition under which individuals do not have the necessary information to assign probabilities to the outcomes of alternative solutions May not even be able to define the problem, much less identify alternative solutions and possible outcomes

Examples of Possible Crises as Sources of Uncertainty and High Risk Economic Crises Physical Crises Recessions Stock market crashes Hostile takeovers Industrial accidents Supply breakdowns Product failures Other crises Natural Disasters Information Crises Fires Floods Earthquakes Theft of proprietary information Tampering with company records Cyberattacks

Integrating Framework Unusual and ambiguous Innovative Decisions Uncertainty Adaptive Decisions Conditions under which decisions are made Risk Routine Decisions Problem Types Certainty Known and well defined Untried and ambiguous Solution Types (Alternative Solutions)

Basic Types of Decisions: Types of Problems Relatively common and well defined Unusual and ambiguous Firefighting Solutions are incomplete Problems recur and cascade Urgency supersedes importance Some problems become crises

Routine Decisions Standard choices made in response to relatively well-defined and common problems and alternative solutions Typically made under certainty and objective probability Standards often used to set the framework for making routine decisions

Examples of decision rules at Four Seasons hotels and resorts Routine Decisions Reservations Hotel Arrival Phone service will be highly efficient, including: answered before the fourth ring; no hold longer than 15 seconds; or, in case of longer holds, call- backs offered, then provided in less than three minutes The doorman (or first-contact employee) will actively greet guests, smile, make eye contact, and speak clearly in a friendly manner Examples of decision rules at Four Seasons hotels and resorts Messages and Paging Hotel Departure Phone service will be highly efficient, including: answered before the fourth ring; no longer than 15 seconds No guest will wait longer than five minutes for baggage assistance, once the bellman is called (eight minutes in resorts)

Adaptive Decisions Choices made in response to a combination of moderately unusual problems and alternative solutions Convergence—a business shift in which two connections with the customer that were previously viewed as competing or separate (e.g., brick-and-mortar bookstores and Internet bookstores) come to be seen as complementary Continuous improvement—a management philosophy that approaches the challenge of product and process enhancements as an ongoing effort to increase the levels of quality and excellence

Innovative Decisions Choices based on the discovery, identification, and diagnosis of unusual and ambiguous problems and/or the development of unique or creative alternative solutions Three forms of innovation for economic progress: Institutional innovation: includes the legal and institutional framework for business, such as deregulation Technological innovation: creates the possibility of new products, services, and production methods Management innovation: major changes in the way organizations are structured and how managers perform their functions

Process of Rational Decision Making: Rational Model Prescribes a set of phases that individuals or teams should follow to increase the likelihood that their decisions will be logical and optimal Rational decision: results in the maximum achievement of a goal in a situation Usually focuses on means—how best to achieve one or more goals

Rational Decision-Making Model (adapted from Figure 8.3) Environmental forces 1 Define and diagnose problem 2 Set goals 3 Search for alternative solutions 7 Follow-up and control results 4 Compare and evaluate alternative solutions 5 Choose among alternative solutions 6 Implement the solution selected Environmental forces

Rational Model: Define and Diagnose the Problem Noticing skill: identifying and monitoring numerous external and internal environmental factors and deciding which ones are contributing to the problem(s) Interpreting skill: assessing the factors noticed and determining which are causes, not merely symptoms, of the real problem(s) Incorporating skill: relating those interpretations to the current or desired goals Need to ask probing questions

Rational Model: Set Goals Goals: results to be attained and indicate the direction toward which decisions and actions should be aimed General goals: provide broad direction for decision making in qualitative terms Operational goals: state what is to be achieved in quantitative terms, for whom, and within what time period Hierarchy of goals: represents the formal linking of goals between organizational levels

Rational Model: Search for Alternative Solutions …I think many people in a rush to make a decision do not have enough of the alternatives out in the open. So, they have two of the alternatives and say, “Okay, I’m going this way” but they didn’t think through it enough when there were possibly three or four alternatives. One of the hidden ones might have been the best, and so the issue is making sure that either all or enough of the alternatives are out in the open to allow you to make the best decision. Gary Tooker Former CEO & Chairman of Board of Directors Motorola

Bounded Rationality Model Decision Biases Inadequate Problem Description Limited Search for Alternatives Limited Information Satisficing

Bounded Rationality Model (adapted from Figure 8.5) Contends that the capacity of the human mind for formulating and solving complex problems is small compared with what is needed for objectively rational behavior Decision Biases Inadequate Problem Description Limited Search for Alternatives Limited Information Satisficing

Bounded Rationality Model: Decision Biases Selective perception bias Concrete information bias Availability bias Gambler’s fallacy bias Law of small numbers bias

Bounded Rationality Model: Decision Biases …When someone comes to you, you often have a bias about what they are talking about. If you have been in business for 20 to 30 years, chances are you’ve been there and done that. Their idea is generally not so new or innovative as they think. You have a strong prejudice about outcomes. That is a dangerous thing. One of the things you have to do very cognitively to be a good leader is not let your biases or your filters totally cloud the message someone’s trying to deliver. Jeffrey McKeever Chairman and CEO MicroAge

Bounded Rationality Model Inadequate problem definition New problems often are viewed as being like old problems Too much focus on symptoms as problems Laziness Limited search for alternatives Options considered until one that seems adequate Limited information Ignorance: the lack of relevant information or the incorrect interpretation of the information that is available

Bounded Rationality Model: Satisficing Satisficing is intended to be used in contrast to the classical economist’s idea that in making decisions in business or anywhere in real life, you somehow pick, or somebody gives you, a set of alternatives from which you select the best one—maximize. The satisficing idea is that first of all, you don’t have the alternatives, you’ve got to go out and scratch for them—and that you have mighty shaky ways of evaluating them when you do find them. So you look for alternatives until you get one from which, in terms of your experience and in terms of what you have reason to expect, you will get a reasonable result. Herbert Simon Recipient of Nobel Prize in Economics

Bounded Rationality Model Level of Satisficing Can be Raised By: Personal determination Setting higher individual or organization standards (goals) Use of management science and computer-based decision-making and problem-solving techniques Following the seven steps in the rational model

Political Model of Decision Making (adapted from Figure 8.6) Multiple Stakeholders with power such as: Customers Investors Employees Divergence in problem definition Divergence in goals Divergence in solutions Political decision making Competitors Unions Suppliers Regulatory Agencies Legislative Bodies