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Dr. Amin Ullah, PhD
Managerial Decision Making
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FOM 4.2
Learning Outcomes
Learn the basic concepts of decision making.
Understand Elements and various steps in the
decision-making process. Learn various types of managerial decision
making.
Learn Types of Problems and Problem
solution. Understand External environmental influence
on DM, certainty, risk, and uncertainty as theyrelate to decision making
Understand various Techniques used in
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What is Decision Making?
Decision making is the process ofselecting the mostappropriatealternative among other alternatives ina given environment/situation.
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Managerial Decision MakingDecision Making in Management:
The ability, and particularly the right, to
make decisions clearly holds considerablestatus and is very attractive in the minds
of many people
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Good or Bad DecisionsGood decision is the one where
Decision maker fully understand :-
Background
Objectives
Alternative courses of action
Range of possible consequences of decision
The choice between alternatives is made
In a rational manner
Consistent with objectives of decision
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ELEMENTS OF DECISION
Key elements in a decision :-
The decision body : individual / group authorized
to make final decision The decision options : Alternate courses of action
from which choice will be made
The uncontrollable factor : factors which will
affect the decision but cannot be controlled bydecision body
The consequences of each option: in what terms
can the possible results of each option be
described6
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Types of ManagementDecision
Strategic and operational decisions.
Structured and Un-structured Decisions.
Dependentand independentdecisions.
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Strategic and Operational Decisions
Operational Decisions
Lower and middle management levels in the
organization make operational decisions in theirspecific areas of responsibility.
These are mostly routine and repetitive
Outcome/ consequences oftheir decisions are
predictable in mostcases.
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Strategic Decisions:
These decisions are taken bythe Top management,though lower and middle managers are also involvedand provide their inputs in strategic decisions.
Strategic decisions are crucial to the reputation andfuture ofthe entire organization.
Strategic decisions are made due to changes in theexternal environmental factors and their complexity
which are characterised by great risks and oruncertainty.
Strategic decisions are made in strategic planningand management. Decisions are made on selectionand changes of organization objectives, policies andResources. 9
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Unstructured and Structured
Decisions:
Structured Decisions:
The decision maker knows the extentof decision and
options are very clear. Evaluation criteria are well thought, explicitand
unambiguous.
Clear procedures to follow for making decisions.
These are known as Programmable.
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Un-Structured: Decision body is notclearly defined.
Options are notclear and explicit.
No clear procedures to follow in decision making.
Difficultto reach atan agreementto choose the best
way as well as to reach atan agreed decision
.
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Dependent and Independent
Decisions:
DependentDecision:
Dependency on the pastdecision. Sometimes past
decisions have determined the resource constraintswith in which we can work on the presentdecision.
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FOM 4.13
Procedure
Rule
Policy
Programmed Decision
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Programmed Vs. Non-programmed decisions
Programmed decisions
Repetitive, well defined
Procedures exist for resolvingproblems
Criteria for performance clear
Good information available for current
performance
Alternatives well specified
Relative certainty that chosen
alternative will be successful
Non Programmed decisions
Novel & poorly defined
No procedure exist for solving the problemClear cut decision criteria do not exist
Alternatives are fuzzy
Uncertainty whether a problem solution will
solve the problem
Few alternatives can be developed
A single solution is custom-tailored to the
problem
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Types of problem for solving/decision
making Crisis Problem:
It is a serious difficulty or problem requiring immediate decision
bythe management.
Non crisis problem:
Issues that require resolution but do not simultaneouslyhave
the importance and urgency of a crisis.
Opportunity problem:
A
situation that offers strong potential for great organizationalprofit or benefits if appropriate action is taken.
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The Problem solving/Decision Making
Process
Steps and their Sequence
The diagram indicates various steps in Decision making/
problem solving process: Observation:
It is the firststep in the process. The individualmanager observes / notices either a problem or a
decision opportunity exists in the organization or itsenvironment.
Formal Recognition:
After the accumulation of information and evidence, theneed for decision arises. Bythis time, the problem oropportunity is quite clear and demonstrable. 16
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Interpretation / Diagnosis:
This is the most importantstage for proper diagnosis of
the real problem or opportunity. Differentpeople seemany problems in differentways and thereforereaching agreementover the nature ofthe problem
itself can become a decision process.
Problem statement / Definition:The agreed interpretation of a problem is translated into
the operational form. The problem is formally stated/defined and boundaries of decision are drawn.
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Set Objectives:
Unless the objectives of a decision are CLEAR and well
understood, managers cannotpossibly judge how farthe selected / preferred options will achieve theobjectives ofthe decision. These objectives areusually concerned with filling the gap between thepresentstate and the desired state, which mustbe a
function ofthe overall objectives ofthe organization.
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Determine the Options/ Alternatives:
Atthis stage, various options are determined with in the
decision boundaries. Managers usually encourageand use creativity and innovative skills and processesto determine the mostsuitable options such asbrainstorming sessions etc.
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Evaluating Options:
Each option is speltout in detail Gathering pertinent information andefficientManagement information system (MIS) will greatly help in
determining various options. Quality and Quantity of information willgreatly affectthe evaluation. Test/ check all options for feasibility,viability and validity.
Moreover understand other factors, which can limitthe range and choiceof options or their applicability.
These are:
TIME
Information
Resources
Knowledge
Managers have to know the real (Notassumed) limits, which the above
factors can impose on the options available to them. 20
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Criteria for evaluating alternatives:
a) Legality:
Action is legal and will notviolate the law and regulations.
b) Ethicalness:
Notharming any stakeholders interest.
c) Costeffectiveness or Economical feasibility:
d) Practicality
Have capability and resources to implementthe decision easily.
e) Marginal Analysis:It is the comparison of additional revenues and additional costs arising
from increasing the output.
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Select the Best Option:
It is in factthe desired action or decision making.
The selection will depend largely on the size andconstitution ofthe Decision Making body.
Individual or single decision maker will choose thebestoption based on his/her value system andinterests.
A multi decision-making body could interacttoresolve the choice by any combination of debate,consultation, delegation or political process.
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Three Approaches are used in Selectionof Best Option:
Experience:Reliance on pastexperience plays importantrole in decision
making. Experience is the bestteacher. Managers believe thattheir success and failure are the bestguide for future decisionmaking.
This attitude of managers may be dangerous because: They have not realized the real reason for success or failure
Change of circumstances
Therefore, after careful analysis ofthe pastexperience, then theexperience can be useful.
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Experimentation:
It is quite expensive and may sometimes be risky.
However in certain situations itbecomes necessarytodo research and experimentation such asdevelopmentof prototypes before actual production.
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Research and analysis:
It is one ofthe mosteffective techniques used for
major decisions in case of planning; problem involvesbreaking it into components or parts and studyingthe various quantitative and qualitative factors.
Study and analysis is more costeffective thanexperimentation. A simulation model is one of manyexamples.
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Implementation:
The selected option or decision is implemented. The
effectiveness of decision shall depend upon the skilland ability ofthe manager charged with the task andthe implementability ofthe option itself.
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Monitoring and Feedback:
During the implementation stage, close monitoring
is required to see effectiveness ofthe decision insolving the problem and achieving the decisionobjectives.
This is the Final stage ofthe decision process.
However, in case ofunsatisfactory results, theprocess is repeated. A regular feedback isprovided which shall further improve the decisionmaking.
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FOM 4.28
Identify
Problem
The Decision-Making
Process
Select
Alternative
Implement
Alternative
Evaluate
Results
1
Develop
Alternatives
Analyze
Alternatives
Develop
DecisionCriteria
Allocate
Weights toCriteria
2 3
4 5
6
7
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The Decision Environment:Environment: The totality of circumstances under
which the organization operates.
Organizations are an Open System and interact
with its environmental factors which may provideopportunities to itor pose threats or challenges.
Loss of control over energy sources.
High rate oftechnological development
Critical focus on social responsibilities of businessorganizations (safety, pollution employees welfare)
Political influence over international trading (WTO),European Economic committees.
Changing role of government in the affairs of work 29
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The External Environment CERTAINTY:
Decision making condition in which managers have
accurate and reliable information aboutthe outcomeof various alternatives under consideration. UNCERTAINTY:
Decision making condition in which managers faceunpredictable external conditions OR lack of
information needed to establish the Proability ofcertain events.
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RISK:
Risk occurs whenever we can notpredictout-come of
an alternative with certainty, butwe do have enoughinformation to predictthe Probability itwill lead tothe desired state.
Probability:
A statistical measure ofthe chance, a certain event Or out-Come will occur.
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INCORPORATING UNCERTAINTY IN
DECISION MAKING:
Three possibilities for decision making underconditions ofuncertainty:
Take the bestpossible estimates for decision makingwithoutconsidering uncertainty.
Take estimates with build-in an allowance to accountfor possibility of estimates being optimistic and nottaking uncertainty into consideration.
Take into accountuncertainty into our modeling.
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Techniques for Decision MakingExamining how to quantifyuncertainty, and usingthree techniques to aid decision making under
uncertainty.a. The Decision Matrix
b. The Decision Tree
c. The Risk Simulation.
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a ) Decision Matrix
The decision matrix is a useful method of describing
decisions, which take place under uncertainty.
It lists all the decision options on one dimension ofthe matrix and all possible states of nature on the
other dimension.
Every square in the matrix will then represent a
possible consequence or outcome.These
consequences can be examined by using Decision
Rules in orderto decide which ofthe options is
preferred.
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State of Nature
N1 N2 N3 N4Decision S1 O11 O12 O13 O14
Options S2 O21 O22 O23 O24
S3 031 O32 O33 O34
S4 O41 O42 O43 O44
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S1 = Decision options
N1 =The uncertain event
O1 =The outcomeThese Outcomes or Consequences can be examined
by using Decision Rules in orderto decide which ofthe
options should be preferred.
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The Four Decision Rules
a) The Optimistic Decision Rule.
b) The Pessimistic Decision Rule.
c) The RegretDecision Rule.d) The Expected Value decision Rule.
a) The Optimistic Decision Rule.
This approach of selecting the preferred option is to
consider all circumstances and choose thatoptionwhich gives the bestpossible outcome orconsequence.
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b. The Pessimistic Decision Rule.
The pessimistshall assume thatthe worst is going to
occur and shall choose the bestoutofthe worstoutcome.
c. The Regret Decision Rule:
Itconsiders the measure of regretnothaving chosenthe option, which turns outto be the bestoption fora particular setof circumstances.
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Regret Tables for Two Alternative Production
Processes
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Available SalesVolume
MaximumRegret
1000
units
2000
Units
$3300(200) $ 2000(0) 200
$3100(0) $ 2400(400)
400Method # 2
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Therefore the Maximum regret in method (1) is $ 200and the Maximum regret in method (2) is $ 400.Under this rule, we shallselectmethod (1) being theminimum ofthe Maximum regrets. (differencebetween whatyou getand the bestcase)
d) ExpectedValue Decision Rule:
The above Three Decision Rules guide us to select
the bestoption, butnon ofthem provides thelikelihood of a particular situation occurring.
The principle of expectation weights each outcomebythe likelihood of itoccurring.
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Expected Value for Revenues from the
Addition of One Ski Lift
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d) Risk Simulation
It is also called Risk Analysis.
It is a useful technique which allows a more
sophisticated approach to the way; the uncontrollablefactors withinthe decisionare described.
Risk Analysis is a process of developing probabilitydistribution for some measure of merit for aninvestmentproposal.
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Steps:1. Selectthe uncontrollable exogenous i.e. (inputs)
variables, which have asignificanteffectonthedecision.
2. Estimate probability foreach variable.
3. Choose the Endogenous variables, the measure ofoutcome, which will be used toevaluate the optionssuch as Rate of Returnorprofit.
4. Determine the function, which relates theuncontrollable exogenous variables totheendogenous variables.
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5. Randomly selecta value from each ofthe probabilitydistribution and combine them to determine a valuefor the endogenous variable.
6. Repeatstep 5 a number oftimes until a distributionof values for the endogenous variable is formed.
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The Decision Tree
The Decision Tree formatprovides sequentialdecisions to be presented and the consequences(outcome) of future decisions to be traced back toassess their influences on the presentdecision.
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Planning Tool
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Decision Trees Enable a business to quantify decision
making
Useful when the outcomes areuncertain
Places a numerical value on likely or
potential outcomesAllows comparison of differentpossible
decisions to be made
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Decision Trees Limitations:
How accurate is the data usedin the construction ofthe tree?
How reliable are the estimatesofthe probabilities?
Data may be historical does this data relate toreal time?
Necessity of factoring in the qualitative factors human resources, motivation, reaction, relationswith suppliers and other stakeholders
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Process
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The Process
Expand by opening new outlet
Maintain current status
Economic growth rises
Economic growth declines
0.7
0.3
Expected outcome300,000
Expected outcome-500,000
0
A square denotes the point where a decision is made, In this example, a business is contemplatingopening a new outlet.The uncertainty is the state ofthe economy ifthe economy continues to growhealthilythe option is estimated to yield profits of 300,000. However, ifthe economy fails to grow asexpected, the potential loss is estimated at 500,000.
There is also the option to do nothing and maintain the current status quo! This would have an outcome of0.
The circle denotes the point where different outcomes could occur. The estimates ofthe probability and the knowledge of the expected outcome allow the firm to make a
calculation of the likely return. In this example it is:
Economic growth rises: 0.7 x 300,000 = 210,000
Economic growth declines: 0.3 x 500,000 = -150,000
The calculation would suggest it is wise to go ahead with the decision ( a net benefit
figure of +60,000)
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The Process
Expand by opening new
outlet
Maintain currentstatus
Economic growth rises
Economic growth declines
0.5
0.5
Expectedoutcome300,000
Expected outcome-500,000
0
Look what happens however if the probabilities change. If the firm is unsureof the potential for growth, it might estimate it at 50:50. In this case the
outcomes will be:
Economic growth rises: 0.5 x 300,000 = 150,000
Economic growth declines: 0.5 x -500,000 = -250,000
In this instance, the net benefit is -100,000 the decision looks lessfavourable!
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Advantages
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Disadvantages