Table of Contents

Definitions
The Manager as Decision Maker
Organizational Decisions Type, Nature, Scope
The Decision Making Process
Decision Making under Certainty
Decision Making under Risk
Decision Making under Uncertainty
Decisions Based on Break-Even Analysis
Group Decision Making
Common Decision-Making Errors and Biases

How Do You Make Decisions?

Think about the way you decided you should
attend the Management lecture today !
Did you decide based on:
Reason (the advantages could be more important than
the disadvantages)
Habit (thats the schedule)
Knowledge gain
Persuasion
Emotion (I like management)
Other

Definitions

Decision Making - the process by which an individual

choose a specific course of action to respond to the
opportunities and problems that confront him/her.

Managerial Decision Making - the process by which

managers respond to opportunities and threats by
analyzing options, and making determinations about
specific organizational goals and courses of action

It is essentially a subjective process, even when managers

use scientific decision making methods

Decisions in the Management Functions

Planning
What are the organization's long-term objectives?
What strategies will best achieve those objectives?
What should the organization's short-term
objectives be?
How difficult should individual goals be?

Decisions in the Management Functions

Organizing

How many employees should I have report directly

to me?
What type of structure works best for my business
in the current situation?
How much centralization should there be in the
organization?
How should jobs be designed?
When should the organization implement a different
structure?

Decisions in the Management Functions

Leading

How do I handle employees who appear to be low

in motivation?
What is the most effective leadership/management
style in a given situation?
How will a specific change affect worker
productivity?
When is the right time to stimulate competition?

Decisions in the Management Functions

Controlling

What activities in the organization need to be

controlled?
How should those activities be controlled?
When is a performance deviation significant?
What type of management information system
should the organization have?

The Manager as Decision Maker

Everyone in an organization makes decisions, but decision

making is particularly important in a managers job.

Decision making is part of all four managerial functions decision making is the essence of management.

There are three perspectives

on how decisions are made:
Rationality
Bounded Rationality
Intuition

Rationality
We assume that managers decision making is going to be
rational.
Managers make consistent, value-maximizing choices with
specified constraints.
Assumptions are that decision makers:

Are perfectly rational, fully objective, and logical.

Have carefully defined the problem and identified all viable
alternatives.
Have a clear and specific goal.
Will select the alternative that maximizes outcomes in the
organizations interests rather than in their personal interests.

Bounded Rationality
Managers make decisions rationally, but are limited
(bounded) by their ability to process information.
Assumptions are that decision makers:

Will not seek out or have knowledge of all alternatives

Will satisficechoose the first alternative encountered that
satisfactorily solves the problemrather than maximize the
outcome of their decision by considering all alternatives and
choosing the best.
Influence on decision making according to their personality and
experience

Escalation of commitment: an increased commitment to a

previous decision despite evidence that it may have been
wrong.

Satisficing (Good Enough)

There is a tradeoff between the time and cost of
searching for an optimum versus the value of obtaining
one
A good enough or satisficing solution may be found if a
certain goal level is attained

Why satisfice?

Humans have a limited capacity for rational thinking

They generally construct and analyze a simplified model
Their behavior with respect to the simplified model may be rational
But, the rational solution for the simplified model may NOT BE
rational in the real-world situation
Rationality is bounded not only by limitations on human processing
capacities, but also by individual differences

The Role of Intuition

Managers often use their intuition and it may actually help
their decision making.
Intuitive decision making - making decisions on the basis of
experience, feelings, and accumulated judgment.
How common is intuitive decision making?

One survey of corporate executives found that almost half of managers

used intuition more than formal analysis to run their companies.

Situations where intuitive approach can help most:

Rapid response is required
The conditions change fast
The problem is poorly structured
The manager has to deal with ambigous, incomplete, or conflicting
information
There is no precedent

Intuition

Basic Types of Organizational Decisions

Non-programmed

Programmed

Novel opportunities or
problems

Recurring opportunities
or problems

Requires extra
information

There are rules or

guidelines to follow
based on experience

Uncertainty

Little ambiguity
involved

Nature of Decision

Structured Problems
Routine and repetitive with standard solution
Well defined decision making procedure
Given a well-defined set of input, a well defined set of output is
defined

Semi-structured Problems
Has some structured aspect
Some of the inputs or outputs or procedures are not well
defined

Unstructured Problems
All phases of decision making process are unstructured
Not well defined input, output set and procedures

Scope of Decision

Operational Planning and Control

Focus on efficient and effective execution
of specific tasks
They affect activities taking place right now
(E.g. What should be today's production level?)

Management Control and Tactical Planning

Focus on effective utilization of resources
Longer range planning horizon
(E.g. What is next years production level?)

Strategic Planning
Long-range goals and policies for resource allocation
(E.g. What new products should be offered?)

Information Characteristics
Characteristics
Accuracy
Level of detail
Time horizon
Use
Source
Scope
Nature
Age

Operational Managerial
High
Detailed
Present
Frequent
Internal
Narrow
Quantitative
Current

Strategic
Low
Aggregate
Future
Infrequent
External
Wide
Qualitative
Current/old

Six Steps in Decision Making

Recognize the need
for a decision
Generate
alternatives
Assess alternatives

Choose among
alternatives
Implement the
chosen alternative
Learn from
feedback

Degrees of Outcome Predictability

Certainty
A situation in
which a manager
can make accurate
decisions because
the outcome of
every alternative is
known.

Risk
A conditions in which
the decision maker is
able to estimate the
likelihood of certain
outcomes.
The ability to assign
probabilities may be
result of past personal
experiences or
secondary information.

Uncertainty
The choice of
alternative is influenced
by the limited amount
of information available
to the decision maker.

Certainty

Full knowledge of available alternatives

Full knowledge of what outcome will result from each
alternative
Few certain decisions in the real world
Example: Suppose a person has 50000 to invest for a oneyear period. One alternative is to open a savings account paying
4% interest and another is to invest in a Government treasury
note paying 9% interest. If both investments are secure and
guaranteed, then there is a certainty that the treasury note will
be the better investment.
Method: Preference Matrix

The Decision Making Process under Certainty

Risk
Knowledge of what the alternatives are
Know the probabilities of outcomes resulting from each
alternative.

Method: Decision Tree

Uncertainty

Goals are known, but

information about
alternatives and future
outcomes is incomplete
(probabilities unknown)

Methods (Decision rules):

Maximin
Maximax
Laplace
Minimax regret

Preference Matrix (Certainty)

Allows the manager to rate one/several alternatives according
to a selection of performance criteria

Alternative/
Criteria

C1

C2

... Cj ...

Cn

A1

a11

a12

... a1j ...

a1n

A2

a21

a22

... a2j ...

a2n

ai1

a12

... aij ...

ain

am1

am2

... amj ...

amn

...
Ai

...
Am

Preference Matrix (Certainty)

Each alternative is scored on any scale, such as from 1 (worst

possible) to 10 (best possible), or from 0 to 1, as long as the
same scale is applied to all the alternatives being compared

The criteria are weighted accordind to their perceived

importance, with the total of these weights tipically equaling
100 (%)

The total score of an alternative is the sum of the weighted

scores (weight x score) for all the criteria

The manager can compare the scores for alternatives against

one another (and choose the one with the highest score) or
against a predetermined standard.

Decision Tree (Risk)

1.

Is a schematic model of available alternatives, along with their

possible consequences

2.

It consists of a number of square nodes representing decision

points, left by branches, representing alternatives; branches leaving
circular nodes represent events

3.

The decision tree is drawn from left to right, but it is solved by

working from right to left

4.

Calculate the expected payoff for each node as follows:

For an event node, multiply the payoff of each branch by the events
probability. Add the results to get the events node expected payoff

For a decision node, pick the alternative that has the best expected
payoff; if an alternative leads to an event node, its payoff is equal to
that nodes expected payoff (already calculated)

Decision Tree (Risk) - Example

Mary is a manager of a gadget factory. Her factory has been
quite successful the past three years. She is wondering
whether or not it is a good idea to expand her factory this year.
The cost to expand her factory is $1.5M. If she does nothing
and the economy stays good and people continue to buy lots of
gadgets she expects $3M in revenue; while only $1M if the
economy is bad.
If she expands the factory, she expects to receive $6M if
economy is good and $2M if economy is bad.
She also assumes that there is a 40% chance of a good
economy and a 60% chance of a bad economy.
Which is the best alternative?

Decision Making under Uncertainty

Alternatives/
Conditions

C1

C2

C3

C4

C5

C6

C7

C8

A1

2000

3100

2650

3200

2600

3350

2980

2800

A2

3290

2300

2400

2650

2800

3100

3200

2700

A3

3700

2900

2300

2150

2600

2900

2700

3150

A4

2400

2540

3000

3100

3000

2900

2750

2850

A5

3100

3300

2200

2350

2400

2350

3500

2600

A6

2900

3200

2850

2500

2550

2900

3600

3300

Decision Making under Uncertainty

1.
2.
3.

4.

The manager can list the possible events but cannot estimate their
probabilities
Decision rules:
Maximin (pesimistic) choose the alternative that is the best of
the worst; anticipates the worst case for each alternative
Maximax (optimistic) choose the alternative that is the best of
the best; used when the decision maker has high expectations
Laplace (realistic) choose the alternative with the best
weighted payoff; to find the weighted payoff, give equal
importance (or probability) to each event
Minimax regret choose the alternative with the best worst
regret (the alternative with the highest compared payoff in case
the worst happens)

Regret the difference between a given payoff and the best payoff in the
same conditions (on the same column); it shows how much is lost by picking
an alternative over the one that is best for this event (situation/conditions)

Decisions Based on Break-Even Analysis

To

evaluate the idea for a new service/product

To asess the performance of an existing service/product
To evaluate a process (make-or-buy decisions)

Break-Even Analysis
Break-even quantity the volume at which total revenues equal
total costs.
money

Revenue (pQ)
Total Cost (F + cQ)

Break-even point
BEP

Variable cost (cQ)

Fixed cost (F)

Units (quantity)

Break-Even Analysis
a)

Evaluating services or products:

Is the predicted sales volume sufficient to break even?

How low must be the variable cost per unit be to break even,
based on current prices and sales forecast?

How low must the fixed cost be to break even?

How do price levels affect the break even volume?

Total cost = F + cQ
Revenue = pQ
Q=

F
p-c

F fixed cost
c variable cost per unit
Q quantity (number of units sold)
p price per unit

Example:
A hospital is considering a new procedure to be offered at 200 RON
per patient.The fixed cost per year would be 100 000 RON, with
variable cost of 100 RON per patient. What is the break even quantity
for this service?

C=F+cQ
C=100000+100*x
R=200*x
C=R
100000+100*x=200*x
x=1000

350.000
300.000

1.500

250.000

1.500

200.000

1.000

150.000

500

100.000

500

50.000

1
-

200

400

600
ct

800

1.000

valoare

1.200

1.400

1.600

Break-Even Analysis
b) Evaluating processes:
When choosing between two internal processes;
When choosing between an internal process and buying
services or materials on the outside
Fb + cbQ = Fm + cmQ

Q=

Fm - Fb
cb - cm

Fb fixed cost (per year) of the buy option

cb variable cost per unit of the buy option
Fm fixed cost (per year) of the make option
cm variable cost per unit of the buy option

Example:
The manager of a fast-food restaurant featuring hamburgers is adding salads
to the menu. For the two new options, the price for the customer will be the
same.
The make options is to install a salad bar stocked with vegetables, fruits, and
toppings and let the customer assemble the salad. The salad bar should have
be leased and a part-time employee hired. The manager estimates the fixed
costs at 12000 RON and variable costs totaling 5,5 RON per salad.
The buy option is to have preassembled salads available for sale. They would
be purchased from a local supplier at 6 RON per salad. Offering preassembled
salads would require installation and operation of additional refrigeration,
with an annual fixed cost of 2400 RON.
The manager expects to sell 25000 salads per year.
What is the break-even quantity?

Group Decision Making

The responsibility of decision making is divided between
group members, and the resulting decision represents the
consensus they reached
Techniques:

Brainstorming - involves a group of people (5-10), sitting around a table,

generating ideas in the form of free association; the primary focus is on
generation of ideas rather then on evaluation of ideas.
Nominal Group Technique (NGT) - is similar to brainstorming except that
the approach is more structured; members form the group in name only and
operate independently, generating ideas for solving the problem on their own, in
silence and in writing. Members do not interact with each other so that strong
personality domination is avoided.
Delphi Technique similar to the nominal group technique, except that it
involves obtaining the opinions of experts physically separated from each other
and unknown to each other.

Group Decision Making

Advantages

Availability/ diversity of
members skills, knowledge,
expertise
Enhanced memory
Greater ability to correct
errors
Greater decision acceptance
More alternatives generated
Better understanding of the
decision

Disadvantages

Time consuming
Group conflict, social
pressure, group polarization
Potential for groupthink
Lack of clear responsibility
(diffusion of responsibility)
Social loafing

Groupthink
Phenomenon in which the norm for consensus
overrides the realistic appraisal of alternative course
of action
Conditions:

Team leaders opinion is known

Team is highly cohesive
Team is isolated from outside influences
Team has recent decision failures

Symptoms of Groupthink
Group members rationalize any resistance to the
assumptions they have made.
Members apply direct pressures on those who express
doubts about shared views or who question the alternative
favored by the majority.
Members who have doubts or differing points of view keep
silent about misgivings
Characteristics:

Illusion of invulnerability
Collective rationalizations
Stereotypes of other groups
Self-censorship

Illusions of unanimity

Steps for Minimizing Groupthink

Group leader encourages thoughtfulness/ criticism

Group leader refrains from expressing own opinion and
views until group has considered all alternatives
Group leader encourages group members to gather
information from outside people
Group leader assigns devils advocate
Group leader holds second meeting for important decisions

Use Individual Decision Making

When
An individual has all capabilities
necessary to make a good decision

An individual can gather and assess

all necessary information

Acceptance of decision is
unnecessary or likely to occur
anyway

Common Decision-Making Errors

and Biases

Common Decision-Making Errors

and Biases

Overconfidence Bias - Holding unrealistically positive views of

ones self and ones performance.
Immediate Gratification Bias - Choosing alternatives that offer
immediate rewards and that to avoid immediate costs.
Anchoring Effect - Fixating on initial information and ignoring
subsequent information.
Selective Perception Bias - Selecting organizing and interpreting
events based on the decision makers biased perceptions.
Confirmation Bias - Seeking out information that reaffirms past
choices and discounting contradictory information.
Framing Bias - Selecting and highlighting certain aspects of a
situation while ignoring other aspects.

Common Decision-Making Errors

and Biases

Availability Bias - Losing decision-making objectivity by focusing

on the most recent events.
Representation Bias - Drawing analogies and seeing identical
situations when none exist.
Randomness Bias - Creating unfounded meaning out of random
events.
Sunk Costs Errors - Forgetting that current actions cannot
influence past events and relate only to future consequences.
Self-Serving Bias - Taking quick credit for successes and blaming
outside factors for failures.
Hindsight Bias - Mistakenly believing that an event could have
been predicted once the actual outcome is known (after-the-fact).