Principles of Management live inclass EXAM
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Ch5Planning.ppt
Ch 5 Planning and Decision Making
- Planning: Choosing a goal and developing a method of strategy to achieve that goal.
- Multiple competing goals
- Legitimacy
- Good planning:
- Goals and plans are inseparable
- Goals and means are suitable
- Planning ahead of time
Hello Class, Today we’ll discuss Chapter 5 Planning and decision making.
As the title of this chapter indicates, we cover two main topics in this chapter: planning and decision making.
For the first topic on planning, we’ll address what is planning, benefits and pitfalls of planning, how to make a plan that works, and planning from top to bottom.
Planning is choosing a goal and developing a method or strategy to achieve that goal.
There are two key elements in the concept of planning: setting goals and developing means.
Goal-setting is what should be done or will be done.
Plan-developing is how should it be done or how will it be done.
Companies have multiple goals. We may not be able to achieve all goals, and so we should set appropriate priorities for our goals.
Very often, goals are in conflict. We need to make decisions about trade-offs among conflicting goals.
E.g. Do you want to put your money in bank for safety and liquidity or you want to invest for higher return but take risk of losing your money? You have to make a balanced decision.
Another issue about goals is legitimacy, which is to make your business goals more acceptable to the public.
E.g. Some people hold negative views of certain types of business, such as single bars, massage therapy, dating services, and night clubs. Some residents resist those businesses opening in their neighborhood. Those businesses need to justify their goals to get support from the public.
Companies make many plans. Some plans work while others don’t.
Good planning should have the following characteristics.
First, goals and plans are inseparable or the planning won’t work.
E.g. if your boss gives you a project and a deadline for it, but gives you no budget, no guidelines, and no support staff. In this case, you have the goal but no resources and no means. The goal cannot be achieved.
Second, goals and means should be suitable. E.g. If you have a small business, you use a big robot to handle your company’s invoicing system. The means is too expensive and not suitable for the goal.
Third, planning ahead of time is the essence of the planning function. See next slide.
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This picture illustrates the importance of planning ahead of time. You are painting on a tall building and then you forgot to leave a ladder for you to get off the building after you finish your job.
E.g. An entrepreneur raised $10 million to produce portable personal computers without first getting permission from a software company to use their software. Later on, it was discovered that the software company did not want to license its software to any hardware computer companies. So the PC company ended up producing computers without badly needed software, and the firm failed in about a year. This is a lesson of not planning ahead of time and not thinking through what you are doing.
Benefits and Pitfalls of Planning
- Benefits of Planning:
- Intensifying effort
- Increasing persistence
- Providing direction
- Creating task strategies
- Pitfalls of Planning:
- Impeding change and adaptation
- Creating a false sense of certainty
- The detachment of planners – lead planners to plan for things they don’t understand.
There are benefits of planning and pitfalls of planning as well.
Planning offers important benefits for companies in four ways: intensifying effort, increasing persistence, providing direction, and creating task strategies.
First, managers and employees put forth greater effort when following a plan.
Take two workers as an example. You instruct one worker to “do your best” to increase production, and instruct the other worker to achieve a 2% increase in production each month. Research shows that the one with the specific plan will work harder.
Second, planning leads to persistence, that is, working hard for long periods. In fact, planning encourages persistence even when there may be little chance of short-term success.
The third benefit of planning is providing direction. Plans encourage managers and employees to direct their persistent efforts toward activities that help accomplish their goals and away from activities that don’t.
The fourth benefit of planning is that it encourages the development of task strategies. After selecting a goal, it’s natural to ask, “How can it be achieved?”
Despite the significant benefits associated with planning, planning is not a cure-all. Plans won’t fix all organizational problems. In fact, many management authors and consultants believe that planning can harm companies in several ways. There are three main pitfalls of planning.
The first pitfall of planning is that it can impede change and prevent or slow needed adaptation. Sometimes companies become so committed to achieving the goals set forth in their plans, or they can become so intent on following the strategies and tactics spelled out in them, that they fail to see that their plans aren’t working or that their goals need to change.
E.g. GM auto company missed initial opportunity to produce environmentally sound cars because its culture was wedded to big cars and horse-power. Since GM was so committed to its original goals and follow the strategies and tactics previously set, it couldn’t quickly make adjustment to the new trends.
The second pitfall of planning is that it can create a false sense of certainty. Planners sometimes feel that they know exactly what the future holds for their competitors, their suppliers, and their companies. However, all plans are based on assumptions. If the assumptions turn out to be false, the plans are likely to fall.
The third pitfall of planning is the detachment of planners, which leads planners to plan for things they don’t understand. Plans are not meant to be abstract theories. They are meant to be guidelines for action.
In theory, strategic planners and top-level managers are supposed to focus on the big picture and not concern themselves with the details of implementation, that is, carrying out the plan. In practice, this leads to the detachment between planners who formulate strategies and the persons who carry out the strategies.
How to make a plan that works
– Five Steps
- Setting S.M.A.R.T. Goals
- Specific – make definite or concrete goals
- Measurable – have a specified measurement
- Attainable – challenging or stretch goals overall
- Realistic – every stage of the goal execution
- Timely – there is a deadline or time frame
How to make a plan that works?
In order to make a plan that works, planning consists of five steps. We will discuss them one by one.
The first step in planning is to set goals. Goals need to be specific and challenging, to provide a target for which to aim and a standard against which to measure to success.
One way of setting effective goals is to use the S.M.A.R.T. guidelines. S.M.A.R.T. are an acronym that stands for specific, measureable, attainable, realistic, and timely.
Specific means that your goals should be definite or concrete, not very broad, very general.
E.g. I want to get a good grade for this class. This goal is not specific.
E.g. Atlanta-based Novelis Company is the biggest recycler of aluminum beverage cans in the world. Its goal is to increase the percentage of recycled material it uses from 33% in 2010 to 56% in 2015 and to 80% in 2020. This goal is specific.
Measurable means that your goals can be measured against a standard.
E.g. Novelis company’s goal above is measurable since the company can easily track and compare the percentage of recycled material it uses now and before.
Attainable refers to goals that are challenging but achievable overall.
Whether a goal is attainable or not depends on many factors. One challenge for Novelis is that beverage cans are made from two types of aluminum: one for the sides of the can and another for can tops and bottoms. Once both types of aluminum are mixed together, they are not suitable for making cans. To overcome this problem, Novelis developed a production method that allows it to greatly increase the amount of recycled material it uses, which seem to make its goals achievable overall.
Realistic means that every stage of the goal execution is practically possible. It takes time to tell whether each stage of the goal execution is realistic. You need to monitor your progress toward goal-attainment. Novelis has reached 43% in 2013, which makes it realistic to achieve 50% in 2015.
Timely refers to a deadline or time frame for a goal.
E.g. Novelis indicates its 50% target in 2015 and 80% target in 2020. It has deadlines for each goal and so those goals are timely.
In summary, Novelis company’s goals are S.M.A.R.T. goals.
2. Developing Commitment to Goals
- The determination to achieve a goal.
- Techniques to increase goal commitment:
- Setting goals participatively
- Making goals public
- Obtaining top management support
3. Developing Effective Action Plans
- An Action Plan lists specific steps, people, resources, time period
The second step of the planning is developing commitment to goals.
Goal commitment is the determination to achieve a goal. Commitment to achieve a goal is not automatic. Managers and workers must choose to commit themselves to a goal.
So how can managers bring about goal commitment? The most popular approach is to set goals participatively. Managers and employees choose goals together. The goals are more likely to be realistic and attainable if employees participate in setting them.
E.g. Edward assigns a goal to his subordinate: John, you’ve got the new design done in a week so we can get more output. This is not setting goals participatively.
Another technique for gaining commitment to a goal is to make the goal public.
E.g. Announcing or displaying each department’s goals in the bulletin or the newsletter
Still another way to increase goal commitment is to obtain top management’s support. Top management can show support for a plan or program by providing funds, speaking publicly about the plan, or participating in the plan itself. E.g. When a CEO wanted to push E-commerce in his firm, he asked each department head to report progress on E-commerce at every company meeting. This shows strong support from top management.
The third step of making a plan that works is to developing effective action plans
An action plan should list specific steps to take (how), the number of people (who), resources (what), and time period (when) for accomplishing a goal.
E.g. When Dunkin’ Donuts expanded into the South, the West, and oversees, it developed action plans for expansion. It was using surveys and demographic studies to find specific areas for expansion, such as which city to enter, where people live, where are your store location, how many stores in a city, how much investment do you need, how many people to hire, etc. This is an example of effective action plans.
4. Tracking Progress
- Setting proximal goals and distal goals.
- Gather and provide performance feedback.
- Proximal goals – are short-term goals or sub-goals.
- Distal goals – are long-term or primary goals.
The fourth step in planning is to track progress toward goal achievement. There are two accepted methods of tracking progress.
The first is to set proximal goals and distal goals. Proximal goals are short-term goals or sub-goals, whereas distal goals are long-term or primary goals. The idea behind setting proximal goals is that they may be more motivating and rewarding than waiting to achieve far-off distal goals.
The second method of tracking progress is to gather and provide performance feedback. Regular, frequent performance feedback allows workers and managers to track their progress toward goal achievement and make adjustments in effort, direction, and strategies.
Case – Feedback on Safe Behavior in a bread factory
The average safety level was 74% in a bread factory, which was very low.
The company offered safety training, set specific goals to increase safety standards, and gave workers daily feedback. The safety level increased to 97.6%. After the company stopped giving daily feedback, the safety level dropped to 71.6%, even worse than before.
This example shows how important for you to get feedback on time. For example, if you get prompt feedback from midterm grade or homework grade, it will help you improve your course grade. When you have concerns about your progress in a class, you shall take immediate and effective corrective actions, such as going over the exam questions and find out why you got questions wrong, using tutors or doing more exercises. Feedback can give you direction to address your problems.
5. Maintaining Flexibility
- Options-based planning:
- Maintaining planning flexibility by making small, simultaneous investments in many alternative plans.
- Slack resources
- A cushion of extra resources that can be used with options-based planning to adapt to unanticipated changes, problems, or opportunities.
- Learning-based planning:
- Plans need to be continuously adjusted
The fifth step, and also the last step of planning is maintaining flexibility.
Because action plans are sometimes poorly conceived and goals sometimes turn out not achievable, the last step in developing an effective plan is to maintain flexibility.
One method of maintaining flexibility while planning is to adopt an options-based approach. The goal of options-based planning is to keep options open by making small, simultaneous investments in many options or plans. Then when one or a few of these plans emerge as likely winners, you invest more in these plans, and discontinue or reduce investment in the others.
In part, options-based planning is the opposite of traditional planning. The purpose of an action plan is to commit people and resources to a particular course of action. However, an options-based planning is to leave those commitments open by maintaining slack resources – a cushion of resources, such as extra time, people, money, or production capacity, that can be used to address and adapt to unanticipated changes, problems, or opportunities. Holding options open gives you choices. And choices, combined with slack resources, give you flexibility.
Another method of maintaining flexibility while planning is to take a learning-based approach. In contrast to traditional planning, which assumes that initial action plans are correct and will lead to success, learning-based planning assumes that action plans need to be continually tested, changed, and improved as companies learn better ways of achieving goals. Because the purpose is constant improvement, learning-based planning not only encourages flexibility in action plans, but also encourages frequent reassessment and revision of organizational goals.
Staying Flexible
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This exhibit shows an example of maintaining flexibility.
Designers of the SBC Center in San Antonio built flexibility into their plans. The arena can accommodate crowds of 18,000 for Spurs games, like this one in the picture, or smaller audiences for events like concerts.
The luxury boxes can be reconfigured into larger party suites (and back again). Flexible design considerations like those will enable the center to adapt to changes in event management and entertainment and keep the arena a viable venue.
Starting at the Top
- Strategic Plans – overall company plans that clarify how the company will serve customers and position itself against competitors (2 to 5+ years)
- Vision – An inspirational statement of what an organizational would like to accomplish in the future.
- Mission – An statement of an organization’s purpose or reason for existing. Typically, it answers questions like what business we are in and why we are in the business.
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Planning from Top to Bottom
This topic is about the hierarchy of planning. There are three general levels of management and therefore planning can be done at three levels too.
A planning cycle in an organization starts from the top management.
Top management is responsible for developing long-term strategic plans.
Strategic plans are to clarify how the company will serve customers and position itself against competitors, and its time frame usually is 2 to 5 years. Some strategic plans could be more than 5 years such as 10 years or longer.
Strategic planning begins with the creation of a vision and a mission.
A vision is an inspirational statement of what an organization would like to accomplish in the mid-term or long-term future. It is intended to serves as a clear guide for choosing current and future courses of action. A vision statement should be enduring, clear, and consistent with widely shared company beliefs and values. Typical vision statement is brief and succinct, but some firms may also have long vision statements.
An example of a short vision statement: To have our product in every home in the United States.
An example of a long vision statement:
"PepsiCo's responsibility is to continually improve all aspects of the world in which we operate - environment, social, economic - creating a better tomorrow than today. Our vision is put into action through programs and a focus on environmental stewardship, activities to benefit society, and a commitment to build shareholder value by making PepsiCo a truly sustainable company."
The mission is a statement of a company’s purpose or reason for existing, sometimes is also called purpose statement. It is a written declaration of an organization’s core purpose and focus. Typically, a mission statement answers such questions as what business we are in and why we are doing this business. Some mission statements also include an organization’s core values.
E.g. Applied Materials company‘s mission is to be the leading supplier of semiconductor fabrication solutions worldwide through innovation and enhancement of customer productivity with systems and service solutions.
Case: Mattel
- What industry is the company in?
- Mattel expanded its business scope
- What is its most popular product?
This is a case studies for Mattel Toy company. Apparently, it is in toy industry. However, a company needs to review its mission statement and see if it needs to revise it.
Mattel realized that kids play video games a lot and so it decided to enter game industry through acquiring Learning Company. The acquisition did not work out well.
Later on, Mattel sold Learning Company and started using specialized experts to develop games for it.
The most popular product of Mattel is Barbie dolls, that was born in 1959. During Barbie’s fifty anniversary celebration in 2009, Barbie House was built in Shanghai, China, but it was closed within three years.
The Barbie sales is slowing down. The company needs to reconsider its strategies to address the challenge.
Bending in the Middle
- Tactical Plans
- Specify how a company will use resources, budgets, and people to accomplish goals within its mission
- 6 months to 2 years
- Management by Objectives
- Managers and employees jointly
- Discuss possible goals.
- Collectively select goals.
- Develop tactical plans.
- Meet regularly to review progress.
Bending in the middle
Middle management is responsible for developing and carrying out tactical plans to accomplish the organization’s mission. Tactical plans specify how a company will use resources, budgets, and people to accomplish specific goals within its mission. Tactical plans and objectives are used to direct behavior, efforts, and attention over the next six months to two years. Tactical plans have a duration within or up to 2 years, compared with strategic plans that start with 2 years.
E.g. If a middle manager develops a plan up to 2 years, it is a tactical plan. If a top manager develops a plan of 2 years to 5 years, it is a strategic plan.
Management by objectives (MBO) is a management technique often used to develop and carry out tactical plans. Management by objectives (MBO), also known as Management by Results (MBR), is a 4-step process in which managers and their employees jointly discuss possible goals, select goals together, jointly develop tactical plans, and meet regularly to review progress toward accomplishment of those goals.
The key difference between MBO and traditional management techniques is that MBO allows employees to have a say in setting goals and developing action plans and defines goals that are agreed to by both management and employees while in traditional management, managers set and assign goals to employees.
The term of MBO was first outlined by management guru Peter Drucker in 1954 in his book "The Practice of Management.“ According to the theory, the MBO approach could ensure better participation and commitment among employees, as well as alignment of objectives across the organization, and therefore improve the organization’s performance.
Finishing at the Bottom
- Operational Plans:
- Day-to-day plans for producing or
delivering products and services over a 30-day to 6-month period
- Single-Use Plans:
- Plans that cover unique, one-time-only events, unlikely repeat.
- Standing Plans:
- Plans used repeatedly to handle frequently recurring events.
Finishing at the Bottom
First-line managers are responsible for developing and carrying out operational plans.
Operational plans are day-to-day plans for producing or delivering products and services over a 30-day to 6-month period. Operational plans have a duration within or up to 6 months, compared with tactical plans that start with 6 months and up to 2 years.
E.g. If a first-line manager develops a plan for 6 months, it is an operational plan. If a middle manager develops a plan of 6 months to 2 years, it is a tactical plan.
Single-use plans and standing plans are often used for operational plans.
Single-use plans deal with unique, one-time-only events that are unlikely repeat.
Examples of single-use plans are programs, projects, and budget.
Standing plans are created once and then used repeatedly to handle frequently recurring events.
Examples of standing plans are policies, procedures, and rules and regulations.
A Comparison of Policies, Procedures, and Rules
- Policies – the general course of action that should be taken
- Procedures – the specific steps that should be taken
- Rules – describe how a particular action should be performed.
Policies Procedures Rules
Broad in scope Narrow in scope
General application Specific application
Deviations common Few deviations
A comparison of policies, procedures, and rules.
There are differences among policies, procedures and rules.
Policies indicate the general course of action that should be taken. Policies are broad in scope and have general application. Deviations from the standards are very common for policy application.
E.g. When a company says that we will provide acceptable working conditions and wages to workers, what constitutes “acceptable” and to whom it is acceptable is subject to interpretation. This is an example of policies since it is broad in scope and has general application. When applying this policy, deviations from the norm are common.
Procedures are the specific steps that should be taken.
An example would be for travel procedures. When you request for funding to attend a conference, you need to submit your funding request for your supervisor’s approval and then the higher level manager’s approval. After you came back from the conference, you need to submit the conference program and receipts along with your request for reimbursement. This is the procedure employees have to follow to get financial support for travel.
Rules and regulations describe how a particular action should be performed. Rules are narrow in scope and have specific application. There are not many deviations from the standards when applying rules.
E.g. When you see a sign of “No food and drink” in a room, this rule applies to this room only.
Sometimes it is difficult to distinguish policies and rules in practice. Look at the following two cases.
Case One: In a supermarket, a cashier asked a lady to show her ID when checking out alcohol the lady purchased. The lady is over 70 years old and took the cashier’s words as compliment and so she laughed. The casher said, I am serious. The lady felt offended, Do I look like under 21 years old. Do I have to show ID to buy alcohol? The cashier said this is company’s policy. The lady talked to the store manager about the incident.
In this case, the cashier implemented the policy as a rule. Since it is a policy, deviation from the standard is common. So the cashier doesn’t have to ask a 74-years-old lady to show her ID.
Case Two: McDonald’s has a rule that doesn’t allow customers enter the restaurant when the restaurant closed during the late-night hours. One day, at 3 am in a McDonald’s restaurant, a man stood outside the window and asked to use the restroom inside. An employee recognized the man is the most popular Minnesota Vikings star. The female assistant manager allowed the man to use the restroom inside. Later, the assistant manager was fired.
In this case, since it is a rule, it is narrow in scope and it has specific application, and few deviations are allowed. Even he is a famous star, there should be no exception for him. The assistant manager treated the rule like a policy, she allowed deviation occur and so she violated the rule.
After the local media reported on the woman's termination, McDonald's gave her back her old job. But we should learn a lesson that it may cost you your job if you don’t implement rules correctly.
Types of Decision Making
- Programmed Decision Making:
- Routine, almost automatic decision making that have well-established solutions
- Non-programmed Decision Making:
- Non-routine decision making that involves new, unusual, or unpredictable situations
Types of decision making.
The second and last major topic in Chapter 5 Planning and Decision Making is about decision making.
You need to make decisions when you have problems or opportunities
If you don’t make decisions and take no actions, you would end up nowhere.
There are two types of decision making: programmed and non-programmed decision making.
Programmed decision making are routine, almost automatic decision making that have well-established solutions.
E.g. Ordering office supplies in companies, or processing billing statements for utility companies, or reviewing financial aids applications at schools would be examples of programmed decision making. These are routine decision making and there are established solutions.
Non-programmed decision making are non-routine decision making that involves new, unusual, or unpredictable situations.
E.g. Relocating your firm to a new site, or responding to your company competitor’s new product line would be examples of non-programmed decision making. These are not routine decisions and involve new situations.
More programmed decision making is more efficient for the company since there is a ready solution to problems. E.g. One multi-billion dollar company developed a manual of 4000 pages and programmed almost all accounting decisions. This way, the company doesn’t need to hire so many CPAs. In case an accountant encounters an accounting problem that is not in the manual, the CPAs in headquarters will figure out a solution and program the decision making, and add it into the manual. By programming accounting decisions, the company could save millions of dollar each year.
What Is Rational Decision Making?
- Decision Making:
- The process of choosing a solution from
available alternatives. - Rational Decision Making:
- A systematic process of defining problems, evaluating alternatives, and choosing optimal solutions.
What is rational decision making?
Decision making is the process of choosing a solution from available alternatives.
Your decisions determine where you go from now and where you will be in the future or what you will become in the future.
Let’s look at a rational decision making model. Rational decision making is a systematic process of defining problems, evaluating alternatives, and choosing optimal solutions.
E.g. You need to make a decision to select a location for your company’s annual vacation. You explore a few sites and find out the facts of each site, such as its facilities, services, convenience, attractiveness, and costs. You compare them and select a optimal location. This is a rational decision making.
Six Steps to Rational Decision Making
- Define the problem
- A problem exists when there is a gap between
a desired state and an existing state
- To make decisions about problems, managers must:
- be aware of the gap
- be motivated to reduce the gap
- have the KSA & resources to fix the problem
Now we’ll introduce rational decision making process. There are six steps for you to make rational decisions.
The first step in decision making is identifying and defining the problem. A problem exists when there is a gap between a desired state and an existing state, or between what you want and the situation that you are facing now.
The existence of a gap between an existing state and a desired state is no guarantee that you will make decisions to solve problems. Three things must occur to solve a problem.
First, managers have to be aware of the gap. They have to know there is a problem before they can begin solving it.
Second, you also have to be motivated to reduce the gap.
Finally, you must also have the knowledge, skills, abilities, and resources to fix the problem.
Case on Airbus A380 Jet.
Defining a problem correctly is what enables an effective solution. Airbus A380 is the largest passenger jet ever built. This airplane is a two-story super-jumbo jet. Nose to tail, it’s longer than the section of terminal where it’s gated, and its 263-foot wingspan is nearly as long as a football field. It is too heavy and not fuel economic.
It’s understandable that potential buyers would be concerned about weight and fuel usage of the jet.
Airbus used lighter materials in the airplane body to reduce the weight and alleviate the problem.
Steps to Rational Decision Making
- 2. Identify decision criteria
- Decision criteria are the standards used to guide judgments and decisions.
- The more criteria a potential solution meets,
the better that solution should be.
- 3. Weight the criteria
- Absolute comparisons – Each criterion is compared to a standard or ranked on its own merits.
- Relative comparisons – Each criterion is compared directly to every other criterion.
The second step in the decision making process is to identify decision criteria.
Decision criteria are the standards used to guide judgments and decisions. Typically, the more criteria that a potential solution meets, the better that solution should be.
Using different criteria will affect your decision making results.
E.g. What criteria do you use to choose your major for your college education?
You can choose your major based on your interest and passion, your talent, your personality, job market opportunities, earnings you can make, and so on. When my son considered art as his major, I didn’t support him. His decision criterion is his interest. My decision criterion is good job with good pay. I told my son to ask his art teacher for advise. The art teacher recommended him to take art as a hobby and choose something else as a profession. Finally my son selected accounting and finance and graduated from the Haas School of Business at Berkeley. Now he is admitted to a doctoral program at Berkeley Haas.
The third step in the process is to identify and weight the criteria that will guide the decision-making process. You often have more than one criterion that you want to meet. Sometime you cannot meet all the criteria you want. Therefore, you have to decide which criteria are more or less important to you.
Although there are numerous math models for weighting decision criteria, all require the decision maker to provide an initial ranking of the decision criteria. Two methods we introduce here are absolute comparisons and relative comparisons.
Two examples will be used to illustrate these two methods in the next two slides.
Absolute Weighting of Decision Criteria
for a car purchase
5 = critically important, 1 = completely unimportant
1. Predicted reliability 1 2 3 4 5
2. Owner satisfaction 1 2 3 4 5
3. Predicted depreciation 1 2 3 4 5
4. Avoiding accidents 1 2 3 4 5
5. Fuel economy 1 2 3 4 5
6. Crash protection 1 2 3 4 5
7. Acceleration 1 2 3 4 5
8. Ride 1 2 3 4 5
9. Front seat comfort 1 2 3 4 5
With the absolute comparison method, each criterion is compared to a standard or ranked on its own merits.
E.g. Consumer Reports use 9 criteria when it rates and recommends new cars: predicted reliability, current owners’ satisfaction, predicted depreciation, ability to avoid an accident, fuel economy, crash protection, acceleration, ride, and front seat comfort.
When you buy a car, you can rank these criteria based on your own preference. Because these weights are absolute, each criterion is judged on its own importance using a five-point scale, with 5 representing critically important and 1 representing completely unimportant. Then you can make decision accordingly.
Relative Comparison of Home Characteristics
+1= more important -1=less important
Characteristics L SQ IP SR QS NBH
Daily commute (L) +1 -1 -1 -1 0
School quality (SQ) -1 -1 -1 -1 -1
Inground pool (IP) +1 +1 0 0 +1
Sun room (SR) +1 +1 0 0 0
Quiet street (QS) +1 +1 0 0 0
Newly built house 0 +1 -1 0 0
Total weight +2 +5 -3 -2 -2 0
Under the relative comparisons, each criterion is compared directly to every other criterion.
This exhibit shows six criteria you may want to use when purchasing a house. When making comparison, if the two criteria are equally important to you, you can put 0 there. If one criterion is more important than another, you put +1 there. If one criterion is less important, you put -1 there.
Finally, you add up those numbers and got a total weight for each criterion. In this case, school quality (SQ) received the highest weight (+5) and daily commute (L) received a weight of +2, thus these are two most important criteria for you when purchasing a house.
Steps to Rational Decision Making
- 4. Generate alternative courses of action
- The idea is to generate as many alternatives as possible.
- 5. Evaluate each alternative
- This step can take much longer and be more expensive than other steps in the process.
- 6. Compute the optimal decision
- Multiply the rating for each criterion by the
weight for that criterion.
- Sum the scores for each alternative course of action.
Now we continue on the rational decision making process.
Step 4 in decision making is to identify possible courses of action that could solve the problem.
In general, the idea is to generate as many alternatives as possible.
Step 5 in decision making is to systematically evaluate each alternative against each criterion. Because of the amount of information that must be collected, this step can take much longer and be much more expensive than other steps in the decision-making process.
The final step, Step 6 in the decision-making process, is to compute the optimal decision by determining each alternative’s optimal value. This is done by multiplying the rating for each criterion (step 5) by the weight for that criterion (step 3), and then summing those scores for each alternative course of action that you generated (Step 4).
Those weights are then multiplied by the ratings in each category.
Although we will not test you on the computation of the scores during exams, understanding these two methods would help you make wise decisions on complex problems.
Limits to Rational Decision Making
- Bounded Rationality:
- A decision-making process is restricted in the real world by:
- limited resources
- incomplete and imperfect information
- limited decision-making capabilities
- Maximizing decisions:
- choose the best alternative
- Satisficing decisions:
- choose a “good enough” alternative
Limits to rational decision making.
In general, managers who diligently complete all six steps of the rational decision-making model will make better decisions than those who don’t. So, when they can, just follow the steps in the rational decision-making process, especially for big decisions with long-range consequences.
In theory, fully rational decision makers maximize decisions by choosing the optimal solution.
However, rational decision making might not help managers choose optimal solutions that provide maximum benefits to their organizations. The terms “optimal” and “maximum” suggest that rational decision making leads to perfect or near-perfect decisions. Of course, for managers to make perfect decisions, they have to operate in a perfect world with no real-world constraints.
In reality, a rational decision-making process is often restricted by limited resources, incomplete and imperfect information, and limited decision-making capabilities. So oftentimes we make decisions with bounded rationality.
In practice, limited resources often make it impossible for managers to maximize decisions. Consequently, most managers “satisfice.” Satisficing is choosing a “good enough” alternative. Managers often don’t have time to make extensive lists of decision criteria. And, they often don’t have the resources to test all possible solutions against all possible criteria. As a result, managers often make “satisficing decisions” and select a good enough alternative.
E.g. When you search for a job, you don’t have time to search for all opening positions. You don’t have resources to apply for all job positions. You may accept a job offer that satisfies you first. So your decision is a good enough alternative, not a maximizing decision.
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Limited decision-making capabilities may restrict your decision making. In this exhibit, the company faces a problem – cannot push the cart forward.
Managers were not able to discover the cause of the problem – a wheel that is not functioning. They may end up with hiring more people.
If the managers has the capability to find out the root of the problem, it is easy to solve the problem – just replace a wheel.
Why Information Is Incomplete?
- Risk: the degree of probability that the possible outcomes will occur.
- Uncertainty: Unpredictability.
- Ambiguous info: that can be interpreted in multiple ways, and often conflicting ways.
- Time constraints and info costs: no time or money to search for all options
Why information is incomplete?
There are a couple reasons that explain why information is often incomplete.
There are risks and uncertainty, which make information incomplete. There is a difference between risk and uncertainty. Under the risk environment, you know good information, good enough for you to calculate your chance to get a certain outcome.
E.g. In movies industry, in every ten movies produced, about 3 movies are profitable, 1 is breakeven, 6-7 are losing money. This is a decision making under risk since you know your chance to win.
Uncertainty means unpredictability. So uncertainty is more risky than risk.
E.g. Pharmaceutical companies need to spend millions of dollars every year in research and product development and may not come out with any new medicine in a year. They still have to keep investing in it. This is decision making under uncertainty.
Sometime you have information but the info is very vague and can be interpreted in multiple ways. As shown in the next exhibit.
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This picture illustrates ambiguous information. This picture gives information to show that this is a lady in the picture.
But you do not have clear information to decide whether she is a young lady or an old lady.
So what you have here is ambiguous information. It may lead to different interpretations and thus different decisions. Therefore, ambiguous information is another reason why information is often incomplete.
As you can see, incomplete information is another reason for imperfect decision making.
We often make decisions under risk, uncertainty, or ambiguous environment, as discussed above.
