Decision Making

What are decision trees?

Decision trees are useful decision-making tools used by managers to make important decisions.

It is usually used by managers to make financial decisions. The final decision is made by calculating the expected value and the net gains.

Firstly, all the alternatives for the situation are noted. Then the possible consequences of the alternatives and the probability of their occurrence are noted. You should collect data about the cost and revenue that are associated with each consequence. The cost is represented in brackets “()”, and the rest represent revenue; these are the financial values of the outcome (see figure 1 below).

The financial value (except the cost) multiplied with the corresponding probability of occurrence is the expected value. The total expected value for an alternative is the sum of the expected values of each consequence of the alternative.

Lastly, the net gains are calculated by subtracting the cost from the total expected value. The alternative showing the highest value in net gains will be selected as the best-suited option by the managers.

Figure 1. Decision Tree, StudySmarter

Influences on decision-making

Mission

The business mission communicates the organisation's purpose and intentions. For example, well-known luxury fashion brand Gucci's mission statement is to become the leader in the luxury market at a worldwide level'.1 All decisions that Gucci makes will be influenced by its mission.

Objectives

Objectives assist a business in achieving its mission or aims. For example, if an organisation's objective is to produce a greater quality of products. Then the organisation will focus on looking for suppliers that supply high-quality materials, and ensure that product is produced with care and high quality.

Ethics

Some businesses focus their objectives on profit maximisation some on being ethical. However, it is important for businesses to have some ethical principles such as environmental and social. Or at least be perceived as having them as this will increase consumers' trust in the brand and their loyalty.

The external environment including competition

This is the major factor that influences business decisions, as it has an impact on competition in the market, demand for goods and services, etc. For example, if in the geographical area that business operates in consumers are increasingly interested in health and exercise businesses decisions regarding marketing and new product range will be influenced by this consumer behavior.

Resource constraints

Businesses should always consider the availability of resources as this will impact on business's decision-making. Especially if resources are scarce and limited the business will be considering the opportunity costs. There are two main types of resources:

Financial resources: Availability of financial resources plays a huge part in decision-making. This will determine wherever businesses can expand or invest in technological developments. However, if a business has only limited financial resources it has to make compromises where to allocate the budget, This could be between marketing or investment in facility developments.

Human resources: The availability of a skilled and trained workforce within the organisation or are interested in applying to work for the organisation is crucial. This will influence the way business runs and develops. Alternatively, if there is limited availability of trained and experienced workforce available businesses should make alternative choices of staff training.

What is scientific decision-making?

All decisions include uncertainty and associated risks. Therefore, decision-making is a very crucial process and decision-makers try to avoid uncertainty by basing their decisions on facts and data rather than relying on intuition. This scientific method helps to foresee the results of the decisions made. Scientific decisions help to set the right objectives to achieve a goal and reset them, if necessary, after evaluation.

Such data-driven decisions help managers reduce the risk and form an analytical process.

Data collection is the primary and most important step in scientific-decision making and can be collected in various ways for different purposes. Data can be collected by conducting research, performing a conjoint analysis, using existing data, etc.

Scientific decision-making in business helps managers to make the right decisions regarding product innovation (to identify what people need), managerial decisions within the company, reallocation of resources, leadership development, and many such business decisions. Scientific decision-making eliminates the risk of making a biased decision and chooses an action plan that will be most effective and fits the company's desired goals perfectly. Decisions made in this manner help the company to optimise their costs and reach their goal efficiently.

Examples of the use of scientific decision-making in business include decision trees, techniques for investment appraisal - for Annual Recurring Revenue (ARR), Net Present Value (NPV), payback period. It is used for sales forecasting and network analysis. The method is also embedded in algorithms in automation for dynamic pricing of services or goods based on data.

The decision-making model

The decision-making model describes the process of scientific decision-making, which is based on research and data. Therefore this method can be also referred to as a hypothetical decision-making model. Figure 2 shows that the scientific decision-making model involves five steps, which are:

1. Set objectives

The first step of the decision-making process is to set objectives, of what the business aims to achieve within the set time period. Importantly, the set objectives must align with the business's vision and corporate mission statement. For example, the business objectives could be to expand to another country that is cost-effective and have demand for the company's products.

2. Gather data

The following step of the decision-making process is to gather relevant data from trusted internal and external sources in regard to the set objective. This can be done using primary and secondary research methods. For example, the data can involve secondary research can legal information and government statistics to gather data involving costs of starting a business, demand in the area, workforce availability, etc.

3. Analysis of data

The collected data must be analysed to make recommendations for making effective decisions. Data can be analysed using various quantitative tools can be used such as the decision-making trees.

4. Select a strategy / make a decision

This step is when the decision is made in regards to which strategy the business will follow. The made decision will be fully based upon recommendations that have arisen from the previous analysis.

5. Implement and review the decision

This is the final step of the scientific decision-making model. In this step, the business should implement the made decision to its practice. As well as review how well it is working in terms of achieving set objectives. For example, if expanding internationally does not bring a lot of revenue but high operational and export costs, a business must re-examine made decision and see if it may be better to stay nationally or reconsider expanding to a different location.

Figure 2. The Process of Decision Making, StudySmarter

Role of risks, rewards, uncertainty, and opportunity cost of decision-making

The outcomes of made decisions cannot be 100% predicted, therefore when making decisions businesses cannot avoid risks and other unexpected outcomes. For that reason, to make well-judged decisions businesses need to understand risk, rewards, uncertainty, and opportunity costs that are involved in decision making.

Risk

Risks cannot be avoided in decision-making. The level of risk depends on the scope of the made decision. For example, introducing a new product may involve risks as businesses cannot predict how successful the product will perform in terms of sales and other key performance indicators (KPIs).

Rewards

Every decision that a business makes is expected to bring some sort of benefits and positive outcomes to the organisation. For example, investing in new technology is expected to reduce the costs of production and make the production process more efficient.

Uncertainty

Even if the risk involves high risk and uncertainty it does not mean that businesses should avoid pursuing this decision. As high-risk decisions usually involve higher potential rewards. However, businesses should aim to minimise risk and uncertainty by undertaking research to avoid potential failure. For example, if a business aims to expand internationally to a particular country it should do market research to see if there is a demand for a market, competition in the area, and the country's legal regulations.

Opportunity cost

All decisions involve opportunity costs. Meaning that once making a decision business has to choose among alternatives and evaluate the opportunity costs involved. These are usually measured in regards to scarce resources such as time and money. For example, by expanding internationally a business may gain additional profit however lots of time, effort and costs will be involved in this decision. Alternatively, if businesses remain nationally they may lose on the opportunity to enter a new market however it can avoid additional costs and save time which may bring more profit.

What is intuition-based decision-making?

When you are put in a situation you have already faced before, your mind subconsciously recalls the patterns or learnings from the previous experience which form the basis of your decision. Intuitive decision-making is making decisions based on your “gut feeling”. It is not a decision-making process that solely relies on emotions or feelings. It is based on logic from the previously acquired information.

What is the role of intuition?

Intuition plays an important role in a rapidly changing environment. It provides you with a fast response and is based on your previous failures and learned lessons. Intuition is the processed information that has been stored in the subconscious mind which helps us form decisions when needed, in the future. It helps you to understand patterns and approach situations with a practical frame of reference. With the acquired knowledge from the past, you can compare the current situation with that of the past and make a decision. It has been scientifically proven that intuition helps us make better and more confident decisions.

What is the role of intuition in decision-making?

People use the experience or knowledge they have gained from a previous similar situation they are currently facing. This leads to “recognition” of the decisions made then, setting a further course of action. Being intuitive can also help us understand the unexpected. When such an unexpected situation presents itself, you seek more information. We then mentally stimulate and possibly modify an action. If this does not work out, you would then consider the next option in mind.

The RDP Model, StudySmarter