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Decision Making

Decision making is defined as selection of a course of action from among


alternatives; it is at the core of planning. A plan cannot be said to exist unless a
decision has been made.

Managers some times see decision making as their central job because they
must constantly choose what is to be done, who is to do it, and when, where,
and occasionally even how it will be done. Decision making is, however, only a
step in planning, even when it is done quickly and with little thought or when it
influences action for only a few minutes. It is also part of everyone's daily
living. A course of action can seldom be judged alone, because virtually every
decision must geared to other plans.

TYPES OF DECISIONS
Decisions may be of different types. Some of the important types of managerial
decisions are explained below.
1. programmed and non-programmed decisions
2. Major and minor decisions
3. Routine and strategic decisions
4. organizational and personal decisions
5. individual and group decisions
6. policy and operation decision

PROGRAMMED AND NON PROGRAMMED DECISIONS


Programmed decisions are made with some rules and procedures. Programmed
decisions are of routine nature and are taken at lower level management. The
decisions like making routine purchases, allowing trade discounts are
programmed decisions. Non-repetitive decisions are on the other hand non
programmed decisions. The need for such decisions arises due to specific
circumstances. These decisions are taken at top level management. The
opening a new branch, launching a new product, purchasing a new machinery
are some of the examples of non programmed decisions.

MAJOR AND MINOR DECISINS


A decision to purchase new machinery costing several lakhs is a major decision
and purchase of few reams of typing paper is a minor decision

ROUTINE AND STRATEGIG DECISIONS


Routine decisions are of repetitive nature, do not require much analysis and
evaluation and can be made quickly at lower and middle level. Strategic
decisions relate to policy matter, are taken at higher level. Examples are capital
expenditure decisions, pricing decisions etc

ORGANIZATIONAL AND PERSONAL DECISIONS


A manager making a decision in the name of a company is an organizational
decision and can be delegated and personal decision taken as an individual
cannot be delegated.

INDIVIDUAL AND GROUP DECISION


Individual decisions are taken by a single individual in context of routine
decisions where guidelines are already provided. Group decisions are taken by a
committee constituted for this specific purpose. Such decisions are very
important for the organization

STEPS IN DECISION MAKING

The following are the steps in the process of decision making

1. defining and analyzing the problem

2. developing alternative solution

3. selecting the best alternative

4. converting the decision into effective action

5. follow up

DEFINING & ANALYSING THE PROBLEM

Before one starts the process of decision making he should clearly understand
the problem for which a decision I needed. Only when the problem is analysed
properly all the aspects of the problem can be understood. Thus a proper
analysis and defining of the problem is the first step in decision making. It is
also necessary to classify the problem in order to know who must take the
decision, who must be consulted in making it and who must be informed.

DEVELOPING ALTERNATIVE SOLUTION

A problem can be solved in different ways. The decision taker has to search for
and identify each possible solution or alternative. Otherwise he may be forced
an alternative which may not be the most efficient or most profitable one.

SELECTING THE BEST ALTERNATIVE

Once the alternative solutions are identified the decision maker will evaluate
each alternative. The merits and demerits of each alternative must be studied
carefully.

CONVERTING THE BEST ALTERNATIVE TO ACTION

A mere decision will not be sufficient. The decision taker should see that it is
implemented successfully. The decision should be taken should be effectively
communicated to those persons who are to implement them.

FOLLOW UP

Follow up helps to evaluate the effectiveness of decision taken and


implemented. This gives the decision taker a chance to revise the past
decisions, if needed, or to make a better decision in the future.
Rationality in Decision Making
It is frequently said that effective decision making must be rational. But what is
rationality? When is a person thinking or deciding rationally?
People acting or deciding rationally are attempting to reach some goal that
cannot be attained without action. They must have a clear understanding of
alternative courses by which a goal can be reached under existing circum-
stances and limitations. They also must have the information and the ability to
analyze and evaluate alternatives in the light of the goal sought. Finally, they
must have a desire to come to the best solution by selecting the alternative that
most effectively satisfies goal achievement.

People seldom achieve complete rationality, particularly in managing In the first


place, since no one can make decisions affecting the past, decisions must
operate for the future, and the future almost invariably involves uncertainties.
In the second place, it is difficult to recognize all the alternatives that might be
followed to reach a goal; this is particularly true when decision making involves
opportunities to do something that has not been done before. Moreover, in most
instances, not all alternatives can be analyzed, even with the newest available
analytical techniques and computers.

Limited or "Bounded" Rationality


A manager must settle for limited rationality, or "bounded" rationality. In other
words, limitations of information, time, and certainty limit rationality even
though a manager tries earnestly to be completely rational. Since managers
cannot be completely rational in practice, they sometimes allow their dislike of
risk — the desire to "play it safe" — to interfere with their desire to reach the
best solution under the circumstances. Herbert Simon has called this
satisfying, that is, picking a course of action that is satisfactory or good
enough under the circumstances. Although many managerial decisions are
made with a desire to "get by" as safely as possible, most managers do attempt
to make the best decisions they can within the limits of rationality and in the
light of the size and nature of risks involved.

The Principle of the Limiting Factor


Assuming that we know what our goals are and agree on clear planning|
premises, the first step of decision making is to develop alternatives. There an
almost always alternatives to any course of action. indeed, if there seems to
only one way of doing a thing, that way is probably wrong. If we can think only
one course of action, clearly we have not thought hard enough. |
The ability to develop alternatives is often as important as being able to select
correctly from among them.. The manager needs help in this situation, and this
he| as well as assistance in choosing the best alternative, is found in the
concept the limiting or strategic factor.

A limiting factor is something that stands in the way of accomplishing desired


objective. Recognizing the limiting factors in a given situation make possible to
narrow the search for alternatives to those that will overcome the limiting
factors.
The principle of the limiting factor is as follows: By recognizing and over
coming those factors that stand critically in the way of a goal, the best
alternative course of action can be selected.

EVALUATION OF ALTERNATIVES

Once appropriate alternatives have been found, the next step in planning is to
evaluate them and select the one that will best contribute to the goal.

This is the point of ultimate decision making, although decisions must also be
made in the other steps of planning in selecting goals, in choosing critical
premises, and even in selecting alternatives.

Quantitative(tangible) and Qualitative(intangible) Factors

In comparing alternative plans for achieving an objective, people are likely to


think exclusively of quantitative factors. These are factors that can be mea-
sured in numerical terms, such as time or various fixed and operating costs. No
one would question the importance of this type of analysis, but the success of
the venture would be endangered if intangible, or qualitative, factors were
ignored.
Qualitative, or intangible, factors are those that are difficult to measure
numerically, such as the quality of labor relations, the risk of technological
change, or the international political climate. There are all too many instances
in which an excellent quantitative plan was destroyed by an unforeseen war, a
fine marketing plan was made inoperable by a long transportation strike, or a
rational borrowing plan was hampered by an economic recession. These illus-
trations point out the importance of giving attention to both quantitative and
qualitative factors when comparing alternatives.
To evaluate and compare the intangible factors in a planning problem and
make decisions, a manager must first recognize these factors and then deter-
mine whether a reasonable quantitative measurement can be given them. If
not, he or she should find out as much as possible about the factors, perhaps
rate them in terms of their importance, compare their probable influence on the
outcome with that of the quantitative factors, and then come to a decision. This
decision may give predominant weight to a single intangible.

Such a procedure allows the manager to make decisions on the basis of the
weight of the total evidence. It does involve fallible personal judgments; how-
ever, few managerial decisions can be so accurately quantified that judgment is
unnecessary. Decision making is seldom simple. It is not without justification
that the successful executive has been cynically described as a person who
guesses right.

Marginal Analysis

Evaluating alternatives may involve utilizing the techniques of marginal


analysis to compare additional revenues arising from additional costs. Where
the objective is to maximize profits, this goal will be reached, as elementary
economics teaches, when the additional revenues and additional costs are
equal. In other words, if the additional revenues of a larger quantity are greater
than its additional costs, more profits can be made by producing more.
However, if the additional revenues of the larger quantity are less than its
additional costs, a larger profit can be made by producing less.

SELECTING AN ALTERNATIVE: THREE APPROACHES

When selecting from among alternatives, managers can use three basic
approaches:

(1) experience

(2) experimentation

(3) research and analysis.

Experience

Reliance on past experience probably plays a larger part than it deserves in


decision making. Experienced managers usually believe, often without realizing
it, that the things they have successfully accomplished and the mistakes they
have made furnish almost guides to the future. To some extent, experience is
the best teacher. The very fact that managers have reached their position
appears to justify their past decisions. Moreover, the process of thinking
problems through, making decisions, and seeing programs succeed or fail does
make for a degree of good judgment. Many people, however, do not profit by
their errors, and there are managers who seem never to gain the seasoned
judgment required by modern enterprise.
Relying on past experience as a guide for future action can be dangerous,
however. In the first place, most people do not recognize the underlying reasons
for their mistakes or failures. In the second place, the lessons of experience may
be entirely inapplicable to new problems. Good decisions must be evaluated
against future events, while experience belongs to the past.

Experimentation
An obvious way to decide among alternatives is to try one of them and see what
happens. The experimental technique is likely to be the most expensive of all
techniques, especially if a program requires heavy expenditures in capital and
personnel and if the firm cannot afford to vigorously attempt several
alternatives. Besides, after an experiment has been tried, there may still be
doubt about what it proved, since the future may not duplicate the present. This
technique, therefore, should be used only after considering other alternatives.

Research and Analysis


One of the most effective techniques for selecting from alternatives when major
decisions are involved is research and analysis. This approach means solving a
problem by first comprehending it. It thus involves a search for relationships
among the more critical of the Variables, constraints, and premises that bear
upon the goal sought. It is the pencil-and-paper (or, better, the computer-and-
printout) approach to decision making. Solving a planning problem requires
breaking it into its component parts and studying the various quantitative and
qualitative factors. Study and analysis are likely to be far cheaper than
experimentation. Hours of time and reams of paper used for analyses usually
cost much less than trying the various alternatives

DECISION MAKING UNDER CERTAINTY, UNCERTAINTY, AND RISK


Virtually all decisions are made in an environment of at least some uncertainty.
However, the degree will vary from relative certainty to great uncertainty. There
are certain risks involved in making decisions. Decision making is classified as

1. under certainty
2. under uncertainty
3. under risk

DECISION MAKING CONDITIONS

Decision making involves selection of alternatives out of several available. The


alternative is put into action which will take place in future period. Thus, the
decision maker is making the decision for the future,

-------------------------------------------------------------------------------------------------------------
-----------
condition conditions of conditions of
complete
of perfect certainty risk
uncertainty

(DECISION MAKING CONDITIONS)

In such conditions, some of a decision differs. An outcome defines what will


happen if a particular alternative or course of action is chosen. Knowledge of
outcome is important when there are multiple alternatives. In the analysis of
decision making, three types of knowledge with respect to outcomes are usually
distinguished as shown in the following table

conditions Nature of outcomes


certainty Complete and accurate knowledge of the outcome of each
alternative
as there is only one outcome of each alternative
risk Multiple outcomes for each alternative can be identified & probability
of occurrence can be attached to each outcome

uncertaint Multiple outcomes for each alternative can be identified but there is
y no knowledge
Of the probability to be attached to each

DECISION MAKING UNDER CERTAINTY


When a manager knows exactly which state of nature will occur, a circumstance
of certainty exists. This means that the manager will be able to make perfectly
accurate decision time after time. Such conditions exist when decision involves
action for immediate future and the manager has made such a decision a
number of times with the same result. Under such conditions, he can use a
deterministic model, the one in which all factors are assumed to be exact with
chance playing no role. Under such conditions, he does not need to analyze the
chance element. This can be explained by an example of pay off table which
indicates the outcomes of a decision under various conditions(table1)

Alternative action situation - demand for product

Alternative action low moderate high

Centralized distribution 30 rores 15 crores 20 crores

Decentralized distribution 10crores 15 crores 35 crores

The decision maker has two alternative actions and three states of nature of
demand for product. The decision involves selecting action action in terms of
distribution- centralized or decentralized. The demand for the product is
considered under three situations-low, moderate ang high.

Revenue to be earned under various conditions and particular action is given in


terms of rupees (ten million). In reaching certainty decision, the manager would
only have to utilize a part of table and would have to examine a number of
alternatives, but only the pay offs related to the one state of nature will occur.

Supposing the manager is sure about the demand, that is high demand, he can
select decentralized distribution which gives maximum revenue of Rs 35 crores.
In this condition, the manager is sure about the demand of the product.
However, such conditions rarely exists because decision making requires more
variables than presented here and all such factors may not behave the same
way. Therefore, in many situations, the manager is forced to use probability
about such happening, demand of product in this case.

DECISION MAKING UNDER RISK


Most of the major organizational decisions particularly involving investments are
made under the conditions of risk in which some information is available but
that is not sufficient to answer overall question about the outcome of decisions.
In such a case, managers have to decide two things – amount of risk involved in
a decision and the amount of risk that the organization is ready to assume.
Amount of risk involved can be calculated by risk analysis.

RISK ANALYSIS
Decision making under risk refers to situations where there are number of
states of nature(outcomes) and the manager knows the probability of
occurrence for each of these outcome.(based on past experience etc)

Alternate action Situation: state demand


of
LOW(0.2) MODERATE(0.5) HIGH(0.3)

CENTRALISED 6 CRORES 7.5 CRORES 6 CRORES

DECENTRALISED 2 CRORES 7.5 CRORES 10.5 CRORES

PAY OFF TABLE FOR DECISION MAKING UNDER RISK

Thus the expected values for centrlised distribution are 19.5 crores and for
decentralized distribution are Rs 20 crores. The checking of pay off table shows
that the expected values are greater for decentralized and the company should
go for this alternative.

DECISION MAKING UNDER UNCERTAINTY


If a decision involves conditions about which the manager has no information,
either about the outcome or the relative chances for any single outcome, he is
said to be operating under conditions of uncertainty. He has no chance of
predicting the events. Under such conditions, a number of different decision
criteria have been proposed as possible bases for decision making as follows
• MAXIMAX CRITERION (maximizing the maximum possible pay off)
• MAXIMIN CRITERION (maximizing the minimum possible payoff)
• MINMAX CRITERION (minimizing the maximum possible regret )
• LAPLACE CRITERION ( assuming equally likely probabilities for the
occurrence of each possible state of nature)

MAXIMAX CRITERION
This decision is applied by the most optimistic decision maker when he thinks
optimistically about the occurrence of events influencing a decision. If this
philosophy is followed, a manager will select that alternative under which it is
possible to receive the most favorable payoff.

I
LLUSTRATION
(TABLE1)
Alternative action situation - demand for product

Alternative action low moderate high

Centralized distribution 30 rores 15 crores 20 crores

Decentralized distribution 10crores 15 crores 35 crores

Referring to table No1, the manager using maximax criterion will select the
most favorable pay off for each alternative as follows
• Centralization Rs 30 crores

• Decentralization Rs 35 crores
If maximum monetary payoff is the objective, the decision maker will
decentralize

MAXIMIN CRITERION
As against maximax criterion, maximin criterion is adopted by the most
pessimistic decision maker. The manager believes that the worst possible may
occur. This pessimism results in the selection of that alternative which
maximizes the least favourable pay off. In table no1, the minimum pay off for
each alternative is as follows
• Centralization Rs 15 crores

• Decentralization Rs 10 crores
Accordingly, the decision would be to centralize the distribution because it
maximizes the minimum payoff

MINIMAX CRITERION
This criterion leads to the minimization of regret. The managerial regret is
defined as the pay off for each alternative under every state of nature of
competitive action subtracted from the most favorable payoff that is possible
with the occurrence of that particular event. If the manager selects an
alternative and if a state of nature occurs that does not result in the most
favorable pay off, regret occurs. The manager is regretful that alternative
selected did not lead to the best pay off. Since the manager does not know the
probability of happening, a particular event, he will choose an alternative which
minimizes his regret. Referring to table 1, the pay off table using minimax
criterion can be constructed as shown in table 2
Alternative action situation - demand for product

Alternative action low moderate high

Centralized distribution 0 crores 0 crores 15 crores

Decentralized distribution 20crores 0 crores 0 crores


Table no 2

The regret table shows in the case of high demand, the manager has a regret
of 15 crores if he chooses centralized distribution. In case of low demand, he
has a regret of Rs 20 crores if he chooses the alternative of decentralized
distribution. Since he is interested in minimizing his regret, he will choose
centralization.

LAPLACE CRITERION

The three preceeding decision criteria assume that without any previous
experience it is not possible to assign any probability to the states of situation.
In this criterion, since the probability cannot be assigned on any basis, equal
probability is assigned to each event. Every event is treated equal . applying
this criterion, in table No1, following payoffs will be expected from two
alternative actions

• Centralization 30+15+20 crores divided by 3=21.67 crores


• Decentralization-10+15+35 crores devided bt 3=20 crores
Since centralized distribution gives better payoff base on equal probabibility, it
will be chosen

MODERN APPROACHES TO DECISION MAKING UNDER UNCERTAINTY

Decision Trees

Decision tree is a geographical method for identifying alternative actions,


estimating probabilities and indicating the resulting expected pay off.

Some decisions involve a series of steps, the second step depending on the
outcome of the first, the third depending on the outcome of the second, and so
on. Uncertainty surrounds each step, so decision maker faces uncertainty piled
on uncertainty. Decision trees are a model for solving such a problem

CONSTRUCTION OF DECISION TREE


1ST STEP-DEFINITION OF ALTERNATIVES
For example, if an organization wants to introduce a new product in the market,
it has two alternatives available to it. Either to go for
• permanent tooling
• or temporary tooling
each alternative will require different investment. And we have to find which
decision will be successful
2nd ALTERNATIVE
The second step involves the estimation of probabilities for various events.
There may be three alternative events so far the success or failure is concerned
and they are
• high success
• moderate success
• failure
3rd STEP
The third step is the calculation of pay off from each alternative in various
events.

ILLUSTRATION
1. INITIAL INVESTMENT
Permanent tooling -2 crores
Temporary tooling -1 crore
2. PAY OFF FROM EACH INVESTMENT
EVENTS PERMANENT TOOLING TEMP TOOLING PROBABILITY
Product succeeds 1 crore 0.6 crore (0.5)
Moderate success0.5 crore 0.3 crore (0.3)
Failure 2 crores I crore
(0.2)

Now a decision tree can be constructed based on these factors as follows

Expected pay off from permanent tooling =successful 1crx.5


=0.5
= moderate success 0.5 crx0.3
=0.15
= fail 2 crx.1 (minus)
=0.2
total=0.45 ie Rs 45 lakhs

Expected pay off from temp tooling = successful 0.6x0.5


=0.3
=moderate success0.3x0.3
=.0’09
fail I cr x 0.1 (minus)
=0.1
total=0.29 ie 29 lakhs

therefore, in terms of total pay off, it is better to select permanent tooling.


However, if return on investment is considered temporary tooling may be
selected.

USES OF DECISION TREE


A decision tree is basically used to make decisions in complex situation
particularly when outcome of a later situation is dependent on outcome of
the former.

It makes it possible for them to see at least the major alternatives open to
them. Then by incorporating the probabilities of various events, it is
possible to take a decision of desired result

A basic value of decision tree lies in expressing all outcomes or events in


quantitative terms .
LIMITATIONS
The system is very complex that relationship between various events and
alternatives cannot be established.

OTHER FACTORS IN DECISION MAKING


.Personal values and organization culture. However, values influence
decision making at all organizational levels, managers and non managers alike.
What is true for individuals is also pertinent to the organization as a whole.
Thus, the pattern of behavior, shared beliefs, and values of members of an
organization do influence decision making
Group decision making. In modern organizations, decisions are often made
by groups of individuals, such as committees or teams.
Creativity and innovation. Effective decision making requires creativity and
innovation.

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