Priciples of Management - Chapter 4.pptx

7/27/2019 Priciples of Management - Chapter 4.pptx

1/64

Principles of Management

Dr. Karim Kobeissi

Islamic University of Lebanon - 2013


2/64

4Chapter

Foundations

ofDecisionMaking

4-2


3/64

Learning Objectives

Describe the decision making process.

Explain the three approaches managers can

use to make decisions.

Describe the types of decisions and decision-

making conditions managers face.

Discuss group decision making. Discuss contemporary issues in managerial

decision making.


4/64

Introduction

Although everyone makes decisions in an organization, decision

making is particularly important to managers and is part of all four

managerial functions, as seen in the next slide.

Most decision making is routine, such as deciding which employee

will work which shift or how to resolve a customers complaint.


5/64


6/64


7/64

The Decision Making Process

Decision making is a basic part of every task a manager is involved, and it can

be viewed as an eight-step process that includes:

Step 1: Identification of a problem.

Step 2: Identification of Decision Criteria.

Step 3: Allocation of Weights to Criteria.

Step 4: Development of Alternatives.

Step 5: Analysis of Alternatives.

Step 6: Selection of an Alternative.

Step 7: Implementation of the Alternative.

Step 8: Evaluation of Decision Effectiveness.


8/64


9/64

Step 1 : Identification of a Problem

ProblemA discrepancy between an existing and a desired state of affairs.

How do managers become aware of such a discrepancy? They have to

compare the current state of affairs with some standard, which can be past

performance, previously set goals, or the performance of another unit

within the organization or in another organization. If, for example, a car is

no longer worth repairing, then the best decision may be to purchase

another car.


10/64


11/64

Step 2: Identification of Decision Criteria

Once a manager has identified a problem that needs attention, he or she must identify

the decision criteria that will be important in solving the problem. In the case of

replacing ones car, the cars owner assesses the relevant criteria, which might include:

Price

Model (two-door or four-door)

Size (compact or intermediate)

Manufacturer (Japanese, South Korean, German, or American)

Optional equipment (navigation system or side-impact protection)

Fuel economy


12/64


13/64

Step 3: Allocation of Weights to Criteria

In many decision-making situations, the criteria are not equally important, so its

necessary to allocate weights to the items listed in Step 2 to factor their relative

priority into the decision.

A simple approach is to give the most important criterion a weight of 10 and then

assign weights to the rest of the criteria against that standard to indicate their

degree of importance. Thus, a criterion that you gave a 5 is only half as important

as the highest-rated criterion.


14/64


15/64

Step 4: Development of Alternatives

In Step 4, the decision maker lists the alternatives that could resolve theproblem. The decision maker only lists the alternatives and does not attempt to

appraise them in this step. Lets assume that our subject has identified 12 cars asviable choices:

Jeep Compass

Ford Focus

Hyundai ElantraFord Fiesta SES

Volkswagen Golf

Toyota Prius

Mazda 3 MT

Kia Soul

BMW 335

Nissan Cube

Toyota Camry

Honda Fit Sport MT.


16/64

Step 5: Analyze of Alternatives

Once the alternatives have been identified, the decision maker moves to Step 5

that is, critically analyzing each alternative by appraising it against the criteria. The

strengths and weaknesses of each alternative become evident when compared with

the criteria and weights established in Steps 2 and 3.

In Exhibit 4-3 we see the assessed values that the subject put on each of her 12

alternatives after having test-driven each car. Some assessments can be achieved

objectively, such as the best purchase price; however, the assessment of how the car

handles is clearly a personal judgment. Most decisions contain judgments and these

judgments are reflected in which criteria is chosen in Step 2, the weights given to those

criteria, and the evaluation of alternatives.


17/64


18/64

Step 6: Selection of an Alternative

Step 6 is the critical act of choosing the best alternative from among those

assessed. Since we determined all the pertinent factors in the decision, weighted

them appropriately, and identified the viable alternatives, we choose the

alternative that generates the highest score in Step 5.

In our vehicle example (shown in Exhibit 4-4) the decision maker would choose the

Toyota Camry. On the basis of the criteria identified, the weights given to the

criteria, and the decision makers assessment of each car based on the criteria, the

Toyota scored highest with 224 points and thus became the best alternative.


19/64


20/64

Step 7: Implementation of the Alternative

Although the choice process is now complete, the decision may still

fail ifits not implemented properly.

Step 7 involves conveying the decision to those affected and to

obtaining their commitment. The people who must carry out a

decision are more likely to enthusiastically endorse the outcome if

they participate in the decision-making process.


21/64


22/64

Step 8: Evaluation of Decision Effectiveness

In Step 8, the last step in the decision-making process, managers

appraise the result of the decision to see whether the problem was

resolved. Did the alternative chosen in Step 6 and implemented in

Step 7 accomplish the desired result? Evaluating the results of a

decision is part of the managerial control process.


23/64


24/64

Common Errors

When managers make decisions, they not only use their own particular style but also

may use rules of thumb or judgmental shortcuts called heuristics to simplify theirdecision making.

Heuristics help make sense of complex, uncertain, and ambiguous information.

However, rules of thumb are not necessarily reliable and can lead managers into error

while processing and evaluating information.

In Exhibit 4-5, we see 12 common decision errors and biases:

1. Overconfidence occurs when decision makers think they know more than they do

or hold unrealistically positive views of themselves and their performance.

2. Immediate gratification describes decision makers who want immediate rewards

but want to avoid immediate costs. For these individuals, decision choices that

provide quick payoffs are more appealing than those with payoffs in the future.


25/64

Common Errors (con)

3. The anchoring effect describes when decision makers fixate on initial

informationsuch as first impressions, ideas, prices, and estimatesand

then fail to adequately adjust for subsequent information.

4. Selective perception occurs when decision makers organize and interpret

events based on their biased perceptions, which influence the information

they pay attention to, the problems they identify, and the alternatives they

develop.

5. Confirmation bias describes decision makers who seek out information that

reaffirms their past choices and who discount information that contradicts

past judgments. Such people tend to accept, at face value, information that

confirms their preconceived views and are critical and skeptical of information

that challenges these views.


26/64

Common Errors (con)

6. The framing bias occurs when decision makers select and highlight certain

aspects of a situation while excluding others. By drawing attention to specific

aspects of a situation and highlighting them, they downplay or omit other

aspects, distort what they see, and create incorrect reference points.

7. The availability bias occurs when decision makers focus on events that are

the most recent and vivid in their memory. As a result, their ability to recall

events objectively results in distorted judgments and probability estimates.

8. Representation bias describes how decision makers assess the likelihood of

an event based on how closely it resembles other events and then draw

analogies and see identical situations where they dont necessarily exist.

9. The randomness bias describes when decision makers try to create meaning

out of random events.


27/64

Common Errors (con)

10. The sunk costs error occurs when decision makers forget that current

choices cant correct the past. They incorrectly fixate on past expenditures oftime, money, or effort rather than on future consequences when they assess

choices.

11. Decision makers exhibiting self-serving bias take credit for their successes

and blame failures on outside factors.

12. Finally, the hindsight bias is the tendency for decision makers to falsely

believe that they would have accurately predicted the outcome of an event

once that outcome is actually known.

Awareness of these biases helps managers to avoid their negative effects and

can encourage them to ask colleagues to identify weaknesses in their decision

making style that the managers can then self-correct.


28/64


29/64


30/64

The Three Approaches Managers Use to making decisions

Managers can use three approaches to making decisions:

1. Rational decision making

2. Bounded rational decision making

3. Intuition


31/64

The Rational Model

In a perfect world, being a rational decision maker means being fully

objective and logical. The problem to be addressed would be clear-

cut and the decision maker would have a specific goal and anticipate

all possible alternatives and consequences. Ultimately, making

decisions rationally would consistently lead to selecting the

alternative that maximizes the likelihood of achieving that goal.


32/64

Bounded Rationality

Since most decisions that managers make dont fit the assumptions

of perfect rationality, a more realistic approach to describing how

managers make decisions is the concept ofbounded rationality. This

means that managers make decisions rationally but are limited (or

bounded) by their ability to process information. Because they cant

possibly analyze all information on all alternatives, managers

satisfice, rather than maximize. That is, they accept solutions thatare good enough.

The decision making is also influenced by the organizations culture,

internal politics, power considerations, and escalation ofcommitment, which is an increased commitment to a previous

decision despite evidence that it may have been wrong.


33/64

Intuition in Decision Making

Intuitive decision making involves making decisions on the basis of

experience, feelings, and accumulated judgment, which can

complement both rational and bounded rational decision making.

Researchers have identified five different aspects of intuition,

described in Exhibit 4-7.

Accordingly, we have:

Affective based decisions

Cognitive based decisions

Experiences based decisions Subconscious based decisions

Ethical or Values based decisions


34/64


35/64


36/64

Types of Problems

Problems can be divided into two categories:

1) Structured problem A straightforward, familiar, and easily

defined problem. Examples include a customer who wants to

return an online purchase or a TV news team that has to respond

to a fast-breaking event.

2) Unstructured problem A problem that is new or unusual for

which information is ambiguous or incomplete. Entering a new

market segment or deciding to invest in an unproven technology

are examples of unstructured problems.


37/64

Types of Decisions

As do problems, decisions can also be divided into two categories:

1) Programmed decisionsRepetitive decisions that can be

handled using a routine approach.

Programmed, or routine, decision making is the most efficient way

to handle structured problems. For example, what does a

manager do if an auto mechanic damages a customers rim while

changing a tire? Because the company probably has a

standardized method for handling this type of problem, itsconsidered a programmed decision, which tends to rely heavily

on previous solutionssuch as replacing the rim at the

companys expense.


38/64

Types of Decisions (con)

2) Nonprogrammed decisionsUnique and nonrecurring decisions;

require a custom-made solution. Nonprogrammed decisions are

used to handle unstructured problems. Examples of

nonprogrammed decisions include deciding whether to acquire

another organization or to sell off an unprofitable division.


39/64

Problems, Decision Types, and Organizational Levels

Exhibit 4-8, seen here,

describes the

relationship among types

of problems, types of

decisions, and ones level

in the organization.


40/64

Problems, Decision Types, and Organizational Levels (con)

Lower-level managers usually confront familiar and repetitive problems

and typically rely on programmed decisions, such as standard operating

procedures. As managers move up the organizational hierarchy, problems

are likely to become less structured.

However, few managerial decisions are either fully programmed or fully

nonprogrammed. This means that few programmed decisions eliminate

individual judgment completely and even the most unusual situation

requiring a nonprogrammed decision can often be helped by programmed

routines.


41/64

Decision Making Conditions

When making decisions, managers may face three different conditions:

certainty, risk, and uncertainty.

1) Certainty - An ideal situation for the decision maker to make accurate

decisions because the outcome of every alternative is known.

2) Risk - A situation where the decision maker is able to estimate the

likelihood of certain outcomes based on data from past personal

experiences or secondary information that lets the manager assign

probabilities to different alternatives.

3) Uncertainty A situation where a decision maker has neither certainty

nor reasonable probability estimates available.


42/64

H D G M k D i i ?


43/64

How Do Groups Make Decisions?

Many decisions in organizations, especially important decisions that have

far-reaching effects on organizational activities and personnel, are typically

made in groups such as:

Committees

Task forces

Review panels

Work teams


44/64

G D i i M ki B fi


45/64

Group Decision Making: Benefits

Group decision-making have their own sets of strengths such as:

Provides more complete information than an individual can,

bringing diversity of experiences and perspectives to the decision

process.

Generates more alternatives than a single individual can.

Quantities and diversity of information are greatest when group

members represent different specialties.

Increases legitimacy and acceptance of a solution because

group decisions may be perceived as more democratic and

legitimate than decisions made by a single person.

G D i i M ki D b k


46/64

Group Decision Making: Drawbacks

Alternatively group decision-making have their own sets of weaknesssuch as:

Group decisions are time-consuming and theinteraction that takesplace after the group is organized is frequently inefficient.

Groups are occasionally subject to domination by a minority of

members whose rank, experience, knowledge about the problem,influence on other members views, which often leads to inefficientinteraction.

Groupthink is a response to pressures to conform in groups inwhich group members withhold deviant, minority, or unpopularviews to give the appearance of agreement.

Occasionally group members share responsibility without anyonetaking responsibility for the final decision which creates a situationofambiguous responsibility in case of dissatisfying consequences.

Wh A G M t Eff ti ?


47/64

When Are Groups Most Effective?

Whether groups are more effective than individuals dependson thecriteria used for defining effectiveness, such as accuracy, speed,

creativity, and acceptance.

Individuals are faster at decision making.

Groups tend to be more accurate, make better decisions, be

more creative, and be more effective in terms of acceptance ofthe final solution.

With few exceptions, group decision making consumes morework hours than individual decision making does.

Ultimately, primary consideration must be given to assessingwhether increases in effectiveness outweigh the losses inefficiency.


48/64

C t I


49/64

Contemporary Issues

Research shows that decision-making practices differ from countryto country and two examples of decision variables that reflect a

countrys national cultural environment are:

The way decisions are made, whether by group or teammembers, participatively (e.g., in Japan), or autocratically by an

individual manager (e.g., in Lebanon).

The degree of risk a decision maker is willing to take.

Decision makers also need creativity: the ability to produce noveland useful ideas. These ideas are different from whats been donebefore but are also appropriate to the problem or opportunitypresented.


50/64

Quantitative Module

Quantitative

Decision-MakingAids

Payoff Matrices


51/64

Payoff Matrices

Uncertainty affects decision making by limiting the amount ofinformation available to managers and exploiting their psychological

orientation.

For instance, the optimistic manager typically follows a maximaxchoice (that is, maximizing the maximum possible payoff); thepessimist will often pursue a maximin choice(that is, maximizing the

minimum possible payoff); and the manager who desires tominimize his regret will opt for a minimax choice.

Lets look at these different approaches using an example of amarketing manager promoting the Visa card throughout the

northeastern United States who has determined four possiblestrategies: S1, S2, S3, and S4. He is also aware that one of his majorcompetitors, American Express, has three competitive strategiesCA1, CA2, and CA3for promoting its own card in the same region.


52/64

Payoff Matrices


53/64

Payoff Matrices

We assume that the Visa executive has no previous knowledge that allows him to place

probabilities on the success of any of his four strategies. With these facts, the Visa card manager

formulates the matrix seen here in Exhibit QM1 to show the various Visa strategies and the

resulting profit to Visa, depending on the competitive action chosen by American Express.

1. If our Visa manager is an optimist, hell choose S4 because that could produce the largest

possible gain ($28 million), which maximizes the maximum possible gain (that is, themaximax choice).

2. If our manager is a pessimist, hell assume only the worst can occur and the worst

outcome for each strategy is as follows: S1, $11 million; S2, $9 million; S3, $15 million; and

S4, $14 million. Following the maximin choice, the pessimistic manager would maximize the

minimum payoff - in other words, hed select S2.

In the remaining two strategic approaches, managers recognize that once a decision is made it

will not necessarily result in the most profitable payoff. What could occur is a regret of profits,

as seen in Exhibit QM-2 in the following slide.


54/64

Payoff Matrices: Regret Matrix


55/64

Payoff Matrices: Regret Matrix

In the third approach, managers acknowledge a regret of profits givenupthat is, regret of the money that could have been made had adifferent strategy been used. Managers calculate regret by subtracting all

possible payoffs in each category from the maximum possible payoff foreach givenin this case, for each competitive action. For our Visamanager, the highest payoff, as seen in QM-1, given that American Expressengages in CA1, CA2, or CA3, is $24 million, $21 million, or $28 million,respectively (that is, the highest number in each column).

Subtracting the payoffs in Exhibit QM1 from these figures produces theresults in Exhibit QM2. That means, starting with column CA1, subtracteach value for S1, S2, S3, and S4 from $24 million to get the values incolumn CA1 in the Regret Matrix. For example, CA1 (which is $24 million) S1 (which is $13 million) = $11 million in the Regret Matrix. Likewise, CA1(which is $24 million) S2 (which is $9 million) = S2 ($15 million), and soon.

The maximum regrets are S1 = $17 million; S2 = $15 million; S3 = $13million; and S4 = $7 million. The minimax choice minimizes the maximumregret, so our Visa manager would choose S4. By making this choice, hellnever have a regret of profits forgone of more than $7 million. This resultcontrasts, for example, with a regret of $15 million had he chosen S2 and

American Express had taken CA1.

Decision Trees


56/64

Decision Trees

Decision trees are useful for analyzing hiring, marketing, investment,equipment purchases, pricing, and similar decisions that involve aprogression of decisions.

Typical decision trees assign probabilities to each possible outcome andcalculate payoffs for each decision path. Exhibit QM3 illustrates a decisionfacing Becky Harrington, the site selection supervisor for Waldenbookstores in the Midwestern region. Becky supervises a small group ofspecialists who analyze potential locations and make store site

recommendations to the regions director. The lease on the companysWinter Park, Florida store is expiring, and the property owner has decidednot to renew it. Becky and her group have to make a relocationrecommendation. Beckys group has identified an excellent site in a nearbyshopping mall in Orlando. The mall owner has offered her two comparablelocations: one with 12,000 square feet (the same as she has now) and theother a larger, 20,000-square-foot space.

Beckys initial decision concerns whether to recommend renting the largeror smaller location. If she chooses the larger space and the economy isstrong, she estimates the store will make a $320,000 profit. However, if theeconomy is poor, the higher operating costs of the larger store will meanthat the profit will be only $50,000. With the smaller store, she estimates

the profit at $240,000 with a good economy and $130,000 with a poor one.


57/64

Decision Trees (con)


58/64

Decision Trees (con)

As we can see from Exhibit QM3, the expected value for the larger store is

$239,000that is, [(.70 x 320) + (.30 x 50)]. The expected value for the

smaller store is $207,000that is [(.70 x 240) + (.30 x 130)]. Given these

projections, Becky plans to recommend the rental of the larger store space.

If Becky wants to consider the implications of initially renting the smaller

space and then expanding if the economy picks up, she can extend the

decision tree to include this second decision point. She has calculated

three options: no expansion, adding 4,000 square feet, and adding 8,000

square feet. Following the approach used for Decision Point 1, she could

calculate the profit potential by extending the branches on the tree and

calculating expected values for the various options.

Break-Even Analysis


59/64

Break-Even Analysis

Break-even analysis is a widely used technique for helping managers makeprofit projections. It points out the relationship among revenues, costs, andprofits. To compute the break-even point (BE), the manager needs to know theunit price of the product being sold (P), the variable cost per unit (VC), and thetotal fixed costs (TFC).

An organization breaks even when its total revenue is just enough to equal itstotal costs. But total cost has two parts: a fixed component and a variablecomponent.

Fixed costs are expenses that do not change, regardless of volume, such asinsurance premiums and property taxes. Fixed costs, however, are fixed onlyin the short term because commitments terminate later on and are thussubject to variation.

Variable costs change in proportion to output and include raw materials, laborcosts, and energy costs.

The break-even point can be computed graphically or by using the followingformula:

BE = [TFC/1P - VC2]

Break-Even Analysis (con)


60/64


Lets assume that at Joses Bakersfield Espresso, Jose charges $1.75

for an average cup of coffee. If his fixed costs (salary, insurance, and

so on) are $47,000 a year and the variable costs for each cup of

espresso are $0.40, Jose can compute his break-even point as

follows: $47,000/(1.75 0.40) = 34,815 /52 weeks = about 670 cups

of espresso sold each week, or when annual revenues are

approximately $60,926. This relationship is shown graphically in

Exhibit QM4.


61/64



62/64


Break-even analysis also serves as a planning and decision-making

tool. As a planning tool, it could help Jose set his sales objective. For

example, he could establish the profit he wants and then work

backward to determine what sales level is needed to reach that

profit. As a decision-making tool, break-even analysis could tell Jose

how much volume has to increase to break even if he is currently

operating at a loss, or how much volume he can afford to lose and

still break even if he is currently operating profitably.

Ratio Analysis


63/64

Ratio Analysis

Managers often examine their organizations balance sheet and

income statements to analyze key ratios. This means they compare

two significant figures from the financial statements and express

them as a percentage or ratio. This practice allows managers to

compare current financial performance with that of previous periods

which aids managers in deciding their future activities. Some of the

more useful ratios evaluate liquidity, leverage, operations, and

profitability. These ratios are summarized in Exhibit QM5.


64/64

Documents

Priciples of Management - Chapter 4.pptx