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Principles of Management Unit 5: Decision Making

Decision making is the core of every management function. This unit covers the steps of making a decision, how real managers depart from pure rationality, the tools for deciding under risk and uncertainty, common biases, and how groups decide.

Covers: The eight-step decision-making process, Rational decision making, bounded rationality and intuition, Programmed and nonprogrammed decisions, Certainty, risk and uncertainty; expected value, Decision rules under uncertainty: maximax, maximin, minimax regret, Decision biases and escalation of commitment, Group decision making and groupthink

Study guide

A decision is a choice among two or more alternatives. Textbooks describe an eight-step process: identify a problem (a gap between an existing and a desired state), identify decision criteria, allocate weights to the criteria, develop alternatives, analyze the alternatives, select an alternative, implement it, and evaluate its effectiveness. Weighting criteria turns a fuzzy choice into a score: multiply each alternative's rating on each criterion by that criterion's weight and add up the results. The alternative with the highest weighted total is the rational choice, though managers should still check whether the numbers capture what really matters.

The rational model assumes a manager has full information, knows all alternatives and picks the one that maximizes value. Herbert Simon argued that real managers face bounded rationality: they have limited information, time and mental capacity, so they satisfice, accepting the first solution that is good enough. Escalation of commitment is the tendency to keep investing in a failing decision because of what has already been spent, even when evidence says to stop. Intuitive decision making uses experience, feelings and accumulated judgment, and it often works well for experienced managers when combined with analysis.

Problems can be structured (straightforward, familiar and easily defined) or unstructured (new, unusual, with incomplete information). Structured problems get programmed decisions, repetitive choices handled with a routine approach: a procedure (a series of steps), a rule (an explicit statement of what to do or not do) or a policy (a general guideline that leaves room for judgment). Unstructured problems require nonprogrammed decisions, unique choices that need a custom solution. Lower-level managers mostly handle programmed decisions, while top managers face more nonprogrammed ones.

Decisions are made under three conditions. Under certainty, the outcome of each alternative is known. Under risk, the manager can estimate the probability of each outcome and compute an expected value: multiply each payoff by its probability and add them. Under uncertainty, probabilities are unknown, and the choice depends on the manager's attitude. An optimist uses maximax (choose the alternative with the best possible payoff). A pessimist uses maximin (choose the alternative whose worst payoff is the best). A manager who wants to avoid regret uses minimax regret: for each possible state, compute regret as the best payoff in that state minus each alternative's payoff, then choose the alternative whose largest regret is smallest.

Managers fall into predictable biases: overconfidence, immediate gratification, anchoring (relying too much on the first information received), selective perception, confirmation (seeking information that supports a prior view), framing (being swayed by how a choice is worded), availability (judging by what is easiest to recall), representation, randomness, sunk costs, self-serving bias (credit for success, blame others for failure) and hindsight. Groups bring more information and acceptance but are slower and can fall into groupthink, where pressure to agree suppresses dissent. Techniques such as brainstorming, the nominal group technique (silent idea writing then ranking), the Delphi technique (anonymous experts answering in rounds) and electronic meetings help groups decide better.

Key ideas

• The decision process runs from identifying a problem through criteria, weights, alternatives, analysis, choice, implementation and evaluation.
• Bounded rationality leads managers to satisfice rather than maximize.
• Structured problems get programmed decisions using procedures, rules and policies; unstructured problems need nonprogrammed decisions.
• Under risk, expected value equals the sum of each payoff times its probability.
• Under uncertainty, maximax reflects optimism, maximin reflects pessimism, and minimax regret minimizes the worst regret.
• Escalation of commitment and the sunk cost error keep managers in failing projects.
• Groupthink can be reduced with devil's advocates, the nominal group technique and the Delphi technique.

Formulas and rules

Common mistakes

• Choosing the alternative with the single highest payoff when asked for maximin; maximin compares each alternative's worst case.
• Forgetting to include negative payoffs (losses) when computing expected value.
• Confusing a rule (exact, no discretion) with a policy (a general guideline that allows judgment).
• Thinking satisficing means making a bad decision; it means accepting a good-enough option under limits.
• Treating sunk costs as relevant to a future decision; money already spent cannot be recovered and should not drive the choice.

Before the test, make sure you can

• List the eight steps of the decision-making process in order.
• Calculate weighted scores for alternatives and choose the best one.
• Explain bounded rationality, satisficing, intuition and escalation of commitment.
• Classify problems and decisions as structured/programmed or unstructured/nonprogrammed, and distinguish procedures, rules and policies.
• Calculate expected value for decisions under risk.
• Apply maximax, maximin and minimax regret to a payoff table described in words.
• Identify common decision biases from examples.
• Compare group decision techniques and explain how to prevent groupthink.

Words to know

Decision

A choice made from two or more alternatives.

Problem

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

Decision criteria

Factors that are relevant in making a decision.

Rational decision making

Making logical, consistent choices to maximize value.

Bounded rationality

Decision making that is rational but limited by an individual's ability to process information.

Satisficing

Accepting solutions that are good enough rather than searching for the best possible one.

Escalation of commitment

Increasing commitment to a decision despite evidence that it may have been wrong.

Intuitive decision making

Making decisions based on experience, feelings and accumulated judgment.

Programmed decision

A repetitive decision that can be handled by a routine approach.

Nonprogrammed decision

A unique, nonrecurring decision that requires a custom-made solution.

Policy

A guideline for making decisions that allows the decision maker some discretion.

Expected value

The sum of each possible payoff multiplied by its probability.

Maximin

Choosing the alternative whose worst possible outcome is the best; a pessimistic rule.

Minimax regret

Choosing the alternative that minimizes the largest possible regret.

Anchoring effect

Fixating on initial information and failing to adjust adequately to new information.

Confirmation bias

Seeking information that confirms past choices and discounting information that contradicts them.

Groupthink

When group members suppress disagreement to reach apparent consensus.

Delphi technique

A group method in which experts answer questionnaires anonymously over several rounds until they converge.

Sample practice questions

30 more questions like these, from level 1 to 5, are in the practice set.