Chapter - 3

Managerial

Decision Making

By. Dr. B. J. Mohite (9850098225)

Decision & Decision making

Decision - choice made from available alternatives

Decision Making - process of identifying problems

and opportunities and resolving them

Williams: It is a process of choosing a course of

actions from two or more alternatives.

Bartol and Martin: The process through which

managers identify organizational problems and

attempt to resolve them.

Stoner and Wankel: The process by which a course

of action is selected as the way to deal with a

specific problem

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Importance & Characteristics of

Decision-Making

• It is prerequisite for every managerial functions.

• It involves problem finding and problem solving using

available alternatives.

• It a process of selecting the course of action to solve the

problem

• It is situational- certainty, uncertainty, risk.

• It is dynamic process

• It is a mental process because the final selection is made

after thoughtful consideration.

• Aimed at achieving the objectives of the org.

Essentials for effective

Decision-Making

1. Accuracy

2. Environment for decision

3. Timely decision

4. Communication of decision

5. Participative decision-making

6. Implementation of decision

Difficulties in Decision-making

1. Incomplete Information

2. Un-supporting environment

3. Non-acceptance by subordinates

4. Ineffective Communication

5. Incorrect timing

Types/ categories of Problems and Decisions Structured problems

Involved clear goals and are familiar or have occurred before.

Information about problem is available & complete.

Programmed decision

A repetitive decision that can be handled by a routine approach.

Managers have made decision many times before

Example: Deciding to reorder office supplies

Unstructured problems

Problems that are new or unusual and for which information is incomplete.

Problems that will require custom-made solutions.

Non-programmed decisions

Decision that are unique and nonrecurring.

No rules to follow since the decision is new

These decisions are made based on information, and a manger’s judgment. Example: Should the firm invest in a new technology?

TYPES OF BUSINESS DECISIONS

• Programmed Decisions

• Non-Programmed

Decisions

• Strategic Decisions

• Tactical Decisions

• Operational Decisions

Programmed vs. Non-programmed Decisions

Characteristics Programmed Non-programmed

Also called Structured decision Unstructured

Type of problem Structured, routine,

well defined

Unstructured, novel,

ill defined

Managerial level Lower level Upper level

Frequency of

problem

Repetitive New, unusual

Information Readily available Ambiguous or

incomplete

Time frame for

solution

Short Relatively long

Judgment Objective Subjective

Solution relies on Procedures, rules, and

policies

Managerial Judgment

and creativity

METHODS OF DECISION MAKING

Decision made by authority without group discussion

Decision by expert team

Decision by averaging individuals

Decision made by authority after group discussion

Decision by minority or by majority vote

Decision by compromise

Types of systems based on the manager’s knowledge about the environment.

1.Closed decision making System: If the manager operates in a

known environment then it is a closed decision making system.

The conditions of the closed decision making system are:

a)The manager has a known set of decision alternatives and

knows their outcomes fully in terms of value, if implemented.

b)The manager has a model, a method or a rule whereby the

decision alternatives can be generated, tested, and ranked.

The manager can choose one of them, based on some goal or objective

A few examples are:

1. Product mix problem,

2. an examination system to declare pass or fail, or

3. an acceptance of the fixed deposits.

2. Open decision making System

If the manager operates in an environment not known to

him, then the decision making system is termed as an ODMS.

The conditions of this system are:

a) The manager does not know all the decision alternatives

b) The outcome of the decision is also not known fully. The

knowledge of the outcome may be a probabilistic one.

c) No method, rule or model is available to study and

finalize one decision among the set of decision

alternatives.

d) It is difficult to decide an objective or a goal and,

therefore, the manager resorts to that decision, where his

aspirations or desires are met best.

DECISION MAKING UNDER CERTANITY

• Outcome of all alternative are fixed and fully

known to Manager then this is called Decision

making under certainty

• It is very difficult to find complete certainty in

most of the business decisions.

• in many routine type of decisions, almost

complete certainty can be noticed.

• Ex: New carpet for a office.

• The decision maker is not in a position, even to

assign the probabilities of happening of the events.

• In the environment of uncertainty, more than one

type of event can take place and the decision maker

is completely in dark regarding the event that is

likely to take place.

• Such situations generally arise in cases where

happening of the event is determined by external

factors and information about alternatives and future

events is incomplete

• For example, demand for the product, moves of

competitors, etc. are the factors that involve

uncertainty.

DECISION MAKING UNDER RISK

• Here more then one state of nature exists and the decision maker has sufficient information to assign probabilities to each of this states.

• These probabilities could be obtained from the past records/ experience and simply the subjective judgment of the decision maker.

• Under condition of risk, knowing the probability distribution of the state of nature, the best decision is to select the course of action which has the largest expected pay off value.

• Under the condition of risk, there are more than one possible events that can take place.

• The decision maker has adequate information to assign probability to the happening or non- happening of each possible event.

Decisions helps to manage four types of risk:

1. Envisioning risk: The risk of solving the wrong problem

2. Ideation risk: the risk of not developing good alternative

3. Evaluation risk: The risk of choosing a poor alternative

4. Strategic risk: The risk of not following a beneficial strategy

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Parameters for Selecting a

Decision Making Model

1. Depends on the manager’s personal preference

2. Whether the decision is programmed or non-

programmed

3. Extent to which the decision is characterized

by risk, uncertainty, or ambiguity

The Classical Model of decision making • This is the earliest model of decision making developed as per

organization’s best economic interests. • They believed that man is completely rational in his decisions,

he always selects that alternative which gives him the greatest advantage.

• This perspective model tells how the decision should be made.

– Assumes managers have access to all the information needed to reach a decision.

– Managers can then make the optimum decision by easily ranking their own preferences among alternatives.

• Unfortunately, mangers often do not have all required information

• Approach assumes that managers are logical and rational.

• Approach assumes that managers’ decisions will be in the best interests of the organization.

The Classical Model

Rank each alternative

from low to high

Select best

alternative

List alternatives

& consequences Assumes all information

is available to manager

Assumes manager can

process information

Assumes manager knows

the best future course of

the organization

Administrative Model of decision making Is Descriptive model describes how non-programmed

decisions are made in uncertainty/ambiguity situation.

This model Challenges the classical assumptions that managers

have information about all process.

Herbert A Simon, a Nobel Prize winner in Economics,

developed the model to describe how decisions are often made

rather than to prescribe how they should be made

Argues that decision makers have incomplete and imperfect

information, are constrained by ‘bounded rationality’ and tend to ‘satisfiec’ when making decisions.

Bounded rationality suggests that decision makers are limited

by their values and unconscious response, skills and habits.

• Satisficing is the tendency to search for alternatives

only until one is found that meets some minimum

standard of sufficiency.

• Rather than conducting an exhaustive search for the

best possible alternative, decision makers tend to

search only until they identify an alternative that

meets some minimum standard of sufficiency.

• The Administrative Model can be used by managers

to develop a better understanding of their inherent

biases and limitations

Normative/ Perspective Descriptive

Theoretical in Nature Practical In nature

Advocate perfect rationality Advocate Bounded rationality

Step 1: Identifying the Problem

Problem: A discrepancy between an existing and desired state of affairs.

Characteristics of Problems

• A problem becomes a problem when a manager becomes aware of it.

• there is a pressure to solve the problem.

• the manager must have the authority, information, or resources needed to solve the problem.

Step 2: Identify the Decision Criteria

Decision criteria are factors that are important or relevant to resolving the problem.

• Costs that will be incurred (investment required).

• Risks likely to be encountered ( chance of failure).

• Outcomes that are desired ( growth of the firm).

Decision making process

Step 3: Allocating Weights to the Criteria

• Decision criteria are not of equal importance:

* Assigning a weight to each item.

* Places the items in the correct priority order of their importance

in the decision making process.

Step 4: Developing Alternatives

• Identifying available alternatives.

* Alternatives are listed that can resolve the problem.

Step 5 : Analyzing alternatives • Appraisi g ea h alter ati e’s stre gths a d eak esses

* A alter ati e’s appraisal is ased o its a ility to resol e the issues identified in step 2 and step 3.

Step 6: Selecting the alternative

Choosing the best alternative

* The alternative with the highest total weight is chosen.

Step 7: Implementing the Alternative

Putting the decision to and gaining comment from those whose will

carry out the decision.

Step 8: Evaluating the decision’s effectiveness

The soundness of the decision is judged by its outcomes.

* How effectively was the problem resolved by outcomes resulting

from the chosen alternatives?

* if the problem was not resolve, what went wrong?

The decision making process-Example

Memory and Storage, Display Quality,

Better Life,Warranty, Carrying weight

Memory and Storage-10, Display

Quality -8, Better Life -6,Warranty -4,

Carrying weight-3

Toshiba, HP, Soni Vaio, Qosmio,

Gateway, Apple iBook, Lenovo, Dell

Toshiba, HP, Soni Vaio, Qosmio,

Gateway, Apple iBook, Lenovo, Dell

Identification of a problem

Identification of Decision Criteria

Allocation of weights to criteria

Development of alternatives

Analyzing of alternatives

Selection of alternatives

Implementation of alternatives

Evaluation of decision alternatives

“My sales Reps need new computers!”

Toshiba, HP, Soni Vaio, Qosmio,

Gateway, Apple iBook, Lenovo, Dell

“ Toshiba!”

Also called Collective participative decision making

style. Democratic decision making is when the leader

gives up ownership and control of a decision and allows

the group to vote. Majority vote will decide the action.

Advantages include a fairly fast decision, and a certain

amount of group participation. The disadvantage of this

style includes no responsibility. An individual is not

responsible for the outcome. In fact, even the group

feels no real responsibility because some members will

say, "I didn't vote for that.". Lack of group and personal

responsibility seems to disqualify this style of decision

making; however, the democratic style does have its

place in business.

Decision Making Style

Autocratic decision making is when the leader maintains total

control and ownership of the decision. The leader is also

completely responsible for the good or bad outcome as a result

of the decision. The leader does not ask for any suggestions or

ideas from outside sources and decides from his or her own

internal information and perception of the situation. Advantages

include a very fast decision, and personal responsibility by the

leader, for the outcome. If an emergency situation exists, the

autocratic style is usually the best choice. The disadvantages

are varied and sometimes include less than desired effort from

the people that must carry out the decision. If the employee is

personally affected by the decision but not included when the

decision is made, morale and effort may or may not suffer. It is

not always predictable. If the outcome for the decision is not

positive, members of the organization begin to feel they could

have done a better job themselves and the leader may lose

credibility.

Collective - Participative decision making is when the leader

involves the members of the organization. Other perspectives of

the situation are discovered because the leader deliberately asks

and encourages others to participate by giving their ideas,

perceptions, knowledge, and information concerning the decision.

The leader maintains total control of the decision because,

although outside information is considered, the leader alone

decides. The leader is also completely responsible for the good or

bad outcome as a result of the decision. The advantages include

some group participation and involvement. This is especially

valuable when a person is affected negatively by the decision. In

most cases, the individual is informed before the decision is

implemented (no surprises) and usually feels good about personal

involvement. If the leader is a good communicator, and listens

carefully to the information collected, he or she will usually have a

more accurate understanding of the situation and make a better

decision. The disadvantages of this style include a fairly slow, time

consuming decision; less security, because so many people are

involved in the decision.

Consensus decision making is when the leader gives up total

control of the decision. The complete group is totally involved in

the decision. The leader is not individually responsible for the

outcome. The complete organization or group is now

responsible for the outcome. This is not a democratic style

because everyone must agree and "buy in" on the decision. If

total commitment and agreement by everyone is not obtained

the decision becomes democratic. The advantages include

group commitment and responsibility for the outcome.

Teamwork and good security is also created because everyone

has a stake in the success of the decision. A more accurate

decision is usually made, with a higher probability of success,

because so many ideas, perspectives, skills and "brains" were

involved in the creation. The disadvantages include a very slow

and extremely time consuming decision. It is also a lot of work

getting everyone in the organization involved. It takes skill and

practice for a group to learn how to work together.

Decision Making Techniques 1. Payoff matrix: Decision analysis tool that summarizes pros and

cons of a decision in a tabular form.

When all the alternatives and their outcomes are firmly not

known in such cases decisions are made with the help of payoff

analysis. In Payoff matrix Column shows condition & Row shows

alternatives. Payoff matrix provides quantitative measures to

decision makers called expected value(EV). This method is highly

relied on decision makers judgment

2. Decision Trees

• Decision trees used for showing sequential decisions

• A decision tree is a graphic display of the decision process

that indicates decision alternatives, states of nature and

their respective probabilities, and payoffs for each

combination of decision alternative and state of nature

Steps:

1. Define the problem

2. Draw the decision tree with nodes & branches

3. Assign probabilities to the states of nature

4. Estimate payoffs for each possible combination of

decision alternatives and states of nature

Decision Tree Example

Favorable market

Unfavorable market

Favorable market

Unfavorable market

Construct small plant

A decision node A state of nature node

Symbols used in a decision tree:

a. —decision node from which one of several alternatives may be selected

b. —a state-of-nature node out of which one state of nature will occur

3. Decision Table

This is very much precise in nature and helps analyst to take into

account various options, conditions, variables and alternatives.

Conditions and alternatives are presented with the help of table

4. Decision rules

• These are generally used in programmable or

operating decisions in economical and

efficient manner.

5. Linear Programming • This technique is used to select optimum solution among all feasible

solutions. • It is used to identify profit maximization and cost minimization situation

among existing one. • It involves making an optimum allocation of limited resources of an

organization to achieve a particular objective.

6. Queuing theory / Waiting – line method • This is and OR method that uses the mathematical technique for balancing

services provided and waiting lines. Waiting lines occur when the demand for the service exceeds the service facilities. as a perfect balancing between demand and supply can be achieved, customer have to wait for the service (demand exceed) or there may be no customers for the organization to serve (excess supply).

• If the queue is long, customer has to wait for long duration, causing frustration, the firm may loose the customer and on the other hand it is not feasible for the firm to maintain facilities to provide quick service all the time since the cost of idle service facilities have to borne by the company. Therefore the company has to strike a balance between the both. The queuing technique helps to optimize the customer service on the basis of quantitative criteria. It provides information for decision making but does not resolve the problem.

Types of Decisions 1. Programmed and Non-Programmed Decisions:

2. Major and Minor decisions

3. Routine and Strategic Decisions

4. Policy and operative decisions

5. Organizational and Personal decisions.

6. Individual and Group Decisions

7. Long-term and short-term decisions

8. Departmental decisions

9. Non-economic decisions: relate to values, moral behavior, etc.

10. Crisis and research Decisions: Crisis decisions are those which are made to meet unanticipated situations. Mostly made immediately under pressure of the circumstances. Research Decisions are made after thorough analysis without any pressure.

11. Initiative and forced Decisions

12. Problem and opportunity Decisions: problem decisions= resolving pro le situatio s hi h ha e arise as a ti ipated or ot…,

opportunity decisions= pertain to taking advantage of an opportu ity…so eti es i ol es risk.

Common decision-Making errors and Biases

Overconfidence Immediate

Gratification

Anchoring

Effect

Selective

Perception

Confirmation

framing Availability

representation

Randomness

Self-serving

Decision-Making

Errors & Biases

Criteria of Decision making

a. Optimistic Decisions: The DM think optimistically about the

event that influence decisions. They choose the alternative that

maximizes the outcome

b. Pessimistic Decisions: They believe that worst possible outcome

will occur no matter what they do. They estimate the worst

outcomes associated with each alternative and select the best of

these worst outcomes.

c. Realistic Decisions: They take the middle path neither optimistic

nor pessimistic.

d. Regret minimizing Decisions: They want to minimize the conflict

they experience after the fact.

e. Insufficient Reason Decisions: These are also called eqi-

probable decision maker. They assume that all the possible

outcomes have equal chance of occurring.

Herbert Simon model: Decision Making

Decision making is a process which the decision maker uses to

arrive at a decision. Simon considered each managerial action as

decision making. He describes the process of decision making as

comprising four steps: Intelligence, Design, Choice & Review

Decision making Phases • Herbert A. Si o ’s four basic phases:

– Intelligence stage: includes collection, classification,

processing & presentation of data related to the

organization & its environment. This is necessary to

identify situations calling for a Decision.

– Design stage: inventing, developing, and analyzing possible

course of actions. And examined for technological,

behavioral & economic feasibility

– Choice stage: Selecting a optimal course of action from

those available.

– Review stage: Assessing past choices and do necessary

changes if any.

Rational decision making model

• Manager is totally rational about the decision making.

• They have all the relevant information needed to take decisions.

• They are aware of the possibilities of the different alternative course

of actions and there outcomes

Significance of rational decision – making

• Manager who use a rational, intelligent, systematic approach are

more likely to come up with high quality solutions to the problem

they face.

• They have clear understanding of the alternative course of action to

accomplish the goal under particular situation.

• It is based on the information available and their ability to evaluate

the alternatives.

• Aim is to select the best alternative course which help to achieve the

goal.

Steps in the Rational decision making model

1. Recognize the need for decision

2. Diagnose the problem

3. Developing alternative

4. Selecting alternative

5. Implementing alternatives

6. Exercising control & follow-up.

Disadvantage

• It is difficult for manager to be completely rational

in decision making by taking future into

consideration, as future is uncertain.

• It is very difficult to determine all the alternative

course of actions.

• It is impossible to be completely rational when the

manager wants to venture into a new area.

• Evaluation of each of the alternative becomes

difficult.

• Ma ager a ’t e o pletely ratio al due to limitation of information, time and certainty.

Bounded Rationality

• Co eptualized y Her ert Si o i early 96 ’s

– He won the Nobel prize

• People try to behave rationally within the limits of their

information processing capabilities and within the context

of their attitudes and emotions

– they engage in restricted searches for information;

– have limited information processing capabilities

– rely on familiar sources of information

• biases and heuristics

• construct simplified models of reality

Simon’s definition...

The capacity of the human mind for

formulating and solving complex problems is

very small compared with the size of the

problems whose solution is required for

objectively rational behavior in the real world

-- or even for a reasonable approximation of

such objective rationality.

Cognitive Limitations

Human decision makers can retain only a few bits of

information in short-term memory

7 plus or minus 2

Those who think in concrete rather than abstract terms tend

to be somewhat limited in their ability to process

information

inside versus outside the box

Propensity for risk may limit the amount of information

needed to arrive at a decision

risk takers may require less information than risk avoiders

Bounded Rationality

Problem Space

Simon refers to this as “satisficing”

Bounded Rationality

• We all suffer from it

• There is no cure

• So how do we deal with it?

– We rely on structured problem solving

methods to help us minimize or overcome

the effects of BR