Risk Management & Decision-Making
Businesses face decisions about risk nearly every day. From equipment purchases to new hires to
acquisitions and closures, each business decision carries an element of risk. The key aspect of making
the right business decisions comes from determining the balance between risk and reward. Companies
that expose themselves to high risks with minimal rewards can gamble themselves right out of business.
At the other extreme, firms that play it too safe can miss out on growth opportunities they need to survive
and thrive in a competitive marketplace.
Identifying Risks
Before a business can make a decision about risks, the company must identify those
risks. The sources of these risks can be from the outside, such as weather events or
market fluctuations, or they can be internal, such as capital acquisitions and training
expenses. Companies must identify where those risks can occur, the conditions that
can bring those risks into reality and the potential damage to the business for ignoring
those risks.
Prioritizing Risks
When identifying risks, businesses should also determine the probability that those risks
will occur. Businesses that face risks that carry heavy consequences and a high
probability of occurring must protect themselves against those risks first. A company
based in a desert is less likely to deal with blizzard conditions as a business risk than
one in a location that sees snowfall every winter, so the firm would not focus its
decision-making efforts on handling such a risk.
Developing Strategies
Another aspect of the decision-making process lies in the development of a strategic
plan. This plan can give businesses the tools they need to prevent the risks that they
can avoid and reduce the damage of those they cannot stop. A strategic plan also
prevents the business owners from being caught by surprise by the consequences of
foreseeable risks. This preparation eases much of the decision-making process and
gives business owners the tools they need to make the right calls.
Measuring Progress
When potential risks become unwelcome facts, businesses must also measure and
assess their decision-making processes. Business owners must measure the
effectiveness of their methods, learn where mistakes were made and adapt their tactics
as needed. As market conditions, legal regulations, technological innovations and
customer tastes change, new risks will inevitably arise. These changes require the
business to identify and prioritize these new risks, develop new strategies and reassess
the strengths and weaknesses of these new processes.
Defining Decision Making
Decision making is the mental process of selecting a course of action from a set of
alternatives.
LEARNING OBJECTIVES
Identify the steps and analyze alternatives in a decision-making process
KEY TAKEAWAYS
Key Points

Decision making is a process of choosing between alternatives.

Problem solving and decision making are distinct but related activities.

Time pressure and personal emotions can affect the quality of decision-making
outcomes.
Key Terms

Problem: A difficulty that has to be resolved or dealt with.
Decision making is the mental process of choosing from a set of alternatives. Every
decision-making process produces an outcome that might be an action, a
recommendation, or an opinion. Since doing nothing or remaining neutral is usually
among the set of options one chooses from, selecting that course is also making a
decision.
Difference Between Problem Analysis and Decision Making
While they are related, problem analysis and decision making are distinct activities.
Decisions are commonly focused on a problem or challenge. Decision makers must
gather and consider data before making a choice. Problem analysis involves framing
the issue by defining its boundaries, establishing criteria with which to select from
alternatives, and developing conclusions based on available information. Analyzing a
problem may not result in a decision, although the results are an important ingredient in
all decision making.
Steps in Decision Making
Decision making comprises a series of sequential activities that together structure the
process and facilitate its conclusion. These steps are:

Establishing objectives

Classifying and prioritizing objectives

Developing selection criteria

Identifying alternatives

Evaluating alternatives against the selection criteria

Choosing the alternative that best satisfies the selection criteria

Implementing the decision
Analysis of Alternatives
A major part of decision making involves the analysis of a defined set of alternatives
against selection criteria. These criteria usually include costs and benefits, advantages
and disadvantages, and alignment with preferences. For example, when choosing a
place to establish a new business, the criteria might include rental costs, availability of
skilled labor, access to transportation and means of distribution, and proximity to
customers. Based on the relative importance of these factors, a business owner makes
a decision that best meets the criteria.
The decision maker may face a problem when trying to evaluate alternatives in terms of
their strengths and weaknesses. This can be especially challenging when there are
many factors to consider. Time limits and personal emotions also play a role in the
process of choosing between alternatives. Greater deliberation and information
gathering often takes additional time, and decision makers often must choose before
they feel fully prepared. In addition, the more that is at stake the more emotions are
likely to come into play, and this can distort one’s judgment.
Decision-Making Styles
Decisions are driven by psychological, cognitive, and normative styles, each of which
take into account varying influences on the final decision.
LEARNING OBJECTIVES
Recognize the various factors which influence a leader’s decision-making style
KEY TAKEAWAYS
Key Points

The ability to make effective decisions that are rational, informed, and
collaborative can greatly reduce opportunity costs while building a strong
organizational focus.

A psychological style to decision-making favors individual values, desires, and
needs to determine the best course of action.

A cognitive style to decision-making is heavily influenced by external factors and
repercussions, such as how a given course of action will impact the broader
environment in which the organization functions.

Normative decision-making relies on logic and communicative rationality, aligning
people based upon a logical progression from premises to conclusion.

Regardless of the style or perspective, managers, and leaders must create
organizational alignment in decision-making through building consensus.
Key Terms

communicative rationality: A theory or set of theories which describes human
rationality as a necessary outcome of successful communication.
Why Decision-making Matters
Decision-making is a truly fascinating science, incorporating organizational behavior,
psychology, sociology, neurology, strategy, management, philosophy, and logic. The
ability to make effective decisions that are rational, informed, and collaborative can
greatly reduce opportunity costs while building a strong organizational focus. As a
prospective manager, effective decision-making is a central skill necessary for success.
This requires the capacity to weigh various paths and determine the optimal trajectory of
action.
Decision-making Styles
There are countless perspectives and tactics to effective decision-making. However,
there are a few key points in decision-making theory that are central to understanding
how different styles may impact organizational trajectories. Decision-making styles can
be divided into three broad categories:

Psychological: Decisions derived from the needs, desires, preferences, and/or
values of the individual making the decision. This type of decision-making is
centered on the individual deciding.

Cognitive: This is an integrated feedback system between the
individual/organization making a decision, and the broader environment’s
reactions to those decisions. This type of decision-making process involves
iterative cycles and constant assessment of the reactions and impacts of the
decision.

Normative: In many ways, decision making (particularly in groups, such as within
an organization) is about communicative rationality. This is to say that decisions
are derived based on the ability to communicate and share logic, using firms
premises and conclusions to drive behavior.
Cognitive Theories
While the above styles give a general sense of the logic that drives choices, it is more
useful to recognize that each of these three styles can play a role in any individual’s
decision-making process. From the cognitive perspective, there are a few specific
stylistic models that are useful to keep in mind:
Optimizing vs. Satisficing
Decision-making is limited to the finite amount of information an individual has access
to. With limitations on information, true objectivity is impossible. Decisions are therefore
intrinsically flawed. A satisficer will recognize this necessary imperfection, and prefer
faster but less perfect decisions while a maximizer will take a longer time trying to find
the optimal choice. This can be viewed as a spectrum, and each decision (depending
on the risk of a mistake) can be viewed with varying levels of perfection.
Intuitive vs. Rational
Daniel Kahneman puts forward the idea of two separate minds that compete for
influence within each of us. One way to describe this is a conscious and a subconscious
perspective. The subconscious mind (referred to as System 1) is automatic and
intuitive, rapidly consolidating data and producing a decision almost immediately. The
conscious mind (referred to as System 2) requires more effort and input, utilizing logic
and rationale to make an explicit choice.
Combinatorial vs. Positional
This relationship was put forward by Aron Katsenelinboigen based on how the game of
chess is played, and an individual’s relationship with uncertainty. A combinatorial player
has a final outcome, making a series of decisions that try to link the initial position with
the final outcome in a firm, narrow, and concrete way (i.e. certainty). The positional
decision-making approach is ‘looser’, with a sense of setting up for an uncertain future
as opposed to pursuing a concrete object. Each move from this type of player would
maximize options as opposed to pursue an outcome.
Consensus Flowchart: Regardless of perspective or style, all leaders must make decisions that create
consensus. This model underlines how a manager or leader can discuss various options within a group setting,
make proposals for action, and iterate until agreement is reached.
Types of Decisions
Three approaches to decision making are avoiding, problem solving and problem
seeking.
LEARNING OBJECTIVES
Differentiate between the three primary decision-making approaches: avoiding, problem solving,
and problem seeking
KEY TAKEAWAYS
Key Points

One approach to decision making is to not make a choice—that is, to avoid
making a decision altogether.

Identifying and selecting a solution to a problem is a frequent type of decision
outcome.

Sometimes decision making results in the need to restate the purpose and subject
of the choice; this is known as problem seeking.
Key Terms

problem seeking: The process of clarifying, understanding, and restating the
problem.

problem solving: Problem solving involves using generic or ad hoc methods, in
an orderly manner, for finding solutions to specific problems.
Every decision-making process reaches a conclusion, which can be a choice to act or
not to act, a decision on what course of action to take and how, or even an opinion or
recommendation. Sometimes decision making leads to redefining the issue or
challenge. Accordingly, three decision-making processes are known as avoiding,
problem solving, and problem seeking.
Avoiding
One decision-making option is to make no choice at all. There are several reasons why
the decision maker might do this:
1. There is insufficient information to make a reasoned choice between alternatives.
2. The potential negative consequences of selecting any alternative outweigh the
benefits of selecting one.
3. No pressing need for a choice exists and the status quo can continue without
harm.
4. The person considering the alternatives does not have the authority to make a
decision.
One example of avoiding a decision occurs routinely at the Supreme Court of the United
States (as well as other appellate courts). The Supreme Court will decline to hear a
case because, in their judgment, the issues have not been sufficiently considered in
lower courts.
Problem Solving
Most decisions consists of problem-solving activities that end when a satisfactory
solution is reached. In psychology, problem solvingrefers to the desire to reach a
definite goal from a present condition. Problem solving requires problem definition,
information analysis and evaluation, and alternative selection.
Problem Seeking
On occasion, the process of problem solving brings the focus or scope of the problem
itself into question. It may be found to be poorly defined, of too large or small a scope,
or missing a key dimension. Decision makers must then step back and reconsider the
information and analysis they have brought to bear so far. We can regard this activity as
problem seeking because decision makers must return to the starting point and respecify the issue or problem they want to address.
Decision Making Process
Identify and Define the Problem
Identifying, defining, and understanding a problem is essential to analyzing and
choosing between alternatives.
LEARNING OBJECTIVES
Express the importance of properly framing and defining the problem prior to pursuing a
decision
KEY TAKEAWAYS
Key Points

Decision makers must first make sure that they completely understand the
problem.

It is a good idea to be able to look at a decision from multiple perspectives. This
can be accomplished through selecting a group of people who will look at and
define the problem from different perspectives.

Data should be gathered on how the current problem is affecting people now.
Some examples of important data to gather include efficiency levels, satisfaction
levels, and output metrics.
Key Terms

Output metrics: Standards or data points that showm the rate and speed of
production over a certain period of time.
Decision making is a central responsibility of managers and leaders. It requires defining
the issue or the problem and identifying the factors related to it. Doing so helps create a
clear understanding of what needs to be decided and can influence the choice between
alternatives.
An important aspect of any decision is its purpose, or objective. This is different from
identifying a specific decision outcome; rather, it has to do with the motivation to make
the decision in the first place. For instance, customer complaints can imply the need to
change aspects of how service is delivered, so decisions must be made to address
them. Factors that are not related to service delivery would not be in consideration in
that decision.
There are a number of ways to define a problem, such as creating a team to tackle it
and gathering relevant data by interviewing employees and customers.
Developing a Group to Define the Problem
It is a good idea to be able to approach decision definition from different perspectives.
Doing so can capture dimensions of the issue that might otherwise have been
overlooked. Involving two or more people can bring different information, knowledge,
and experience to a decision. This can be accomplished through forming a group to
consider and define the problem or issue, and then to frame the decision based on their
collective ideas. Having a shared definition and understanding of a decision helps the
decision-making process by creating focus for discussions and making them more
efficient.
Gathering Data to Define the Decision
Most decisions require a good understanding of the current state in order to understand
all implications of the potential choices. For this reason it can be valuable to consider
the views of all parties that will be affected by the decision. These may include
customers, employees, or suppliers. Data should be gathered on how the current
problem is affecting people now. Some examples of important data to gather include
efficiency levels, satisfaction levels, and output metrics. Interviews, focus groups, or
other qualitative methods of data collection can be used to identify existing conditions
that may be connected to the decision in question. As much information as possible
should be gathered to build confidence that a decision has been accurately and
appropriately formulated before additional analysis and assessment of alternatives
begin.