Managerial Decision Making

Khalil Ur Rehman malik [email protected] 0323-5807442 Page 1

MANAGERIAL DECISION MAKING

Manager’s challenge

Marjorie Yang is contemplating the biggest decision of her career—perhaps the

biggest decision in her company’s history. As chairperson and CEO of Esquel

Group, a textile manufacturer in Hong Kong that makes clothes for J. Crew,

Tommy Hilfiger, Brooks Brothers, and other top brands, Yang has the ultimate

say in whether the company invests $150 million in a brand-new fabric mill that

will be the best mill in China and could make Esquel the top shirt maker in the

world. Like most textile manufacturers, Esquel is going through a rough period.

With the end of U.S. textile quotas in early 2005, world capacity is going up,

prices are going down, and profit margins are squeezed in the middle. Esquel’s

strategy for years has been to go for top quality, first aiming to achieve

Japanese quality in the 1980s and now shooting to reach Italian quality, the best

in the world. Esquel grows its own high quality cotton in western China, and

Yang figures the new factory can help them make the most of it. With the end of

quotas, she reasons that more competitors will be investing in the low-quality

end of the market; thus, if Esquel can be the first company in China to reach the

pinnacle of quality, it will have a huge advantage with higher profit margins and

less competition. Yet doing the deal now is risky. At least half of the money will

have to be borrowed, and profits are sure to suffer in the short run. Although

most of Esquel’s top executives agree that the idea is good, at least half of them

believe building the factory now is too risky and that Yang should wait a couple

of years until the industry settles down and trends are clearer.

Every organization grows, prospers, or fails as a result of decisions by its

managers, and top executives like Marjorie Yang make difficult decisions every

day. Managers often are referred to as decision makers. Although many of their

important decisions are strategic, such as Yang’s decision whether to build a new

factory. Managers also make decisions about every other aspect of an

organization, including structure, control systems, responses to the

environment, and human resources. Managers scout for problems, make

decisions for solving them, and monitor the consequences to see whether


additional decisions are required. Good decision making is a vital part of good

management, because decisions determine how the organization solves its

problems, allocates resources, and accomplishes its goals.

A decision is a choice made from available alternatives. For example, an

accounting manager’s selection among Colin, Tasha, and Carlos for the position

of junior auditor is a decision. Many people assume that making a choice is the

major part of decision making, but it is only a part.

Decision making is the process of identifying problems and opportunities and

then resolving them. Decision making involves effort both before and after the

actual choice. Thus, the decision as to whether to select Colin, Tasha, or Carlos

requires the accounting manager to ascertain whether a new junior auditor is

needed, determine the availability of potential job candidates, interview

candidates to acquire necessary information, select one candidate, and follow up

with the socialization of the new employee into the organization to ensure the

decision’s success.

Programmed decision A decision made in response to a situation that has

occurred often enough to enable decision rules to be developed and applied in

the future.

Non-programmed decision

A decision made in response to a situation that is unique, is poorly defined and

largely unstructured, and has important consequences for the organization.

Many nonprogrammed decisions involve strategic planning, because uncertainty

is great and decisions are complex. Decisions to build a new factory, develop a

new product or service, enter a new geographical market, or relocate

headquarters to another city are all nonprogrammed decisions.

Programmed decisions are made in response to recurring organizational

problems. The decision to reorder paper and other office supplies when

inventories drop to a certain level is a programmed decision. Other programmed

decisions concern the types of skills required to fill certain jobs, the reorder point


for manufacturing inventory, exception reporting for expenditures 10 percent or

more over budget, and selection of freight routes for product deliveries. Once

managers formulate decision rules, subordinates and others can make the

decision, freeing managers for other tasks.

Certainty, Risk, Uncertainty, and Ambiguity

One primary difference between programmed and non-programmed decisions

relates to the degree of certainty or uncertainty that managers deal with in

making the decision. In a perfect world, managers would have all the

information necessary for making decisions. In reality, however, some things are

unknowable; thus, some decisions will fail to solve the problem or attain the

desired outcome. Managers try to obtain information about decision alternatives

that will reduce decision uncertainty.

Every decision situation can be organized on a scale according to the availability

of information and the possibility of failure. The four positions on the scale are

certainty, risk, uncertainty, and ambiguity, as illustrated in Exhibit 9.1. Whereas

programmed decisions can be made in situations involving certainty, many

situations that managers deal with every day involve at least some degree of

uncertainty and require nonprogrammed decision making.


Certainty

Certainty means that all the information the decision maker needs is fully

available. Managers have information on operating conditions, resource costs or

constraints, and each course of action and possible outcome. For example, if a

company considers a $10,000 investment in new equipment that it knows for

certain will yield $4,000 in cost savings per year over the next five years,

managers can calculate a before-tax rate of return of about 40 percent. If

managers compare this investment with one that will yield only $3,000 per year

in cost savings, they can confidently select the 40 percent return. However, few

decisions are certain in the real world. Most contain risk or uncertainty.

Risk

Risk means that a decision has clear-cut goals and that good information is

available, but the future outcomes associated with each alternative are subject

to chance. However, enough information is available to allow the probability of a

successful outcome for each alternative to be estimated.8 Statistical analysis

might be used to calculate the probabilities of success or failure. The measure of

risk captures the possibility that future events will render the alternative

unsuccessful. For example, to make restaurant location decisions, McDonald’s

can analyze potential customer demographics, traffic patterns, supply logistics,

and the local competition and come up with reasonably good forecasts of how

successful a restaurant will be in each possible location.

Many decisions made under uncertainty do not produce the desired results, but

managers face uncertainty every day. They find creative ways to cope with

uncertainty in order to make more effective decisions.

Ambiguity

Ambiguity is by far the most difficult decision situation. Ambiguity means that

the goals to be achieved or the problem to be solved is unclear, alternatives are

difficult to define, and information about outcomes is unavailable. Ambiguity is

what students would feel if an instructor created student groups, told each group

to complete a project, but gave the groups no topic, direction, or guidelines

whatsoever. Ambiguity has been called a wicked decision problem. Managers


have a difficult time coming to grips with the issues. Wicked problems are

associated with manager conflicts over goals and decision alternatives, rapidly

changing circumstances, fuzzy information, and unclear linkages among decision

elements. Sometimes managers will come up with a “solution” only to realize

that they hadn’t clearly defined the real problem to begin with.

Decision-making models

The approach managers use to make decisions usually falls into one of three

types— the classical model, the administrative model, or the political model. The

choice of model depends on the manager’s personal preference, whether the

decision is programmed or nonprogrammed, and the extent to which the

decision is characterized by risk, uncertainty, or ambiguity.

Classical Model

The classical model of decision making is based on economic assumptions. This

model has arisen within the management literature because managers are

expected to make decisions that are economically sensible and in the

organization’s best economic interests. The four assumptions underlying this

model are as follows:

1. The decision maker operates to accomplish goals that are known and agreed

upon. Problems are precisely formulated and defined.

2. The decision maker strives for conditions of certainty, gathering complete

information. All alternatives and the potential results of each are calculated.

3. Criteria for evaluating alternatives are known. The decision maker selects the

alternative that will maximize the economic return to the organization.

4. The decision maker is rational and uses logic to assign values, order

preferences, evaluate alternatives, and make the decision that will maximize the

attainment of organizational goals.

The classical model of decision making is considered to be normative, which

means it defines how a decision maker should make decisions. It does not

describe how managers actually make decisions so much as it provides

guidelines on how to reach an ideal outcome for the organization. The value of


the classical model has been its ability to help decision makers be more rational.

Many managers rely solely on intuition and personal preferences for making

decisions.

In many respects, the classical model represents an “ideal” model of decision

making that is often unattainable by real people in real organizations. It is most

valuable when applied to programmed decisions and to decisions characterized

by certainty or risk, because relevant information is available and probabilities

can be calculated.

Administrative Model

The administrative model of decision making describes how managers actually

make decisions in difficult situations, such as those characterized by

nonprogrammed decisions, uncertainty, and ambiguity. Many management

decisions are not sufficiently programmable to lend themselves to any degree of

quantification.

Managers are unable to make economically rational decisions even if they want

to.

Bounded Rationality and Satisfying

The administrative model of decision making is based on the work of Herbert A.

Simon. Simon proposed two concepts that were instrumental in shaping the

administrative model: bounded rationality and satisfying. Bounded rationality

means that people have limits, or boundaries, on how rational they can be. The

organization is incredibly complex, and managers have the time and ability to

process only a limited amount of information with which to make decisions.

Because managers do not have the time or cognitive ability to process complete

information about complex decisions, they must satisfies. Satisfying means that

decision makers choose the first solution alternative that satisfies minimal

decision criteria. Rather than pursuing all alternatives to identify the single

solution that will maximize economic returns, managers will opt for the first

solution that appears to solve the problem, even if better solutions are presumed

to exist.


The decision maker cannot justify the time and expense of obtaining complete

information. The administrative model relies on assumptions different from those

of the classical model and focuses on organizational factors that influence

individual decisions.

It is more realistic than the classical model for complex, nonprogrammed

decisions. According to the administrative model:

1. Decision goals often are vague, conflicting, and lack consensus among

managers. Managers often are unaware of problems or opportunities that exist

in the organization.

2. Rational procedures are not always used, and, when they are, they are

confined to a simplistic view of the problem that does not capture the complexity

of real organizational events.

3. Managers’ searches for alternatives are limited because of human,

information, and resource constraints.

4. Most managers settle for a satisficing rather than a maximizing solution,

partly because they have limited information and partly because they have only

vague criteria for what constitutes a maximizing solution.

The administrative model is considered to be descriptive, meaning that it

describes how managers actually make decisions in complex situations rather

than dictating how they should make decisions according to a theoretical ideal.

The administrative model recognizes the human and environmental limitations

that affect the degree to which managers can pursue a rational decision-making

process.

Political Model

The third model of decision making is useful for making nonprogrammed

decisions when conditions are uncertain, information is limited, and managers

may disagree about what goals to pursue or what course of action to take. Most

organizational decisions involve many managers who are pursuing different

goals, and they have to talk with one another to share information and reach an

agreement. Managers often engage in coalition building for making complex

organizational decisions. A coalition is an informal alliance among managers


who support a specific goal. Coalition building is the process of forming alliances

among managers. In other words, a manager who supports a specific

alternative, such as increasing the corporation’s growth by acquiring another

company, talks informally to other executives and tries to persuade them to

support the decision. When the outcomes are not predictable, managers gain

support through discussion, negotiation, and bargaining. Without a coalition, a

powerful individual or group could derail the decision-making process.

Coalition building gives several managers an opportunity to contribute to

decision making, enhancing their commitment to the alternative that is

ultimately adopted.

The political model begins with four basic assumptions:

1. Organizations are made up of groups with diverse interests, goals, and

values. Managers disagree about problem priorities and may not understand or

share the goals and interests of other managers.

2. Information is ambiguous and incomplete. The attempt to be rational is

limited by the complexity of many problems as well as personal and

organizational constraints.

3. Managers do not have the time, resources, or mental capacity to identify all

dimensions of the problem and process all relevant information. Managers talk to

each other and exchange viewpoints to gather information and reduce

ambiguity.

4. Managers engage in the push and pull of debate to decide goals and discuss

alternatives.

Decisions are the result of bargaining and discussion among coalition members.

The key dimensions of the classical, administrative, and political models are

listed in Exhibit 9.2. Recent research into decision-making procedures found

rational, classical procedures to be associated with high performance for


organizations in stable environments. However, administrative and political

decision making environments in which decisions must be made rapidly and

under more difficult conditions.

Decision-Making Steps

Whether a decision is programmed or nonprogrammed and regardless of

managers’ choice of the classical, administrative, or political model of decision

making, six steps typically are associated with effective decision processes.

These steps are summarized in Exhibit 9.3.


Recognition of Decision Requirement

Managers confront a decision requirement in the form of either a problem or an

opportunity. A problem occurs when organizational accomplishment is less than

established goals. Some aspect of performance is unsatisfactory. An

opportunity exists when managers see potential accomplishment that exceeds

specified current goals. Managers see the possibility of enhancing performance

beyond current levels.

Awareness of a problem or opportunity is the first step in the decision sequence

and requires surveillance of the internal and external environment for issues that

merit executive attention.

Diagnosis and Analysis of Causes

Once a problem or opportunity comes to a manager’s attention, the

understanding of the situation should be refined. Diagnosis is the step in the

decision-making process in which managers analyze underlying causal factors

associated with the decision situation. Managers make a mistake here if they

jump right into generating alternatives without first exploring the cause of the

problem more deeply.

Kepner and Tregoe, who conducted extensive studies of manager decision

making, recommend that managers ask a series of questions to specify

underlying causes, including the following:

:: What is the state of disequilibrium affecting us?

:: When did it occur?

:: Where did it occur?

:: How did it occur?

:: To whom did it occur?

:: What is the urgency of the problem?

:: What is the interconnectedness of events?

:: What result came from which activity?

Such questions help specify what actually happened and why. Managers at

General Motors are struggling to diagnose the underlying factors in the


company’s recent troubles. The problem is an urgent one, with sales, profits,

market share, and the stock price all plummeting and the giant corporation on

the verge of bankruptcy. Managers are examining the multitude of problems

facing GM, tracing the pattern of the decline, and looking at the

interconnectedness of issues such as changing consumer tastes in vehicles,

surging gas prices etc.

Development of Alternatives

Once the problem or opportunity has been recognized and analyzed, decision

makers begin to consider taking action. The next stage is to generate possible

alternative solutions that will respond to the needs of the situation and correct

the underlying causes. Studies find that limiting the search for alternatives is a

primary cause of decision failure in organizations.

For a programmed decision, feasible alternatives are easy to identify and in fact

usually are already available within the organization’s rules and procedures.

Nonprogrammed decisions, however, require developing new courses of action

that will meet the company’s needs. For decisions made under conditions of high

uncertainty, managers may develop only one or two custom solutions that will

satisfies for handling the problem.

Decision alternatives can be thought of as the tools for reducing the difference

between the organization’s current and desired performance. For example, to

improve sales at fast-food giant McDonald’s, executives considered alternatives

such as using mystery shoppers and unannounced inspections to improve quality

and service, motivating demoralized franchisees to get them to invest in new

equipment and programs, taking R&D out of the test kitchen and encouraging

franchisees to help come up with successful new menu items, and closing some

stores to avoid its own sales.

Selection of Desired Alternative

Once feasible alternatives are developed, one must be selected. The decision

choice is the selection of the most promising of several alternative courses of

action. The best alternative is one in which the solution best fits the overall goals

and values of the organization and achieves the desired results using the fewest


resources. The manager tries to select the choice with the least amount of risk

and uncertainty. Because some risk is inherent for most nonprogrammed

decisions, managers try to gauge prospects for success.

Implementation of Chosen Alternative

The implementation stage involves the use of managerial, administrative, and

persuasive abilities to ensure that the chosen alternative is carried out. The

ultimate success of the chosen alternative depends on whether it can be

translated into action. Sometimes an alternative never becomes reality because

managers lack the resources or energy needed to make things happen.

Implementation may require discussion with people affected by the decision.

Communication, motivation, and leadership skills must be used to see that the

decision is carried out. When employees see that managers follow up on their

decisions by tracking implementation success, they are more committed to

positive action At Boeing Commercial Airplanes, CEO Alan R. Mulally engineered

a remarkable turnaround by skillfully implementing decisions that reduced

waste, streamlined production lines, and moved Boeing into breakthrough

technologies for new planes.48 If managers lack the ability or desire to

implement decisions, the chosen alternative cannot be carried out to benefit the

organization.

Evaluation and Feedback

In the evaluation stage of the decision process, decision makers gather

information that tells them how well the decision was implemented and whether

it was effective in achieving its goals.

Feedback is important because decision making is a continuous, never-ending

process. Decision making is not completed when an executive or board of

directors votes yes or no. Feedback provides decision makers with information

that can precipitate a new decision cycle. The decision may fail, thus generating

a new analysis of the problem, evaluation of alternatives, and selection of a new

alternative. Many big problems are solved by trying several alternatives in

sequence, each providing modest improvement. Feedback is the part of

monitoring that assesses whether a new decision needs to be made


Personal decision framework

Imagine you were a manager at Tom’s of Maine, Boeing Commercial Airplanes, a

local movie theater, or the public library. How would you go about making

important decisions that might shape the future of your department or

company? So far we have discussed a number of factors that affect how

managers make decisions. For example, decisions may be programmed or

nonprogrammed, situations are characterized by various levels of uncertainty,

and managers may use the classical, administrative, or political model of

decision making.

In addition, the decision making process follows six recognized steps. However,

not all managers go about making decisions in the same way. In fact, significant

differences distinguish the ways in which individual managers may approach

problems and make decisions concerning them. These differences can be

explained by the concept of personal decision styles. Following Exhibit

illustrates the role of personal style in the decision-making process. Personal

decision style refers to distinctions among people with respect to how they

perceive problems and make decisions. Research identified four major decision

styles: directive, analytical, conceptual, and behavioural.

1. The directive style is used by people who prefer simple, clear-cut solutions

to problems. Managers who use this style often make decisions quickly because

they do not like to deal with a lot of information and may consider only one or

two alternatives. People who prefer the directive style generally are efficient and

rational and prefer to rely on existing rules or procedures for making decisions.

2. Managers with an analytical style like to consider complex solutions based

on as much data as they can gather. These individuals carefully consider


alternatives and often base their decisions on objective, rational data from

management control systems and other sources. They search for the best

possible decision based on the information available.

3. People who tend toward a conceptual style also like to consider a broad

amount of information. However, they are more socially oriented than those with

an analytical style and like to talk to others about the problem and possible

alternatives for solving it. Managers using a conceptual style consider many

broad alternatives, rely on information from both people and systems, and like

to solve problems creatively.

4. The behavioural style is often the style adopted by managers having a deep

concern for others as individuals. Managers using this style like to talk to people

one on- one and understand their feelings about the problem and the effect of a

given decision upon them. People with a behavioural style usually are concerned

with the personal development of others and may make decisions that help

others achieve their goals.

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Managerial Decision Making