Decision Making and Organizational Learning Part I Professor Rao Decision Making Decision making is the process by which members of an organization choose a specific course of action to respond to the opportunities and problems that confront them Opportunities Problems 15-2 1 The Decision-Making Process  How are decisions made? Classical decisionmaking model Administrative decisionmaking model 15-3 Classical Decision-Making Model Assumptions  People have access to all necessary information  People choose the best possible solution Steps in the Classical Model List all alternatives List consequences of each alternative Rank sets from most preferred to least preferred based on personal preference Select alternative that results in most preferred 15-4 set of consequences 2 Problems with the Classical Model  Limited Li it d iinformation f ti iis available. il bl  Cognitive abilities are limited.  Information overload  Impossible to make the best possible decision. Administrative Decision-Making Model  Descriptive  Satisficing  Bounded rationality y 3 Decision Making Part II Professor Rao Common Biases and Errors in Decision Making • Heuristics: shortcuts or rules of thumb used to simplify decision d i i making. ki • Leads to biases - systematic errors that lowers decision making quality • Common Heuristics: • Availability Heuristic • Representative p Heuristic • Anchoring and adjustment Heuristic • Other sources of errors • Risk Aversion • Escalation of Commitment Bias 4 Availability Heuristic  The tendency to determine the frequency of an eventt (and ( d it its causes)) b by h how easy th these events t (and causes) are to remember  Biases based on the overestimation of frequency of  Events that evoke emotion  Vivid Vi id events t  Recent events  Example:  Risk of flying vs risk of driving Representativeness Heuristic  Tendency y to p predict the likelihood of an event occurring from the extent to which the event is typical of similar kinds of past events  Biases Failure to consider base rate ((actual recorded frequency with which an event occurs) Overestimating likelihood of rare event 5 Representativeness Heuristic  The best student in your introductory MBA class l thi this pastt semester t writes it poetry t and d is i rather shy and small in stature.  What was the student’s undergraduate major:  Chinese studies? Or  Psychology? Representativeness Heuristic  The answer is b.  Most students would offer “Chinese studies,” overlooking that psychology majors outnumber Chinese studies majors 50:1.  This example illustrates representative heuristic. 6 Anchoring and Adjustment Heuristic  Tendency to make decisions based on adjustments from some initial amount  Biases  Biased decisions when initial amounts (or anchor) are too high or too low  Salary adjustments are often made from an “anchor” or initial pay. If the anchor is not reasonable, this heuristic will lead to biased decision making. Risk Aversion  Tendency to prefer a sure gain of a moderate amountt over a riskier i ki outcome, t even if the th riskier outcome might have a higher expected payoff.  Example: Which would you choose? A) 50-50 flip of a coin for $200 $ B) A sure promise of $50 7 Risk Aversion  The answer is B.  There is a tendency to prefer the sure thing over the riskier outcome of the coin flip, even though mathematically the coin flip is worth twice as much.  This is an example of risk aversion. Escalation of Commitment  Tendency of decision makers to invest additional time time, money money, or effort into poor decisions.  Why?  Reconfirm correctness of original decision  Desire to recoup losses  Sunk costs  Risky behaviors increased by negative situation 8 Escalation of Commitment Why Does Escalation of Commitment Occur?  Decision makers do not want to admit that they have made a mistake  Decision makers erroneously believe that an additional commitment of resources is justified to recoup losses  Decision makers tend to take more risks when they frame or view decisions in negative terms (as a way to recover something that has been lost) rather than in positive terms (as a way to generate something) 9 Decision Making Part III Professor Rao Group Decision Making Advantages g  Availability/diversity of members’ skills, knowledge, expertise  Enhanced memory  Greater ability to correct errors  Greater decision acceptance 10 Group Decision Making Disadvantages g  Time to make a decision  Group conflict  Diffusion of responsibility  Potential for groupthink Groupthink  A pattern of faulty decision making that occurs in cohesive groups whose members strive for agreement at the expense of accurately assessing information relevant to the decision.  The group becomes closed-minded, and fails to pay attention to important information.  Result is poor decision making. 11 Steps for Minimizing Groupthink  Group leader encourages thoughtfulness/criticism  Group leader refrains from expressing own opinions and views until group has considered all alternatives  Group leader encourages group members to gather information from outside people  Group leader assigns devil’s advocate  Group leader holds second meeting for important decisions 12
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