Decision Making
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Decision Making
• What is decision making?
It is the process of selecting among alternatives.
Chester Bernard in “The Functions of the Executive”
gave a comprehensive analytical treatment of decision
making and noted: “The process of decision … are
largely techniques for narrowing choice.”
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Example of error in decision-making process
• Shane Frederick had used simple puzzles to study cognitive
self monitoring, as in the following example: “A bat and a ball
cost 1.10 dollars in total. The bat costs 1 dollar more than the
ball. How much does the ball cost?” Almost everyone reports
an initial tendency to answer “10 cents” because the sum 1.10
dollars separate naturally into 1 dollar and 10 cents and
because 10 cents is about the right magnitude. Frederick
found that many intelligent people yield to this immediate
impulse” 50% (47/93) of Princeton students and 56%
(164/293) of students at the University of Michigan gave the
wrong answer. Clearly, these respondents offered a response
without checking it.
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Decision Making
Intelligence Activity
Design Activity
Feedback
Choice Activity
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Decision-making process
•
Herbert A. Simon, the well known Nobel Prize winning
organization and decision theorist conceptualized three major
phases in decision-making process:
1. Intelligence activity – Consists of searching the
environment for conditions calling for decision
making
2. Design activity – During this phase, inventing,
developing, and analyzing possible courses of action
take place
3. Choice activity – This is the actual choice - selecting
a particular course of action from among those
variables
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Mintzberg’s Model
Phase 1
Phase 2
IDENTIFICATION
1. Recognition
2. Diagnosis
DEVELOPMENT
1. Search
2. Design
Phase 3
SELECTION
1. Judgement
2. Analysis
3. Bargaining
Authorization
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Behavioural Decision Making
Decision Rationality
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Behavioral Decision Making Models
Economic Rationality Model
•
1.
2.
3.
4.
5.
This model comes from classic model, in which the decision
maker is perfectly and completely rational in every way.
Regarding decision-making activities, the following conditions
are assumed.
The decision will be completely rational in the means-end
sense.
There is a complete and consistent system of preferences which
allows a choice among alternatives.
There is complete awareness of all the possible alternatives.
There is no limits to the complexity of computations that can
be performed to determine the best alternatives.
Probability calculations are neither frightening nor mysterious.
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Simon’s Bounded Rationality Model
•
To present a more realistic alternative to the economic
rationality model, Herbert A Simon proposed an
alternative model. He felt that management decisionmaking behavior could best be described as follows”
1.
In choosing between alternatives, managers attempt to
satisfice, or look for the one which is satisfactory or “good
enough”. Examples of satisficing criteria would be
adequate profit or share of the market and fair price.
They recognize that the world they perceive is a
drastically simplified model of the real world. They are
content with this simplification because they believe the
real world is empty anyway.
2.
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Simon’s Bounded Rationality Model (contd…)
3.
4.
Because they satisfice rather than maximize, they can make
their choices without first determining all possible behavior
alternatives and without ascertaining that these are in fact
all the alternatives.
Because they treat the world rather empty, they are able to
make decision with relatively simple rules of thumb or
tricks of the trade or force of habits. These techniques do
not make impossible demands upon their capacity for
thought.
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New Rational Techniques: ABC and EVA
Traditionally, accounting identified costs according to the category of
expenses (for example, salaries, supplies and fixed costs). Activity-based
Costing (ABC), on the other hand, determines costs according to what is paid
for the different tasks employees perform. Under ABC, costs associated with
activities such as processing sales orders, expediting supplies and/or customer
orders, resolving supplier quality and/or problem, and retooling of machines
are calculated. Both the traditional and ABC methods reach the same bottom
line costs, but ABC provides decision makers a much more accurate
breakdown of the cost data. For instance, at Hewlett-Packard when ABC
showed that testing new designs and parts was extremely expensive,
engineer changed their plans on the spot to favour components that required
less testing, thus greatly lowering costs.
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New Rational Techniques: ABC and EVA …
Another example of rethinking the traditional economic rationality used by
management decision makers is the finance technique of Economic Value
Added (EVA). A long standing tenet of the economic model has been that a
rational decision is one which resulted in the earning higher than the cost of
capital. Traditionally, the cost of capital has simply been equated with the
interest paid on borrowed capital. Under EVA, however, the true cost of all
capital is determined. For example, the true cost of equity capital is the
opportunity cost (what shareholders could earn in price appreciation and
dividends if they invested in similar company). Also, what a firm spends on
research and development or employee training has been traditionally treated
as expenses, but under EVA, it is treated as capital investment and is added into
the cost of capital. The EVA is determined by subtracting this total cost of
capital from the after-tax operating profit.
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The Social Model
At the opposite extreme from the economic rationality model is the Social Model.
Sigmund Freud presented humans as bundles of feelings, emotions, and instincts
with their behaviour guided by their unconscious desires.
Although most contemporary psychologists would take issue with the Freudian
description of humans, almost all would agree that social influences have
significant impact on decision-making behaviour. Furthermore, social pressures
and influences may cause managers to make irrational decisions.
There seems to be a tendency on the part of many decision makers to stick with a
bad decision alternative, even when it is unlikely that things can be turned
around. Staw and Ross have identified four major reasons why this phenomenon
of escalation of commitment might happen.
1)
2)
3)
4)
Project Characteristics
Psychological Determinants
Social Forces
Organizational Determinants
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Judgmental Heuristics and Biases Model (Kahneman &Tversky)
1. Are there more words in the English language that (a) begin with the
letter r or (b) have r as the third letter?
2. One one day in a large metropolitan hospital, eight birth were recorded by
gender in the order of their arrival. Which of the following orders of birth
(B= boy, G=girl) was most likely to be reported?
a. BBBBBBBB
b. BBBBGGGG
c. BGBBGGGB
3. A newly hired engineer for a computer firm in the Boston metropolitan
area has four years of experience and good all-around qualifications. When
asked to estimate the starting salary for this employee, Prof. Luthens
secretary (knowing very little about the profession or the industry) guesses
an annual salary of $50,000. What is your estimate?
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Judgmental Heuristics and Biases Model (Kahneman &Tversky)
The availability heuristic
This cognitive input into judgment refers to decision makers’ tendencies to assess
the frequency, probability, or likelihood of an event occurring by how readily
they can remember it. “An event that evokes emotions and is vivid, easily
imagined, and specific will be more ‘available’ from memory than will an event
that is unemotional in nature, bland, difficult to imagine, or vague.”
The representativeness heuristic
This second major heuristic uses decision rules of thumb based on the likelihood
of an event’s occurrence as judged by the similarity of that occurrence to
stereotypes of similar occurrences.
“the problem here is that we believe that a sequence of independent events (such
as eight births) generated from a random process should resemble the essential
characteristics of random process, even when the sequence is too short for that
process to express itself statistically. Decision makers expect a few examples of a
random event to behave in the same way as large numbers of the event.”
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The anchoring and adjustment heuristic
In this heuristic, the decision maker makes a judgment by starting from an initial
value or anchor and then adjusts to make the final decision.
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