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

Feedbac
k

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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Mintzbergs 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
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.
1. The decision will be completely rational in the means-end
sense.
2. There is a complete and consistent system of preferences
which allows a choice among alternatives.
3. There is complete awareness of all the possible
alternatives.
4. There is no limits to the complexity of computations that
can be performed to determine the best alternatives.
5. Probability calculations are neither frightening nor
mysterious.
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Simons 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 decision-making 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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Simons 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).
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)Project Characteristics
2)Psychological Determinants
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3)Social Forces
4)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 allaround 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 events 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
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examples of a random event to behave in the same way as large

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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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