Chapter Five – Understanding Management Decision Making
KEY TERM(S)
Management and Decision Making
The Decision Making Model
Scientific Decision Making
A logical and research based approach to decision
making.
The Decision Making Process
Intuition
The process of making a decision based not upon
scientific research but a ‘gut feeling’ of the manager.
Good decision making lies at the heart of business
success. A wrong decision about what market to
enter for example, could result in a product’s
failure and the associated costs and time that this
brings.
Businesses have to decide the best course of action
to take from many different alternatives. All
decisions involve some element of risk and
businesses seek to minimise this through the
collection of data and the use of decision making
models.
Opportunity Cost
The cost of missing out on the next best alternative
forgone.
Amongst other things managers must decide upon:
Decision Tree
A diagrammatic model showing the probability of
different outcomes and the financial consequences
of each option.
Corporate and
Functional Objectives
What Resources are
Required
Set
Objectives
Expected Value
The expected monetary value of a specific course of
action multiplied by the probability of its occurrence.
Net Gain
The total monetary value to be gained from making
a particular decision minus the costs associated with
that decision.
Probability
The statistical odds of an outcome occurring which
assumes a value of between 0 and 1.
Ethics
Moral principles underpinning business decisions.
Managers then must decide which decisions are
critical to the success of the business and do
everything that they can to make the right
decisions.
Review
Strategy
Appropriate Corporate
and Functional Strategies
Resource Allocation
Select and
Implement
Strategy
Gather Data
Analyse Data
The decision making model helps to illustrate the
fact that decisions are dynamic and that the
process is a continual one as the business
environment never remains static and managers
need to respond to this.
Chapter Five – Understanding Management Decision Making
Types of Decisions
‘Paralysis By Analysis’
Uncertainty
Programmed Decisions
Becoming over
burdened with data
in an attempt to
improve the quality
of the decision made.
It simply leads to lost
time and expense
and the possibility
that the basis of the
final decision may be
meaningless, as the
grounds for the decision may have changed!
For non-programmed
decisions, the lack of
structure and familiarity
with a decision brings
about a significant level
of uncertainty. This
makes assessment of
the level of risk very
difficult.
Rewards
When making a decision, a manager must consider
the cost of not selecting the next best alternative
option. It is important to understand that resources
such as money are limited and decisions have to be
made on how best to use these resources.
These type of decisions are repetitive and routine
and therefore managers are able to plan effectively
when making them. Such examples include the
re-ordering of inventories.
Non-Programmed Decisions
These decisions are often unique and the outcomes
are unpredictable. The skills of the managers are
tested as the decisions made can have a significant
impact upon the organisation. Such examples
include entering new markets.
Decision Making, Risks, Rewards and
Uncertainty
A Decision Is More Likely To Succeed If:




The objectives are clear
Relevant data has been collected
Data analysis is effective and appropriate
The decision can be easily implemented.
In reality, all decisions involve an
element of risk and it is the role of
the manager to carefully assess and
minimise this. One of the main ways
in which risk is reduced is through
the collection of data but this needs
to be carefully managed to avoid it
creating additional problems.
When managers make good decisions then rewards
are forthcoming. These might be in the form of
financial benefits, personal advancement or both.
Decisions that benefit the business are profitable
and help to secure short-term business success.
Exam Advice
The higher the risk involved the higher the
potential rewards but remember that the
business environment is continually evolving and
that many more decisions will need to be made
to secure future long-term success.
Opportunity Costs
The Basic Elements of Decision Making
A risk taker will often trust their own intuition
whereas a more conservative manager may look
harder at the data from research. This leads to
decisions being taken either through a rigorous
scientific method that relies upon data analysis or
through the use of intuition or hunch.
Chapter Five – Understanding Management Decision Making
Decision Making Elements Model
Facts
Experience
Intuitive Decision Making
Problems of Decision Trees
In contrast, the use of intuition (gut feelings or
hunches), does not rely upon first collecting
and analysing data but instead follows through
upon the decisions of the manager. This
method of decision making carries more risk
but it allows for greater creativity and enables
faster decisions to be taken which can improve
competitiveness through first-mover
advantage.
It must be remembered that the decision tree is
only a forecast and as with all forecasts is only as
reliable as the information upon which it is based
e.g. how reliable are the estimates?
Intuition
When Intuition Might Be Used In Decision Making
In reality decisions are likely to incorporate all
three elements but this will depend upon the
individual manager’s personality.
Factors Influencing Decisions:




The degree of risk
How many resources are involved
The experience of the manager
The confidence of the managers in
their own abilities.
Scientific Decision Making
This involves the systematic collection of data
and decision making techniques, instead of
using generalisation and intuition. This
technique is time consuming and therefore
costly but it does carry less risk!




When time is limited
The decision carries only a small
degree of risk
The necessary data is not available
or is too expensive to obtain.
The decision needs to be creative
e.g. fashion designs.
Making a decision using the decision tree might the
easy part. You still have to implement the decision
correctly!
A decision tree takes no account of QUALITATIVE
elements of a decision e.g.




Business ethics
The reaction of employees
Whether the decision enhances the
image of the firm
Employee morale.
Decision Trees
Benefits of Decision Trees
A decision tree enables all of the options open to
managers to be seen clearly.
The construction of the tree will force managers to
consider the implications of each decision and to
make more informed decisions based upon data.
New scenarios can also be tested using the decision
tree and the model can help to determine the best,
worst and expected values for different scenarios.
Exam Advice
Whilst candidates are not required to draw
decision trees, they are expected to be able to
analyse their use and to calculate both net gains
and expected values.
Chapter Five – Understanding Management Decision Making
DECISION TREE EXAMPLE
NET GAIN = £14M £5M = £9M
EV= (£23M x 0.4) +
(£8M x 0.6) = £14M
SUCCESS
£23M
P=0.4
YES
£5M
FAILURE
£8M
Expand the
business
into China?
P=0.6
EV= (£10M x 0.7) +
(£5M x 0.3) = £8.5M
SUCCESS
£10M
P=0.7
2
DEVELOP UK MARKET
NET GAIN = £8.5M £1M = £7.5M
£1M
FAILURE
P=0.3
8
£5.5
M
EXPECTED VALUE
This is calculated by multiplying the expected value of each outcome by its probability of occurrence.
The values are then added together to create an expected value for this outcome. The probability of
each outcome MUST total 1. For example, P=0.4 + P=0.6 totals 1.
DECISION NODE
CHANCE NODE
NET GAIN
The expected value for a chance node minus the cost of implementing that decision to show the overall
financial gain or loss from making that decision.
Chapter Five – Understanding Management Decision Making
Influences On Decision Making
Competition
Mission & Objectives
A mission outlines what a business is trying to
achieve in the long-term and therefore all
decisions will be taken with this aim in mind. For
example, a business might make a decision to
invest in additional training in order to meet their
objective of delivering first class customer service.
Resource Constraints
All resources are finite and therefore all
businesses operate with a limited level of
finance, human and physical resources. The
key decisions revolve around how best to
utilise these resources.
How does a business look to respond to
competitor actions? Are you proactive or
reactive in your decision making?
OTHER
DECISION
MAKING
FACTORS
Ethics
Are decisions taken with a consideration for
what is morally right or does profit
dominate manager thinking? Does a
business make decisions with a real desire
to act ethically or because they wish to
avoid negative publicity?
External Environment
What decisions do you make if interest rates fall or
rise and customer incomes are affected? What
about new legislation, environmental concerns or a
changing customer demographic?