Understanding Management Decision Making

The Value of Decision Making Based on Data(Scientific Decision Making)And on Intuition

All business decisions contain risk. The risk is that the rewards for a decision are outweighed by the costs.

Decisions take into account possible future events.

Good management weighs up as much information as possible, predicts what the possible outcomes might be and then decides which course of action generates the best rewards.

Risks include:

  1. Lack of sales.
  2. Higher costs than expected.
  3. Projects not being completed on time.
  4. More competition than expected.

Rewards are the potential profits from a decision. Rewards can also be expressed in terms of better recruitment, lower costs of materials acquisition or opening new markets.

Making decisions takes time, cost and requires expertise.

The best managers have a strong knowledge of the possible outcomes, sometimes based on data, sometimes on past experiences.

Decisions made using data are called scientific decisions__. The process follows a logical sequence of setting objectives, gathering and analysing data, selecting a decision and executing, before reviewing and then starting the process again (see diagram),

Decisions made without much consideration for the data are called intuition.

In practice, all decisions will probably be a combination of both.

Though it would be preferable to have as much information as possible, this takes time and can come at a considerable cost. If managers spend too much time on a decision, the opportunity might have gone.

More data may reduce uncertainty, but nothing is completely certain. Therefore, data should only be part of the decision-making process.

Also, it’s possible to have too much data, meaning more time and resources are taken up analysing the possible outcomes.

A decision can be worthless unless it is executed properly. And, once implemented, it needs to be measured against the objectives. This might lead to different decisions in the future.

Expected values

To help deal with uncertain outcomes, it is possible to come up with expected values. That is a way of calculating the potential gains (or losses) of a project by taking into account several possible outcomes.

Understanding Management Decision Making, figure 1

Understanding Management Decision Making, figure 2

Net gains are the expected values less the initial cost of a given choice.

Understanding Management Decision Making, figure 3

Expected gains can be put into a model called a decision tree, which maps out possible outcomes. It’s unlikely that you will need to draw a decision tree in an exam, but you need to know how to calculate expected values, and then assess the net gains.

In decision making, it’s good to use the opportunity costs of any decision. Opportunity cost measures the value of one decision against what could have been gained by taking the next best decision.

For example, the opportunity cost of launching a new product in the UK could be the benefit foregone of repurposing and relaunching an old product.

The Use and Value of Decision Trees in Decision Making

Decision trees are a useful tool to help order the decision-making process. They make managers consider all the courses of action.

The outcomes of the decision tree are only as strong as the original data and interpretation. Because markets are dynamic (ever-changing) and it’s hard to find data for new products, they have limited use, particularly in relation to new products.

They also don’t reflect possible long-term consequences of the decision.

The business needs to take into account non-financial information, such as the possible impact on the other objectives of the business, whether the staff will be able to embrace the change or the possible implications for stakeholders like the local community.

As with all models, weigh up the pros and cons by considering:

  1. How accurate is the data?
  2. How good is the analysis?
  3. What non-numerical information needs to be considered?
  4. How does the outcome fit with this business’s objectives, people and product?
  5. Finally, how much risk is this business prepared to take?

Understanding Management Decision Making, figure 1

Influences on Decision Making

Decision making needs to consider more than the immediate impact of an action.

It needs to fit into:

  1. Mission – does it follow the way the business operates as a whole?
  2. Objectives – will it help meet its short-term and long-term objectives, and will it impact negatively on other objectives in other areas of the business?
  3. Ethics – will the decision be morally wrong in the eyes of the stakeholders, for example, sourcing materials from countries with a poor record on human rights or working conditions?

There are also external constraints to consider, which are out of the control of the business. These include government policies, legislation and competition.

In addition, the business needs to take into account the resource constraints:

  1. Employees, present and future – and their qualities.
  2. Suppliers
  3. Transport
  4. Finance – does the business have access to the cash it needs to implement the initial plan?

Why use a scientific approach? Depends on how much risk-averse the leader is. Risk-averse means how much a person wants to avoid risk. The more risk-averse, the more likely the leader will look for as much information as possible before the moment has come when a decision has to be made.

Definitions

Risk-averseHow much a decision maker wants to avoid risk
ConsultationAsking others for their opinions on a decision
RisksThe possible downsides of a decision
Decision treesA model that shows possible decisions and their expected outcomes based on probabilities
EthicsWhat is considered morally right or wrong
UncertaintyAny outcome which is unpredictable
Opportunity costThe benefit foregone of the next best alternative