Foundations of Decision Making Chapter 4 Foundations of Decision Making PowerPoint Presentation by LiZhe Management College C.C.N.U

L E A R N I N G O U T C O M E S After reading this chapter, I will be able to: Describe the steps in the decision-making process. Identify the assumptions of the rational decision-making model. Explain the limits to rationality. Define certainty, risk, and uncertainty as they relate to decision making. Describe the actions of the bounded-rational decision maker.

L E A R N I N G O U T C O M E S (cont’d) After reading this chapter, I will be able to: Identify the two types of decision problems and the two types of decisions that are used to solve them. Define heuristics and explain how they affect the decision-making process. Identify four decision-making styles. Describe the advantages and disadvantages of group decisions. Explain three techniques for improving group decision making.

Decision-making Decision-making process Problem Decision criteria A set of eight steps that includes identifying a problem, selecting a solution, and evaluating the effectiveness of the solution Problem A discrepancy between an existing and a desired state of affairs Decision criteria Factors that are relevant in a decision

Examples of Planning-Function Decisions What are the organization’s long-term objectives? What strategies will best achieve those objectives? What should the organization’s short-term objectives be? What is the most efficient means of completing tasks? What might the competition be considering? What budgets are needed to complete department tasks? How difficult should individual goals be? EXHIBIT 4.1

The Decision-Making Process EXHIBIT 4.2

Criteria and Weight in Car-Buying Decision (Scale of 1 to 10) CRITERION WEIGHT Price 10 Interior comfort 8 Durability 5 Repair record 5 Performance 3 Handling 1 EXHIBIT 4.3

Assessment of Car Alternatives INITIAL INTERIOR DURA- REPAIR ALTERNATIVES PRICE COMFORT BILITY RECORD PERFORMANCE HANDLING TOTAL Jeep Cherokee 2 10 8 7 5 5 37 Ford Mustang 9 6 5 6 8 6 40 Mercedes C230 8 5 6 6 4 6 35 Pontiac Grand Am 9 5 6 7 6 5 38 Mazda Tribute 5 6 9 10 7 7 44 Dodge Durango 10 5 6 4 3 3 31 Volvo S60 4 8 7 6 8 9 42 Isuzu Axiom 7 6 8 6 5 6 38 BMW 325 9 7 6 4 4 7 37 Audi A6 5 8 5 4 10 10 42 Toyota Camry 6 5 10 10 6 6 43 Volkswagen Passat 8 6 6 5 7 8 40 EXHIBIT 4.4

Weighting of Vehicles (Assessment Criteria X Criteria Weight) EXHIBIT 4.5

Decision-making (cont’d) Decision implementation Putting a decision into action; includes conveying the decision to the persons who will be affected by it and getting their commitment to it

Making Decisions: The Rational Model Certainty The implication that the outcome of every possible alternative is known Uncertainty A condition under which there is not full knowledge of the problem and reasonable probabilities for alternative outcomes cannot be determined. Risk The probability that a particular outcome will result from a given decision

Assumptions of Rationality EXHIBIT 4.6

Making Decisions: The Rational Model Describes choices that are consistent and value-maximizing within specified constraints Bounded rationality Behavior that is rational within the parameters of a simplified model that captures the essential features of a problem Satisfice Making a “good enough” decision

Three Elements of Creativity Creativity The ability to produce novel and useful ideas EXHIBIT 4.7 Source: T. M. Amabile, “Motivating Creativity in Organizations,” California Management Review (Fall 1997): 43.

Common Decision-making Errors Heuristics: Using judgmental shortcuts Availability heuristic the tendency for people to base their judgments on information that is readily available to them Representative heuristic The tendency for people to base judgments of probability on things with which they are familiar Escalation of commitment An increased commitment to a previous decision despite negative information

How Do Problems Differ? Well-structured problems Straightforward, familiar, easily defined problems Ill-structured problems New problems in which information is ambiguous or incomplete Programmed decision A repetitive decision that can be handled by a routine approach Nonprogrammed decisions Decisions that must be custom-made to solve unique and nonrecurring problems

Programmed Decision-Making Aids Policy A general guide that establishes parameters for making decisions about recurring problems Procedure A series of interrelated sequential steps that can be used to respond to a well-structured problem (policy implementation) Rule An explicit statement that tells managers what they ought or ought not to do (limits on procedural actions)

Types of Problems, Types of Decisions, and Level in the Organization EXHIBIT 4.8

Technology And Decision Making Expert systems Software that acts like an expert in analyzing and solving ill-structured problems Use specialized knowledge about a particular problem area rather than general knowledge Use qualitative reasoning rather than numerical calculations Perform at a level of competence higher than that of nonexpert humans. Neural networks Software that is designed to imitate the structure of brain cells and connections among them

Decision Making: Styles Directive style Characterizes the low tolerance for ambiguity and a rational way of thinking of individuals who are logical and efficient and typically make fast decisions that focus on the short term. Analytic style Characterizes the high tolerance for ambiguity combined with a rational way of thinking of individuals who prefer to have complete information before making a decision.

Decision Making: Styles (cont’d) Conceptual style Individuals who tend to be very broad in outlook, to look at many alternatives, and to focus on the long run and often look for creative solutions. Behavioral style Individuals who think intuitively but have a low tolerance for uncertainty; they work well with others, are open to suggestions, and are concerned about the individuals who work for them.

Decision-Making Styles EXHIBIT 4.9

Group Decision Making Advantages Disadvantages Make more accurate decisions Provides more complete information Offers a greater diversity of experiences and perspectives Generates more alternatives Increases acceptance of a solution Increases the legitimacy of a decision. Disadvantages Is more time-consuming and less efficient Minority domination can influence decision process Increased pressures to conform to the group’s mindset (groupthink) Ambiguous responsibility for the outcomes of decisions

Improving Group Decision Making Brainstorming An idea-generating process that encourages alternatives while withholding criticism Nominal group technique A decision-making technique in which group members are physically present but operate independently Electronic meeting A type of nominal group technique in which participants are linked by computer

Payoff Matrix for VISA VISA AMERICAN EXPRESS’ MARKETING RESPONSE STRATEGY (IN MILLIONS OF $) CA1 CA2 CA3 S1 13 14 11 S2 9 15 18 S3 24 21 15 S4 18 14 28 EXHIBIT QM–1

Regret Matrix for VISA VISA AMERICAN EXPRESS’ MARKETING RESPONSE STRATEGY (IN MILLIONS OF $) CA1 CA2 CA3 S1 11 7 17 S2 15 6 10 S3 0 0 13 S4 6 7 0 EXHIBIT QM–2

Decision Tree and Expected Values for Renting a Large or Small Retail Space EXHIBIT QM–3

The Breakeven Analysis EXHIBIT QM–4

Popular Financial Controls OBJECTIVE RATIO CALCULATION Liquidity test Current ratio _Current assets_ Current liabilities Acid test Current assets level inventories Current liabilities Leverage test Debt-to-assets _Total debt_ Total assets Times-interest-earned Profits before interest and taxes Total interest charges Operations test Inventory turnover Cost of sales Inventory Total-assets-turnover Revenues Total assets Profitability Profit margin-on-revenues Net profit after taxes Total revenues Return-on-investment Net profit after taxes Total assets EXHIBIT QM–5

Production Data for Virus Software Number of Hours Required per Unit WINDOWS MAC MONTHLY PRODUCT DEPARTMENT VERSION VERSION CAPACITY (HOURS) Design 4 6 2,400 Manufacture 2.0 2.0 900 Profit per unit $18 $24 EXHIBIT QM–6

Graphical Solution to Hernandez’s Linear Programming Problem EXHIBIT QM–7

Queuing Theory Queuing theory A technique that balances the cost of having a waiting line against the cost of service to maintain that line

Determining the Most Economic Order Quantity EXHIBIT QM–8

Economic Order Quantity Economic order quantity (EOQ) A technique for balancing purchase, ordering, carrying, and stock-out costs to derive the optimum quantity for a purchase order