16 Decision making basics

Required readings: Section 11.2 of Saylor Academy (2002).

Saylor Academy. (2002). Principles of management (1.1 ed.). https://saylordotorg.github.io/text_principles-of-management-v1.1/

Learning objectives:

Students will be able to:

Make informed decisions with a clear understanding of their nature and purpose.
Identify and explain the trade-offs involved in decision-making processes.
Describe the different characteristics of various types of decisions.
Utilize a range of decision-making strategies effectively.
Explain the rational decision-making model and the concept of homo economicus.
Discuss the concept of bounded rationality and its impact on human decision-making.
Apply heuristics to enhance decision-making in practical situations.

16.1 Definition: Decision

The statement of Eilon (1969) still holds true:

Eilon, S. (1969). What is a decision? Management Science, 16(4), B172–B189.

“An examination of the literature reveals the somewhat perplexing fact that most books on management and decision theory do not contain a specific definition of what is meant by a decision. One can find detailed descriptions of decision trees, discussions of game theory and analyses of various statistical treatments of payoffs matrices under conditions of uncertainty, but the definition of the decision activity itself is often taken for granted and is associated with making a choice between alternative courses of action.”

The word decision stems from the latin verb decidere which can have different meanings including

make explicit,
put an end to,
bring to conclusion,
settle/decide/agree (on),
die,
end up,
fail,
fall in ruin,
fall/drop/hang/flow down/off/over,
sink/drop,
cut/notch/carve to delineate,
detach,
cut off/out/down,
fell.

Wikipedia (2024) defines decision making as follows:

Wikipedia. (2024). Decision-making — Wikipedia, the free encyclopedia. https://en.wikipedia.org/w/index.php?title=Decision-making&oldid=1244138603

“In psychology, decision-making […] is regarded as the cognitive process resulting in the selection of a belief or a course of action among several alternative possibilities. Decision-making is the process of identifying and choosing alternatives based on the values, preferences and beliefs of the decision-maker. Every decision-making process produces a final choice, which may or may not prompt action. […] Decision-making can be regarded as a problem-solving activity yielding a solution deemed to be optimal, or at least satisfactory. It is therefore a process which can be more or less rational or irrational…”

Let’s agree on the following working definition that is symbolized in Figure 16.1:

Fitzgerald (2002, p. 8): “A decision is the point at which a choice is made between alternative—and usually competing—options. As such, it may be seen as a stepping-off point—the moment at which a commitment is made to one course of action to the exclusion of others.”

Exercise 16.1 Why are you studying here?

There are probably many personal reasons why you have chosen your study program. Take a moment to think about the decisions that led you to choose this program. Think back to the moment you signed the contract - was it a difficult decision? What factors influenced your choice? Perhaps you had several options; why did you ultimately choose this degree program? Think about your decision-making process and write a short summary of how you came to this decision.

Exercise 16.2 Solve the puzzles

The nine dots problem Connect the dots shown in figure Figure 16.2 with no more than 4 straight lines without lifting your hand from the paper.

The tasty cake puzzle In figure Figure 16.3 you see a tasty cake with the nine dots representing strawberries. Cut this cake up with exactly four straight cuts so that each portion of the cake contains just one strawberry on the top.

Reflect on how you tried to solve the puzzles. Did you have a problem solving strategy? How did you come to the right decision? Think of restrictions you imposed on yourself which was not inherent to the problem.

The house of Santa Claus The house of Santa Claus is an old German drawing game. It goes like this: You have to draw a house in one line where you
1. must start at bottom left (point 1),
2. you are not allowed to lift your pencil while drawing and
3. it is forbidden to repeat a line.
During drawing you say: “Das ist das Haus des Nikolaus”. What do you think is the success-rate of kids who play this game for the first time?

Solution

There are 44 solutions (see Figure 16.5) and only 10 different ways to fail (see Figure 16.6). Thus, the probability to fail is about 18.5% and hence the probability to succeed is about 81.5%.

Figure 16.5: Forty-four ways to solve the puzzle

Figure 16.6: Ten ways to fail in the puzzle

16.2 How to characterize decisions

Decision making is a process of investing time and effort to make a decision that leads to a results. Before we talk about the results, let’s discuss some (stereo) types of decisions that can help to design an appropriate decision making process. Using stereotypes and categorizations can be beneficial as they simplify complexities and provide guidance. For example, we often employ stereotypes to appropriately engage with others. When encountering a person dressed formally, it is generally advisable to approach them in a professional manner, even when uncertain of their preferences. In this case, our prior experiences help guide our behavior based on stereotypes.

According to Fitzgerald (2002, p. 9f) decisions can be roughly divided into two generic types:

Fitzgerald, S. P. (2002). Decision making. Capstone Publishing.

Routine decisions: Decisions that must be made at regular intervals.
Non-routine: Unique, random, non-recurring decision situations.

Another common method of dividing decisions into two categories is as follows:

Operative decisions: This type of decision usually involves day-to-day business operations. There is a lot of overlap with the routine category here. Examples of this type of decision include
- setting production levels,
- determining employee work shifts for the upcoming week to ensure adequate coverage,
- coordinating daily delivery routes for distributing products to customers,
- deciding to stop production or fix a problem if quality standards are not met during routine inspections, or, when it comes to decisions in our daily lives,
- where, what, when, and what to eat for lunch.
Strategic decisions: These decisions typically concern long-term company policies and direction. Examples include
- entering a new market or exiting an industry,
- choosing a corporate design, or
- acquiring a competitor.
- In our personal lives, a strategic decision might be choosing between renting an apartment near the university or commuting from our parents’ home.

People often distinguish between decisions at work and private decisions. Private decisions affect fewer people on average, but usually the people involved are closer to you personally. However, both types of decisions involve the same things such as people (human resources), money (budgeting), buying and selling (marketing), how we do something (operations) or how we want to do it in the future (strategy and planning).

Some decisions are more important than others because the potential impact of a decision varies, that is, the scope of a decision. For example, decisions can affect one person or millions, one pound/dollar or millions, one product/service or an entire market, one day or ten years, etc.

However, it is not entirely clear how to validate the scope. It depends heavily on the perspective of the decision-maker. For a small company, for example, an investment of 10,000 euros may be a big decision, while for a multinational cooperation it is a drop in the ocean. So the scope for decisions is relative, not absolute. It depends entirely on the context in which the decision is made and on the characteristics of the person(s) making it.

Figure 16.7: Conditions of decision making

There are three general conditions (see Figure 16.7) that determine the design of the optimal decision making process:

Certainty: A condition under which taking a decision involves reasonable degree of certainty about its result, what are the opportunities and what conditions accompany this decision.
Risk: A condition under which taking a decision involves reasonable degree of certainty about its result, what are the opportunities and what conditions accompany this decision.
Uncertainty: A condition in which decision maker does not know all the choices, as well as risks associated with each of them and possible consequences.

16.3 Decision making strategies

Exercise 16.3 Different schemes of a decision making process

Google for “decision making strategies” and look at the images that Google suggests you.
Read Indeed Editorial Team (2023) and discuss the twelve decision making strategies. The article can be found here.
Compare these strategies to the scheme shown in Figure 16.8.

Choose a problem of your choice and try to solve the problem using the two illustrations above by making a good decision.
Discuss in class whether the diagram or the strategies in Indeed Editorial Team (2023) are helpful in making a wise decision or solving a problem.
Watch https://youtu.be/pPIhAm_WGbQ and answer the following questions: How is the nature of decisions discussed here? Does it contain a rational model of problem solving? Reflect on which ways to solve a problem and come to a decision, respectively, have been addressed.

Indeed Editorial Team. (2023). 12 decision-making strategies. Accessed March 11, 2023. https://www.indeed.com/career-advice/career-development/decision-making-strategies?utm_campaign=earnedsocial%3Acareerguide%3Ashareemail%3AUS&utm_content=12%20Decision-Making%20Strategies&utm_medium=social&utm_source=directshare

Exercise 16.4 The businessman and the fisherman

A classic tale that exist in different version^[This one stems from thestorytellers.com. A famous version stems from Paulo Coelho^[See https://paulocoelhoblog.com and it goes like this:

One day a fisherman was lying on a beautiful beach, with his fishing pole propped up in the sand and his solitary line cast out into the sparkling blue surf. He was enjoying the warmth of the afternoon sun and the prospect of catching a fish.

About that time, a businessman came walking down the beach, trying to relieve some of the stress of his workday. He noticed the fisherman sitting on the beach and decided to find out why this fisherman was fishing instead of working harder to make a living for himself and his family. “You aren’t going to catch many fish that way”, said the businessman to the fisherman.

“You should be working rather than lying on the beach!” The fisherman looked up at the businessman, smiled and replied, “And what will my reward be?” “Well, you can get bigger nets and catch more fish!” was the businessman’s answer. “And then what will my reward be?” asked the fisherman, still smiling. The businessman replied, “You will make money and you’ll be able to buy a boat, which will then result in larger catches of fish!” “And then what will my reward be?”” asked the fisherman again.

The businessman was beginning to get a little irritated with the fisherman’s questions. “You can buy a bigger boat, and hire some people to work for you!” he said. “And then what will my reward be?” repeated the fisherman. The businessman was getting angry. “Don’t you understand? You can build up a fleet of fishing boats, sail all over the world, and let all your employees catch fish for you!”

Once again the fisherman asked, “And then what will my reward be?” The businessman was red with rage and shouted at the fisherman, “Don’t you understand that you can become so rich that you will never have to work for your living again! You can spend all the rest of your days sitting on this beach, looking at the sunset. You won’t have a care in the world!”

The fisherman, still smiling, looked up and said, “And what do you think I’m doing right now?”

Define the cost and benefits of both persons. Who do you think has a better life overall. Who is acting rationally here? In other words, who is maximizing utility here? The fishermen or the businessmen? Both? None?

Review

Decision analysis is about using information in order to come to a decision.
A structured and rational process can help improve the chances of receiving good decision outcomes.
As decision problems are often (too) complex to fully capture or solve rationally. Thus, a good decision analysis should try to use the available information and the existing understanding of the problem as transparent, consistent, and logical as possible.
A complex decision problem should be simplified and hence decomposed into its basic and most important components.
There are hundred of different schemes or strategies how to make decisions in certain circumstances. Many heuristics exist how to think, behave, and calculate to come to a wise decision.
Mostly decisions are based on subjective expectations. These expectations are difficult to validate.
Articulating exact expectation and preferences is a difficult task and the information that stems from these articulation is full of biases. Decision analytic tools need to take that into consideration.