Ch no. 6 Managing as Decision Makers

1. 6–1
ManagersManagers
asas
Decision MakersDecision Makers
ChapterChapter
66
Management
Stephen P. Robbins Mary Coulter
tenth edition

2. 6–2
Learning OutcomesLearning Outcomes
Follow this Learning Outline as you read andFollow this Learning Outline as you read and
study this chapter.study this chapter.
6.1 The Decision-Making Process.
• Define decision.Define decision.
• Describe the eight steps in the decision-making process.Describe the eight steps in the decision-making process.
6.2 Managers Making Decisions.
• Discuss the assumptions of rational decision making.Discuss the assumptions of rational decision making.
• Describe the concepts of bounded rationality, satisficing, andDescribe the concepts of bounded rationality, satisficing, and
escalation of commitment.escalation of commitment.
• Explain intuitive decision making.Explain intuitive decision making.

3. 6–3
Learning OutcomesLearning Outcomes
6.3 Types Of Decisions and Decision-Making
Conditions.
• Explain the two types of problems and decisions.Explain the two types of problems and decisions.
• Contrast the three decision making conditions.Contrast the three decision making conditions.
• Explain maximax, maximin, and minimax decision choiceExplain maximax, maximin, and minimax decision choice
approaches.approaches.
6.4 Decision-Making Styles
• Describe two decision-making styles.Describe two decision-making styles.
• Discuss the twelve decision-making biases.Discuss the twelve decision-making biases.
• Explain the managerial decision-making model.Explain the managerial decision-making model.

4. 6–4
Learning OutcomesLearning Outcomes
6.5 Effective Decision Making In Today’s World.
• Explain how managers can make effective decisionsExplain how managers can make effective decisions
in today’s world.in today’s world.
• List the six characteristics of an effective decisionList the six characteristics of an effective decision
making process.making process.
• List the five habits of highly reliable organizations.List the five habits of highly reliable organizations.

5.  It is the first management function
‘A man who does not plan long ahead will
find trouble at his door’ – Confucius
‘Always plan ahead. It wasn’t raining
when Noah built the ark’ – Richard
Cushing

6.  Decision Making is the essence of management
 What managers do and try to avoid
 All the managers like to make good decision
 They are judged on the outcomes of those
decisions

7.  All organizational members make decisions that
affect their jobs and organization but our focus is on
how managers make decisions
 Managers at all levels and in all areas make
decisions
 Top-level managers
 Organization Goals
 Where to locate manufacturing facilities
 What new markets to move into
 Middle and lower-lever Managers
 Production Schedules
 Product Quality Problems
 Pay raises
 Employee Discipline

8.  Decision making is typically described as
choosing among alternatives
 That is too simplistic view
 Because decision making is a process, not just
as simple as choosing among alternatives.
 Example: Deciding where to go for lunch
Example of a manager deciding what laptop
computers to purchase to understand the process of
decision making.

9. 6–9

10.  Every decision starts with a problem
 Discrepancy between an existing and desired condition
Characteristics of Problems
A problem becomes a problem when a manager becomes aware of it.
There is pressure to solve the problem.
The manager must have the authority, information, or resources needed
to solve the problem
 Mr.Khan is a sales manager whose reps need new laptops
 Old ones are outdated and inadequate for doing their job
 Problem – Disparity between the current computers (existing condition)
and their need to have more efficient (desired condition)
 Mr. Khan has a decision to make

11.  Problems don’t come with neon signs flashing
‘problems’
 When reps started complaining, it was pretty clear to
Mr.Khan that something needed to be done for the
laptops
 But very few problems are that obvious.
 Managers must not confuse problems with symptoms
of a problem
 5 percent drop in sales??

12.  It is not a problem, but a symptom of the real
problem, such as poor quality products, high prices or
bad advertising.
 Problem Identification is subjective.
 What one manager considers a problem might not
considered as a problem by another manager.
 A manager who resolves the wrong problem perfectly
is as poor as the manager who doesn’t even recognize a
problem and does nothing.
 Effectively, identifying a problem is very important.

13.  Identifying decision criteria; things that are important
and relevant to resolving the problem.
•Costs that will be incurred (investments
required)
•Risks likely to be encountered (chance of
failure)
•Outcomes that are desired (growth of the firm)
 In our example, Mr. Khan after careful consideration
decides that memory and storage capabilities, display
quality, battery life, warranty and carrying weight are
relevant criteria in his decision.

14. • Decision criteria are not of equalDecision criteria are not of equal
importance:importance:
 Assigning a weight to each item places theAssigning a weight to each item places the
items in the correct priority order of theiritems in the correct priority order of their
importance in the decision-making process.importance in the decision-making process.

15.  List variable alternatives that could resolve the
problem
 The decision maker needs to be creative for this step
of decision making
 Alternatives are only listed, not evaluated
 Mr.Khan identifies eight laptops as possible choices
 Toshiba Protégé
 Dell Inspiron
 HP Pavillion
 Apple iBook
 Sony Vaio
 Gateway
 Toshiba Qosmio
 Lenovo Thinkpad

16. Evaluating AlternativesEvaluating Alternatives
Legal?Legal?
EthicalEthical
Economical?Economical?
Practical?
Is the possible course of action:

17. Evaluating AlternativesEvaluating Alternatives
• Is it legal?Is it legal? Managers must first be sure that anManagers must first be sure that an
alternative is legal both in this country and abroadalternative is legal both in this country and abroad
for exports.for exports.
• Is it ethical?Is it ethical? The alternative must be ethical andThe alternative must be ethical and
not hurt stakeholders unnecessarily.not hurt stakeholders unnecessarily.
• Is it economically feasible?Is it economically feasible? Can our organization’sCan our organization’s
performance goals sustain this alternative?performance goals sustain this alternative?
• Is it practical?Is it practical? Does the management have theDoes the management have the
capabilities and resources to do it?capabilities and resources to do it?

18. Decision maker after identifying the alternatives must evaluate
them. Mr.Khan after some research gave these values to
each alternative
Laptop
Memory &
Storage
Battery
Life
Carrying
Weight
Warranty
Display
Quality
Toshiba Protégé 10 3 10 8 5
Dell Inspiron 8 7 7 8 7
HP Pavillion 8 5 7 10 10
Apple iBook 8 7 7 8 7
Sony Vaio 7 8 7 8 7
Gateway 8 3 6 10 8
Toshiba Qosmio 10 7 8 6 7
Lenovo Thinkpad 4 10 4 8 10
These values are only an assessment of those eight laptops and do not include weighing of the decision
criteria.

19. Result after multiplying each alternative by assigned
weight
Laptop
Memory
& Storage
Battery
Life
Carrying
Weight
Warrant
y
Display
Quality
Total
Toshiba
Protégé
10x10=10
0
3x8=24 10x6=60 8x4=32 5x3=15 231
Dell Inspiron 80 56 42 32 21 231
HP Pavillion 80 40 42 40 30 232
Apple iBook 80 56 42 32 21 231
Sony Vaio 70 64 42 32 21 229
Gateway 80 24 36 40 24 204
Toshiba
Qosmio
100 56 48 24 21 249
Lenovo
Thinkpad
40 80 24 32 30 206
We don’t need this step if any one of the alternatives score highest in every criteria, we would not
consider the weights in that case.

20. 6–20
Step 4: Developing AlternativesStep 4: Developing Alternatives
• Identifying viable alternativesIdentifying viable alternatives
 Alternatives are listed (without evaluation) that canAlternatives are listed (without evaluation) that can
resolve the problem.resolve the problem.
Step 5: Analyzing AlternativesStep 5: Analyzing Alternatives
• Appraising each alternative’s strengths andAppraising each alternative’s strengths and
weaknessesweaknesses
 An alternative’s appraisal is based on its ability toAn alternative’s appraisal is based on its ability to
resolve the issues identified in steps 2 and 3.resolve the issues identified in steps 2 and 3.

21.  Choosing the best alternative, the one that generated
highest total in step 5.
 Mr.Khan would choose Thosiba Qosmio because it
scored highest (249).

22.  Putting the decision into action
 Managers must reassess the environment for any
changes
 Especially with the long term decisions
 They must check if the criteria, alternatives, choices
are still the best
 Or has the environment changed in such a way that
you need to reassess

23.  The last step in decision making is evaluating the
outcome to see if the problem was resolved
 If the problem still exists, then the manager needs to
assess what went wrong
 Was the problem incorrectly identified?
 Were the errors made when evaluating alternatives?
 You might end up redoing an earlier step or even the
whole process

24. 6–24
Step 6: Selecting an AlternativeStep 6: Selecting an Alternative
• Choosing the best alternativeChoosing the best alternative
 The alternative with the highest total weight isThe alternative with the highest total weight is
chosen.chosen.
Step 7: Implementing theStep 7: Implementing the
AlternativeAlternative
• Putting the chosen alternative into action.Putting the chosen alternative into action.
 Conveying the decision to and gaining commitmentConveying the decision to and gaining commitment
from those who will carry out the decision.from those who will carry out the decision.

25. 6–25
Step 8: Evaluating the Decision’sStep 8: Evaluating the Decision’s
EffectivenessEffectiveness
• The soundness of the decision is judged by itsThe soundness of the decision is judged by its
outcomes.outcomes.
 How effectively was the problem resolved byHow effectively was the problem resolved by
outcomes resulting from the chosen alternatives?outcomes resulting from the chosen alternatives?
 If the problem was not resolved, what went wrong?If the problem was not resolved, what went wrong?

26. 6–26
Exhibit 6–5Exhibit 6–5 Decisions in the ManagementDecisions in the Management
FunctionsFunctions

27. 6–27
Making DecisionsMaking Decisions
• RationalityRationality
 Managers make consistent, value-maximizing choicesManagers make consistent, value-maximizing choices
with specified constraints.with specified constraints.
 They have all the tools to make decisions and accessThey have all the tools to make decisions and access
to informationto information
 Assumptions are that decision makers:Assumptions are that decision makers:
 Are perfectly rational, fully objective, and logical.Are perfectly rational, fully objective, and logical.
 Have carefully defined the problem and identified all viableHave carefully defined the problem and identified all viable
alternatives.alternatives.
 Have a clear and specific goalHave a clear and specific goal
 Will select the alternative that maximizes outcomes in theWill select the alternative that maximizes outcomes in the
organization’s interests rather than in their personal interests.organization’s interests rather than in their personal interests.

28. 6–28
Making Decisions (cont’d)Making Decisions (cont’d)
• Bounded RationalityBounded Rationality
 Managers make decisions rationally, but are limitedManagers make decisions rationally, but are limited
(bounded) by their ability to process information.(bounded) by their ability to process information.
There is a large number of alternatives andThere is a large number of alternatives and
information is vast so that managers cannotinformation is vast so that managers cannot
consider it all.consider it all.
 Decisions are limited by people’s cognitive abilities.Decisions are limited by people’s cognitive abilities.
 Incomplete information:Incomplete information: most managers do not see allmost managers do not see all
alternatives and decide based on incompletealternatives and decide based on incomplete
informationinformation
 Also Called the Administrative model of DecisionAlso Called the Administrative model of Decision
making…making…
• Challenged the classical assumptions thatChallenged the classical assumptions that
managers have and process all the information.managers have and process all the information.
 As a result, decision making is risky.As a result, decision making is risky.

29. Bounded RationalityBounded Rationality
 Assumptions are that decision makers:Assumptions are that decision makers:
 Will not seek out or have knowledge of all alternativesWill not seek out or have knowledge of all alternatives
 WillWill satisficesatisfice—choose the first alternative encountered that—choose the first alternative encountered that
satisfactorily solves the problem—satisfactorily solves the problem—rather than maximize therather than maximize the
outcome of their decision by considering all alternatives andoutcome of their decision by considering all alternatives and
choosing the best.choosing the best.
 This is the response of managers when dealing withThis is the response of managers when dealing with
incomplete information.incomplete information.
 Managers assume that the limited options theyManagers assume that the limited options they
examine represent all options.examine represent all options.
 Influence on decision makingInfluence on decision making
 Escalation of commitmentEscalation of commitment: an increased commitment to a: an increased commitment to a
previous decision despite evidence that it may have beenprevious decision despite evidence that it may have been
wrong.wrong.
6–29

30. Why Information is IncompleteWhy Information is Incomplete
UncertaintyUncertainty
& risk& risk
AmbiguousAmbiguous
InformationInformation
Time constraints &
information costs
IncompleteIncomplete
InformationInformation

31. 6–31
The Role of Rationality in DMThe Role of Rationality in DM
• The rational decision making process reliesThe rational decision making process relies
mostly on logic and quantitative analysismostly on logic and quantitative analysis
 You consciously analyze all the options. YouYou consciously analyze all the options. You
formulate the main criteria for judging the expectedformulate the main criteria for judging the expected
outcomes of your options and you assign certainoutcomes of your options and you assign certain
weights to those criteria to reflect their relativeweights to those criteria to reflect their relative
importance. Then, based on the expected outcomesimportance. Then, based on the expected outcomes
and their weights, you rate your options by theirand their weights, you rate your options by their
perceived utility. Finally, you choose the option thatperceived utility. Finally, you choose the option that
has the highest rating.has the highest rating.
 IfIf expected outcomes involve uncertainty, you willexpected outcomes involve uncertainty, you will
also need to incorporate in your ratings the perceivedalso need to incorporate in your ratings the perceived
probabilities of different possibilitiesprobabilities of different possibilities

32. Rational Decision MakingRational Decision Making
• Rational analysis still plays crucial role in manyRational analysis still plays crucial role in many
situations, especially when you have clearsituations, especially when you have clear
criteria and have to deal with extensivecriteria and have to deal with extensive
quantitative data, like quantitative finance. Yet,quantitative data, like quantitative finance. Yet,
you will likely face even more businessyou will likely face even more business
situations where the rational decision makingsituations where the rational decision making
becomes impractical.becomes impractical.
6–32

33. 6–33
The Role of IntuitionThe Role of Intuition
• Intuitive decision makingIntuitive decision making
 Making decisions on the basis of experience, feelings,Making decisions on the basis of experience, feelings,
and accumulated judgment.and accumulated judgment.
 The main alternative to the intuition-based approachThe main alternative to the intuition-based approach
is rational thinkingis rational thinking
 The rational decision making process reliesThe rational decision making process relies
mostly on logic and quantitative analysismostly on logic and quantitative analysis

34. 6–34
Exhibit 6–6Exhibit 6–6 What Is Intuition?What Is Intuition?

35. 6–35
Intuition in Decision MakingIntuition in Decision Making
• key features that characterize the intuitive modekey features that characterize the intuitive mode
of thinkingof thinking
 dominated by your subconscious mind, even if youdominated by your subconscious mind, even if you
use your conscious mind to formulate or rationalizeuse your conscious mind to formulate or rationalize
the final results.the final results.
 more connected with your emotionsmore connected with your emotions
 Instead of going through a logical sequence ofInstead of going through a logical sequence of
thoughts one by one, you see the situation more as athoughts one by one, you see the situation more as a
wholewhole

36. 6–36
Types of Problems and DecisionsTypes of Problems and Decisions
• Structured ProblemsStructured Problems
 Involve goals that are clear.Involve goals that are clear.
 Are familiar (have occurred before).Are familiar (have occurred before).
 Are easily and completely definedAre easily and completely defined—infor—information aboutmation about
the problem is available and complete.the problem is available and complete.
• Programmed DecisionProgrammed Decision
 A repetitive decision that can be handled by a routineA repetitive decision that can be handled by a routine
approach.approach.

37. 6–37
Types of Programmed DecisionsTypes of Programmed Decisions
• ProcedureProcedure
 A series of interrelated steps that a manager can useA series of interrelated steps that a manager can use
to respond (applying a policy) to a structured problem.to respond (applying a policy) to a structured problem.
• RuleRule
 An explicit statement that limits what a manager orAn explicit statement that limits what a manager or
employee can or cannot do.employee can or cannot do.
• PolicyPolicy
 A general guideline for making a decision about aA general guideline for making a decision about a
structured problem.structured problem.

38. 6–38
Policy, Procedure, and RulePolicy, Procedure, and Rule
ExamplesExamples
• PolicyPolicy
 Accept all customer-returned merchandise.Accept all customer-returned merchandise.
• ProcedureProcedure
 Follow all steps for completing merchandise returnFollow all steps for completing merchandise return
documentation.documentation.
• RulesRules
 Managers must approve all refunds over $50.00.Managers must approve all refunds over $50.00.
 No credit purchases are refunded for cash.No credit purchases are refunded for cash.

39. 6–39
Problems and Decisions (cont’d)Problems and Decisions (cont’d)
• Unstructured ProblemsUnstructured Problems
 Problems that are new or unusual and for whichProblems that are new or unusual and for which
information is ambiguous or incomplete.information is ambiguous or incomplete.
 Problems that will require custom-made solutions.Problems that will require custom-made solutions.
• Nonprogrammed DecisionsNonprogrammed Decisions
 Decisions that are unique and nonrecurring.Decisions that are unique and nonrecurring.
 Decisions that generate unique responses.Decisions that generate unique responses.
 May require intiutive deicision makingMay require intiutive deicision making

40. 6–40
Exhibit 6–7 Programmed Versus Nonprogrammed DecisionsExhibit 6–7 Programmed Versus Nonprogrammed Decisions

41. 6–41
Decision-Making ConditionsDecision-Making Conditions
• CertaintyCertainty
 A situation in which a manager can make an accurateA situation in which a manager can make an accurate
decision because the outcome of every alternativedecision because the outcome of every alternative
choice is known.choice is known.
• RiskRisk
 A situation in which the manager is able to estimateA situation in which the manager is able to estimate
the likelihood (probability) of outcomes that resultthe likelihood (probability) of outcomes that result
from the choice of particular alternatives.from the choice of particular alternatives.

42. 6–42
Exhibit 6–8Exhibit 6–8 Expected Value for RevenuesExpected Value for Revenues
from the Addition of One Ski Liftfrom the Addition of One Ski Lift
Expected
Expected × Probability = Value of Each
Event Revenues Alternative
Heavy snowfall $850,000 0.3 = $255,000
Normal snowfall 725,000 0.5 = 362,500
Light snowfall 350,000 0.2 = 70,000
$687,500

43. 6–43
Decision Making ConditionsDecision Making Conditions
• UncertaintyUncertainty
 Limited information prevents estimation of outcomeLimited information prevents estimation of outcome
probabilities for alternatives associated with theprobabilities for alternatives associated with the
problem and may force managers to rely on intuition,problem and may force managers to rely on intuition,
hunches, and “gut feelings.”hunches, and “gut feelings.”
 Maximax:Maximax: the optimistic manager’s choice to maximize thethe optimistic manager’s choice to maximize the
maximum payoffmaximum payoff
 Maximin:Maximin: the pessimistic manager’s choice to maximize thethe pessimistic manager’s choice to maximize the
minimum payoffminimum payoff
 Minimax:Minimax: the manager’s choice to minimize maximum regret.the manager’s choice to minimize maximum regret.

44. Chap 17-44
QT in Decision Making OverviewQT in Decision Making Overview
Decision Making
Certainty Nonprobabilistic
Uncertainty Probabilistic
Decision Environment Decision Criteria

45. Chap 17-45
The Decision EnvironmentThe Decision Environment
Certainty
Uncertainty
Decision Environment Certainty: The results of decision
alternatives are known
Example:
Must print 10,000 color brochures
Offset press A: $2,000 fixed cost
+ $.24 per page
Offset press B: $3,000 fixed cost
+ $.12 per page
*

46. Chap 17-46
The Decision EnvironmentThe Decision Environment
Uncertainty
Certainty
Decision Environment
Uncertainty: The outcome that
will occur after a choice is
unknown
Example:
You must decide to buy an item
now or wait. If you buy now the
price is $2,000. If you wait the
price may drop to $1,500 or rise
to $2,200. There also may be a
new model available later with
better features.
*
(continued)

47. Chap 17-47
Decision CriteriaDecision Criteria
Nonprobabilistic
Probabilistic
Decision CriteriaNonprobabilistic Decision Criteria:
Decision rules that can be
applied if the probabilities of
uncertain events are not known. *
 maximax criterion
 maximin criterion
 minimax regret criterion

48. Chap 17-48
Nonprobabilistic
Probabilistic
Decision Criteria
*
Probabilistic Decision Criteria:
Consider the probabilities of
uncertain events and select an
alternative to maximize the
expected payoff of minimize the
expected loss
 maximize expected value
 minimize expected opportunity loss
Decision CriteriaDecision Criteria
(continued)

49. Chap 17-49
A Payoff TableA Payoff Table
A payoff table showsA payoff table shows alternativesalternatives,,
states of naturestates of nature, and payoffs, and payoffs
Investment
Choice
(Alternatives)
Profit in $1,000’s
(States of Nature)
Strong
Economy
Stable
Economy
Weak
Economy
Large factory
Average factory
Small factory
200
90
40
50
120
30
-120
-30
20

50. Chap 17-50
Maximax SolutionMaximax Solution
Investment
Choice
(Alternatives)
Profit in $1,000’s
(States of Nature)
Strong
Economy
Stable
Economy
Weak
Economy
Large factory
Average factory
Small factory
200
90
40
50
120
30
-120
-30
20
1.
Maximum Profit
200
120
40
The maximax criterion (an optimistic approach):
1. For each option, find the maximum payoff

51. Chap 17-51
Maximax SolutionMaximax Solution
Investment
Choice
(Alternatives)
Profit in $1,000’s
(States of Nature)
Strong
Economy
Stable
Economy
Weak
Economy
Large factory
Average factory
Small factory
200
90
40
50
120
30
-120
-30
20
1.
Maximum Profit
200
120
40
The maximax criterion (an optimistic approach):
1. For each option, find the maximum payoff
2. Choose the option with the greatest maximum payoff
2.
Greatest
maximum is to
choose Large
factory
(continued)

52. Chap 17-52
Maximin SolutionMaximin Solution
Investment
Choice
(Alternatives)
Profit in $1,000’s
(States of Nature)
Strong
Economy
Stable
Economy
Weak
Economy
Large factory
Average factory
Small factory
200
90
40
50
120
30
-120
-30
20
1.
Minimum Profit
-120
-30
20
The maximin criterion (a pessimistic approach):
1. For each option, find the minimum payoff

53. Chap 17-53
Maximin SolutionMaximin Solution
Investment
Choice
(Alternatives)
Profit in $1,000’s
(States of Nature)
Strong
Economy
Stable
Economy
Weak
Economy
Large factory
Average factory
Small factory
200
90
40
50
120
30
-120
-30
20
1.
Minimum Profit
-120
-30
20
The maximin criterion (a pessimistic approach):
1. For each option, find the minimum payoff
2. Choose the option with the greatest minimum payoff
2.
Greatest
minimum is to
choose Small
factory
(continued)

54. Chap 17-54
Opportunity LossOpportunity Loss
Investment
Choice
(Alternatives)
Profit in $1,000’s
(States of Nature)
Strong
Economy
Stable
Economy
Weak
Economy
Large factory
Average factory
Small factory
200
90
40
50
120
30
-120
-30
20
The choice “Average factory” has payoff 90 for “Strong Economy”. Given
“Strong Economy”, the choice of “Large factory” would have given a
payoff of 200, or 110 higher. Opportunity loss = 110 for this cell.
Opportunity loss is the difference between an actual
payoff for a decision and the optimal payoff for that
state of nature
Payoff
Table

55. Chap 17-55
Opportunity LossOpportunity Loss
Investment
Choice
(Alternatives)
Profit in $1,000’s
(States of Nature)
Strong
Economy
Stable
Economy
Weak
Economy
Large factory
Average factory
Small factory
200
90
40
50
120
30
-120
-30
20
(continued)
Investment
Choice
(Alternatives)
Opportunity Loss in $1,000’s
(States of Nature)
Strong
Economy
Stable
Economy
Weak
Economy
Large factory
Average factory
Small factory
0
110
160
70
0
90
140
50
0
Payoff
Table
Opportunity
Loss Table

56. Chap 17-56
Minimax Regret SolutionMinimax Regret Solution
Investment
Choice
(Alternatives)
Opportunity Loss in $1,000’s
(States of Nature)
Strong
Economy
Stable
Economy
Weak
Economy
Large factory
Average factory
Small factory
0
110
160
70
0
90
140
50
0
Opportunity Loss Table
The minimax regret criterion:
1. For each alternative, find the maximum opportunity
loss (or “regret”)
1.
Maximum Op.
Loss
140
110
160

57. Chap 17-57
Minimax Regret SolutionMinimax Regret Solution
Investment
Choice
(Alternatives)
Opportunity Loss in $1,000’s
(States of Nature)
Strong
Economy
Stable
Economy
Weak
Economy
Large factory
Average factory
Small factory
0
110
160
70
0
90
140
50
0
Opportunity Loss Table
The minimax regret criterion:
1. For each alternative, find the maximum opportunity
loss (or “regret”)
2. Choose the option with the smallest maximum loss
1.
Maximum Op.
Loss
140
110
160
2.
Smallest
maximum loss
is to choose
Average
factory
(continued)

58. Chap 17-58
Expected Value SolutionExpected Value Solution
• The expected value is the weighted averageThe expected value is the weighted average
payoff,payoff, given specified probabilities for each stategiven specified probabilities for each state
of natureof nature
Investment
Choice
(Alternatives)
Profit in $1,000’s
(States of Nature)
Strong
Economy
(.3)
Stable
Economy
(.5)
Weak
Economy
(.2)
Large factory
Average factory
Small factory
200
90
40
50
120
30
-120
-30
20
Suppose these
probabilities have been
assessed for these states
of nature

59. Chap 17-59
Expected Value SolutionExpected Value Solution
Investment
Choice
(Alternatives)
Profit in $1,000’s
(States of Nature)
Strong
Economy
(.3)
Stable
Economy
(.5)
Weak
Economy
(.2)
Large factory
Average factory
Small factory
200
90
40
50
120
30
-120
-30
20
Example:Example: EV (Average factory) = 90(.3) + 120(.5) + (-30)(.2)EV (Average factory) = 90(.3) + 120(.5) + (-30)(.2)
= 81= 81
Expected
Values
61
81
31
Maximize
expected value
by choosing
Average
factory
(continued)

60. Chap 17-60
Expected Opportunity LossExpected Opportunity Loss
SolutionSolution
Investment
Choice
(Alternatives)
Opportunity Loss in $1,000’s
(States of Nature)
Strong
Economy
(.3)
Stable
Economy
(.5)
Weak
Economy
(.2)
Large factory
Average factory
Small factory
0
110
160
70
0
90
140
50
0
Example:Example: EOL (Large factory) = 0(.3) + 70(.5) + (140)(.2)EOL (Large factory) = 0(.3) + 70(.5) + (140)(.2)
= 63= 63
Expected Op.
Loss
(EOL)
63
43
93
Minimize expected
op. loss by
choosing Average
factory
Opportunity Loss Table

61. Chap 17-61
Cost of UncertaintyCost of Uncertainty
• Cost of Uncertainty (also called Expected ValueCost of Uncertainty (also called Expected Value
of Perfect Information, or EVPI)of Perfect Information, or EVPI)
• Cost of UncertaintyCost of Uncertainty
= Expected Value Under Certainty (EVUC)= Expected Value Under Certainty (EVUC)
–– Expected Value without information (EV)Expected Value without information (EV)
so: EVPI = EVUC – EVso: EVPI = EVUC – EV

62. Chap 17-62
Expected Value Under CertaintyExpected Value Under Certainty
• Expected ValueExpected Value
UnderUnder
CertaintyCertainty
(EVUC):(EVUC):
EVUC =EVUC =
expected valueexpected value
of the bestof the best
decision,decision, givengiven
perfectperfect
informationinformation
Investment
Choice
(Alternatives)
Profit in $1,000’s
(States of Nature)
Strong
Economy
(.3)
Stable
Economy
(.5)
Weak
Economy
(.2)
Large factory
Average factory
Small factory
200
90
40
50
120
30
-120
-30
20
Example: Best decision given “Strong
Economy” is “Large factory”
200 120 20

63. Chap 17-63
Expected Value Under CertaintyExpected Value Under Certainty
Investment
Choice
(Alternatives)
Profit in $1,000’s
(States of Nature)
Strong
Economy
(.3)
Stable
Economy
(.5)
Weak
Economy
(.2)
Large factory
Average factory
Small factory
200
90
40
50
120
30
-120
-30
20
200 120 20
(continued)
EVUC = 200(.3)+120(.5)+20(.2)
= 124
• Now weightNow weight
these outcomesthese outcomes
with theirwith their
probabilities toprobabilities to
find EVUC:find EVUC:

64. Chap 17-64
Cost of Uncertainty SolutionCost of Uncertainty Solution
• Cost of Uncertainty (EVPI)Cost of Uncertainty (EVPI)
= Expected Value Under Certainty (EVUC)= Expected Value Under Certainty (EVUC)
–– Expected Value without information (EV)Expected Value without information (EV)
so: EVPI = EVUC – EV
= 124 – 81
= 43
Recall: EVUC = 124
EV is maximized by choosing “Average factory”,
where EV = 81

65. Chap 17-65
Decision Tree AnalysisDecision Tree Analysis
• A Decision tree shows a decision problem,A Decision tree shows a decision problem,
beginning with the initial decision and ending willbeginning with the initial decision and ending will
all possible outcomes and payoffs.all possible outcomes and payoffs.
Use a square to denote decision nodesUse a square to denote decision nodes
Use a circle to denote uncertain eventsUse a circle to denote uncertain events

66. Chap 17-66
Sample Decision TreeSample Decision Tree
Large factory
Small factory
Average factory
Strong Economy
Stable Economy
Weak Economy
Strong Economy
Stable Economy
Weak Economy
Strong Economy
Stable Economy
Weak Economy

67. Chap 17-67
Add Probabilities and PayoffsAdd Probabilities and Payoffs
Large factory
Small factory
Decision
Average factory
Uncertain Events
(States of Nature)
Strong Economy
Stable Economy
Weak Economy
Strong Economy
Stable Economy
Weak Economy
Strong Economy
Stable Economy
Weak Economy
(continued)
PayoffsProbabilities
200
50
-120
40
30
20
90
120
-30
(.3)
(.5)
(.2)
(.3)
(.5)
(.2)
(.3)
(.5)
(.2)

68. Chap 17-68
Fold Back the TreeFold Back the Tree
Large factory
Small factory
Average factory
Strong Economy
Stable Economy
Weak Economy
Strong Economy
Stable Economy
Weak Economy
Strong Economy
Stable Economy
Weak Economy
200
50
-120
40
30
20
90
120
-30
(.3)
(.5)
(.2)
(.3)
(.5)
(.2)
(.3)
(.5)
(.2)
EV=200(.3)+50(.5)+(-120)(.2)=61
EV=90(.3)+120(.5)+(-30)(.2)=81
EV=40(.3)+30(.5)+20(.2)=31

69. Chap 17-69
Make the DecisionMake the Decision
Large factory
Small factory
Average factory
Strong Economy
Stable Economy
Weak Economy
Strong Economy
Stable Economy
Weak Economy
Strong Economy
Stable Economy
Weak Economy
200
50
-120
40
30
20
90
120
-30
(.3)
(.5)
(.2)
(.3)
(.5)
(.2)
(.3)
(.5)
(.2)
EV=61
EV=81
EV=31
Maximum
EV=81

70. Chap 17-70
SummarySummary
• Examined decision making environmentsExamined decision making environments
 certainty and uncertaintycertainty and uncertainty
• Reviewed decision making criteriaReviewed decision making criteria
 nonprobabilistic: maximax, maximin, minimax regretnonprobabilistic: maximax, maximin, minimax regret
 probabilistic: expected value, expected opp. lossprobabilistic: expected value, expected opp. loss
• Computed the Cost of Uncertainty (EVPI)Computed the Cost of Uncertainty (EVPI)
• Developed decision trees and applied them toDeveloped decision trees and applied them to
decision problemsdecision problems

71. 6–71
Decision-Making StylesDecision-Making Styles
• Linear thinking styleLinear thinking style
 A person’s preference for using external data andA person’s preference for using external data and
facts and processing this information through rational,facts and processing this information through rational,
logical thinkinglogical thinking
• Nonlinear thinking styleNonlinear thinking style
 A person’s preference for internal sources ofA person’s preference for internal sources of
information and processing this information withinformation and processing this information with
internal insights, feelings, and hunchesinternal insights, feelings, and hunches

72. Cognitive BiasesCognitive Biases
•AA cognitive biascognitive bias is the human tendency to makeis the human tendency to make
systematic errors in judgment, knowledge, and reasoning.systematic errors in judgment, knowledge, and reasoning.
•Suggests decision makers use heuristics to dealSuggests decision makers use heuristics to deal
with bounded rationality.with bounded rationality.
 A heuristic is a rule of thumb to deal with complexA heuristic is a rule of thumb to deal with complex
situations.situations.
 If the heuristic is wrong, however, then poor decisionsIf the heuristic is wrong, however, then poor decisions
result from its use.result from its use.
•Systematic errorsSystematic errors can result from use of ancan result from use of an
incorrect heuristic.incorrect heuristic.
 These errors will appear over and over since the ruleThese errors will appear over and over since the rule
used to make decision is flawed.used to make decision is flawed.
•CognitionCognition is the scientific term for "the processis the scientific term for "the process
of thought".of thought". 6–72

73. 6–73
Exhibit 6–11 Common Decision-Making Errors and BiasesExhibit 6–11 Common Decision-Making Errors and Biases

74. 6–74
Decision-Making Biases and ErrorsDecision-Making Biases and Errors
• HeuristicsHeuristics
 Using “rules of thumb” to simplify decision making.Using “rules of thumb” to simplify decision making.
• Overconfidence BiasOverconfidence Bias
 Holding unrealistically positive views of oneself andHolding unrealistically positive views of oneself and
one’s performance.one’s performance.
• Immediate Gratification BiasImmediate Gratification Bias
 Choosing alternatives that offer immediate rewardsChoosing alternatives that offer immediate rewards
and that to avoid immediate costs.and that to avoid immediate costs.

75. 6–75
Decision-Making Biases and ErrorsDecision-Making Biases and Errors
• Anchoring EffectAnchoring Effect
 Fixating on initial information and ignoring subsequentFixating on initial information and ignoring subsequent
information.information.
• Selective Perception BiasSelective Perception Bias
 Selecting organizing and interpreting events based onSelecting organizing and interpreting events based on
the decision maker’s biased perceptions.the decision maker’s biased perceptions.
• Confirmation BiasConfirmation Bias
 Seeking out information that reaffirms past choicesSeeking out information that reaffirms past choices
and discounting contradictory information. People areand discounting contradictory information. People are
bias towards confirming their existing beliefsbias towards confirming their existing beliefs

76. 6–76
Decision-Making Biases and ErrorsDecision-Making Biases and Errors
(cont’d)(cont’d)
• Framing BiasFraming Bias
 Selecting and highlighting certain aspects of aSelecting and highlighting certain aspects of a
situation while ignoring other aspects.situation while ignoring other aspects.
• Availability BiasAvailability Bias
 Losing decision making objectivity by focusing on theLosing decision making objectivity by focusing on the
most recent events.most recent events.
• Representation BiasRepresentation Bias
 Drawing analogies and seeing identical situationsDrawing analogies and seeing identical situations
when none exist.when none exist.
• Randomness BiasRandomness Bias
 Creating unfounded meaning out of random events.Creating unfounded meaning out of random events.

77. 6–77
Decision-Making Biases and ErrorsDecision-Making Biases and Errors
• Sunk Costs ErrorsSunk Costs Errors
 Forgetting that current actions cannot influence pastForgetting that current actions cannot influence past
events and relate only to future consequences.events and relate only to future consequences.
• Self-Serving BiasSelf-Serving Bias
 Taking quick credit for successes and blaming outsideTaking quick credit for successes and blaming outside
factors for failures.factors for failures.
• Hindsight BiasHindsight Bias
 Mistakenly believing that an event could have beenMistakenly believing that an event could have been
predicted once the actual outcome is known (after-predicted once the actual outcome is known (after-
the-fact).the-fact).

78. 6–78
Exhibit 6–12 Overview of Managerial Decision MakingExhibit 6–12 Overview of Managerial Decision Making

79. 6–79
Decision Making for Today’s WorldDecision Making for Today’s World
• Guidelines for making effective decisions:Guidelines for making effective decisions:
 Understand cultural differences.Understand cultural differences.
 Know when it’s time to call it quits.Know when it’s time to call it quits.
 Use an effective decision making process.Use an effective decision making process.
• Habits of highly reliable organizations (HROs)Habits of highly reliable organizations (HROs)
 Are not tricked by their success.Are not tricked by their success.
 Defer to the experts on the front line.Defer to the experts on the front line.
 Let unexpected circumstances provide the solution.Let unexpected circumstances provide the solution.
 Embrace complexity.Embrace complexity.
 Anticipate, but also anticipate their limits.Anticipate, but also anticipate their limits.

80. 6–80
Characteristics of an EffectiveCharacteristics of an Effective
Decision-Making ProcessDecision-Making Process
• It focuses on what is important.It focuses on what is important.
• It is logical and consistent.It is logical and consistent.
• It acknowledges both subjective and objective thinkingIt acknowledges both subjective and objective thinking
and blends analytical with intuitive thinking.and blends analytical with intuitive thinking.
• It requires only as much information and analysis as isIt requires only as much information and analysis as is
necessary to resolve a particular dilemma.necessary to resolve a particular dilemma.
• It encourages and guides the gathering of relevantIt encourages and guides the gathering of relevant
information and informed opinion.information and informed opinion.
• It is straightforward, reliable, easy to use, and flexible.It is straightforward, reliable, easy to use, and flexible.