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This chapter focuses on decision making, and we start by outlining different kinds of decisions we tend to think about in the management field.
I think itís important to consider this idea fairly early on in the book because the perspective used when scholars study management
and when folks practice management is often different than the perspectives that drive other fields such as accounting, finance, and economics.
At the beginning of the chapter we outline three primary fields of study within the greater realm of management.
The first is human resource management, which focuses on decisions relevant to policies and practices often related to hiring and firing employees,
administration of benefits, and making sure that individuals are treated in a manner that meets legal standards.
The second is the field of organizational behavior, where we examine decisions relevant to understanding how people behave as individuals,
as well as in teams or in organizations.
For example, understanding decisions made to try and motivate individuals at work is something weíll look a lot at later in the book.
Understanding the role of different personalities in the management process is also important.
Effectively communicating goals and showing leadership are two other key areas of concern that fall within the domain of organizational behavior.
The third area of management we outline is strategic management, which examines decisions made to differentiate some firms from others
in ways that make organizations perform better from a long-term perspective.
This is an important distinction because strategic management often operates from a much longer-term perspective than other fields like economics.
In strategic management, weíre often curious and fascinated how companies such as Colgate, which was founded in 1805,
can stay around and be competitive for over 100 years.
The image you see here is a Palmolive soap ad from 1915.
So looking back at an ad like this and considering Colgateís success is pretty different than the focus of economics, for example,
which tends to care more about short-term fluctuations.
An example of the difference in perspective is evidenced by the famous economist John Maynard Keynes, who once quipped,
ìin the long run, weíre all dead.î
But in strategic management we do care about these much longer time horizons and how firms can manage to stay around for decades.
One of the areas we often study to get insights into a firmís long and short term focus is the companyís vision and mission statements.
Vision refers to seeing something and a vision statement outlines what an organization aspires to become.
Jonathon Swift, the Irish writer of Gulliverís Travels once said that vision is the art of seeing what is invisible to others.
So a firmís vision is something that looks to the future. For example, Googleís aspiration to develop a perfect search engine.
In contrast, a mission statement outlines what a firm is doing right now.
And this means they need to make decisions.
The Latin root of the word decision refers to the idea of cutting off something and thatís what a good mission notes
because firms canít successfully serve all markets so they need to focus on some areas to the exclusion of others.
Looking at Googleís mission you see a much more specific focus on organizing information and making it accessible.
This is much more specific than their vision of developing a perfect search engine.
So, mission tells us where weíre at and vision tells us where weíre going.
And as the firm goes about its day to day operations, the next challenge is to assess their progress towards meeting their vision and mission.
Itís easy for a lot of companies to get bogged down in day to day operations and forget to assess how theyíre doing.
And this is a problem because research shows managers often fail to notice all but dramatic changes.
In addition, some managers actively ignore information and react negatively to data that is inconsistent with their beliefs and strategies.
Another issue is that, in contrast to many problems in the academic world,
most strategic issues for managers are not presented in obvious ways where the exact challenge to be solved is spelled out.
One of the reasons that managing organizations is difficult is because there are so many ways to gauge the performance of a firm.
For example, economics tends to look at short-term profits.
Stock price is a key measure in finance.
In accounting, there are many financial returns calculated.
The challenge for managers is to balance these multiple measures.
And the old tale of the blind men and the elephant tells us a bit about why managing this challenge is as difficult as it is important.
In this story, six blind men went to try and ëseeí an elephant.
The first man touched the elephantís side and thought the animal must be like a great wall.
The second blind man felt the tusk and thought that elephants must be like massive spears.
The third man felt the trunk and thought an elephant must be like some type of snake.
The fourth felt the elephantís knee, which seemed very much like a tree trunk.
The fifth touched an ear, which seemed something like a large fan.
The sixth man touched the elephantís tail and thought the animal must certainly be like a rope.
If the men failed to communicate their different impressions, they would have all been partially right but mostly wrong.
The same idea applies to firms trying to assess their performance.
And this issue of balancing different performance measures play out in management a lot.
For example, the concept of social entrepreneurship examines the balance between firm profits and measures that might benefit society.
The concept of the triple bottom line balances people measures that make sure the firmís actions are socially responsible,
with planet measures (those that promote environmental sustainability), and profit measures (those that ensure the firm can stay in business).
To make sense of all these different performance measures, we examine the balanced scorecard framework.
This framework is a key management tool thatís helpful to nonprofits, entrepreneurial firms, and large corporations.
The idea here is to balance financial measures that tend be important for understanding a firmís short-term performance
with other measures that help track long-term goals of a firm.
And this framework tracks four types of measures.
Ideally, managers would select a few relevant ones from each category to give them
a manageable set of measures that is useful to their organization without being overwhelming.
The first category of measures is financial measures that relate to organizational effectiveness and profits.
Examples include stock price, sales, profits, and accounting ratios such as return on assets or return on investment.
Customer measures relate to customer attraction and satisfaction.
These measures help balance the financial measures by tracking on long term aspects of the firmís performance.
An example would be tracking the number of repeat customers.
This is important for firms in the restaurant industry where having repeat customers and regulars is important for long-term success.
And, if there are very few repeat customers that could tell you something is wrong with the quality of the food or the wait staff.
Internal business process measures relate to organizational efficiency.
Auto manufacturers have long studied ways to speed up assembly lines.
Companies such as Starbuckís and McDonaldís regularly perform studies to try and improve the speed at which their orders are fulfilled.
Finally, learning and growth measures work to track measures that relate to the future.
For example, the number of new skills acquired by employees each year.
Generating these types of measures is difficult because the idea is to measure skills that may not be currently required by employees to do their jobs.
But these are often the very types of measures that are important for the success of companies long-term ñ
especially in tech industries where change is constant.
The need to foster growth in these types of measures explains why many firms pay for their employees to earn advanced degrees.
And the idea of the balanced scorecard can be applied to any type of organization.
In this chapter we apply the concept to Cat Lady Coffee ñ the coffee shop Atlas and David frequent.
Itís important for coffee shops to meet financial targets to stay in business, but without a steady stream of repeat customers thatís difficult.
And as they train new employees they want to monitor their internal business processes
by making sure workers become faster at making different coffee drinks over time.
They might foster learning and growth by encouraging workers to learn new skills the longer that they work at the shop.
So the goal of the balanced scorecard is to help provide a broad but manageable spectrum of performance measures
to help avoid a common bias in decision making where managers focus too much on short-term measures such as sales.
But there are many other biases that might effect our decision-making and we focus on several of those in this chapter.
To understand why we study decision making biases, we start by presenting one model of ideal or rational decision making.
This model involves a number of steps.
First, you have to define the problem.
And we already noted that problem definition isnít always obvious in real business problems.
But lets say itís a fairly obvious problem like buying a car.
In this case, problem definition is pretty simple.
In the second step you would then identify key criteria.
For example, if you have a long commute gas mileage might be important.
But If you live in the country four wheel drive might be key.
If youíre going through a mid-life crisis maybe something sporty or a convertible is important.
So in the third step the decision maker needs to weigh the criteria in terms of importance.
This assumes that you can provide a mathematical weight to something like color of the car versus gas mileage versus body style.
But if you could come up with this information then you could potentially generate possible alternatives and narrow your search.
This is the fourth step.
Then, you would rate each possible alternative on each criteria.
And this might be difficult if you lived in a place where there are many car dealerships,
or if you looked at many possibilities like buying new versus pre-owned.
If you had many, many alternatives this could be very time consuming.
And this process also assumes you have access to perfectly accurate information.
But if you could, ideally, this would allow you to compute an optimal decision that would solve your search criteria.
So, this is the rational decision making model.
Of course, this rational decision making model is most useful for big, important decisions without infinite possibilities.
Things like buying a house or a car or something like deciding between different career possibilities.
For simple decisions, you might end up taking forever to make a decision if you used this model.
So there are some problems with this model.
In his Nobel Prize winning work in 1957, Herbert Simon suggested that judgment is bounded in its rationality.
In other words, we donít really make rational decisions because we lack information, or the ability to compute decisions using the kind of mathematical
efficiency suggested by this model.
In Simonís view, we can better understand decision making by looking at what happens, as opposed to what should happen.
So, letís look at some common ways individuals really deviate from rationality and do things that defy rationality
to learn about how to make better decisions.
This makes sense for a lot of reasons because I alluded to the fact that the rational decision making model can at times not make a lot of sense.
For example, some folks might argue that getting married is the least rational thing you can ever do
because it would be impossible to rationally evaluate every potential for a mate in the world on every criteria.
Even with the help of websites such as match.com trying to follow the rational decision making model would be a bit ridiculous.
So letís adopt Simonís approach and examine some of the common biases that keep us from making ideal decisions.
One decision bias is called anchoring and adjustment.
This occurs when individuals react to an arbitrary or irrelevant number when setting numerical targets.
For example, people tend to repay their credit cards in smaller increments when the bank displays a minimum payment size on their bill compared to
situtations where no minimum payment is listed.
In contrast, a more useful target would be one that pays off debt in a certain period of time that makes sense for the card holder.
The availability bias occurs when you think information that is readily available to you is more likely to occur.
For example, investors encounter many short term fluctuations from day to day.
But long-term investing is generally a better strategy.
A famous study on the subject found that individuals generally think auto accidents are more likely to cause death than stomach cancer
because accidents are reported in the media at a ratio of more than 100 to 1.
But in reality stomach cancer causes more deaths by a ratio of more than 2 to 1.
Escalation of commitment occurs when individuals keep moving down a losing course of action
because they have already committed time, money, or other resources.
The awareness of this bias is heard in the expression ìthrowing good money after bad.î
An example would be purchasing another scratch off ticket after the previous one was a loser
because you thought the lottery folks must print winning tickets at predictable intervals.
Hindsight is a bias that occurs when knowledge of an occurrence makes you think the outcome was obvious before it happened.
Monday morning quarterbacks who second guess decisions of coaches and players do this a lot.
Judgments about correlation and causality can also become a source of potential bias.
To really establish cause, we need to have three criteria.
First, we need to know correlation.
In other words, is one element of the organization improving such as firm sales tied to another element such as increases in marketing spending.
Then we need to know time order.
So, spending money on marketing should precede an increase in sales.
And finally, we need to be able to rule out alternative causes.
In the business world, this is impossible since so many other things are going on.
Itís not like a lab setting where many elements can be controlled at once.
Thatís why the CEO of one company famously quipped, ìWe always know we waste half of our marketing budget ñ we just donít know which half.î
Misunderstandings about the nature of sampling can also lead to bias.
Ideally, conclusions about the nature of relationships would be drawn from large, random samples.
But pollsters are often forced to rely on convenience samples.
For example, election polls draw from folks at home that will answer the phone and then answer a few questions
rather than a true cross-section of society that will actually vote.
Or sometimes, we rely on information from one source rather than multiple data points.
Thatís why an old journalist joke tells reporters that even when your mom tells you she loves you, you still need to get a second source.
Overconfidence is another bias that plagues many of us.
This occurs when individuals are more confident in their abilities to predict an event than logic suggests is actually possible.
For example, most people think they are good drivers.
Most attorneys believe they will win the cases they take.
Most entrepreneurs think they will be successful while others in the same industry fail.
The framing bias refers to how information is presented to individuals.
This is a bias we think about a lot when we say some folks see a glass as half empty where others see it as half full.
But we need to be careful that how information is presented to us doesnít bias our interpretation of events or impact the actions we take.
Research on this subject has found that individuals make different choices
depending on if information is presented as a potential loss versus a potential gain.
Because of the difficulty of digesting information, many individuals satisfice.
This occurs when individuals select the first alternative that meets minimum criteria.
For example, if someone was standing at a vending machine and tried to apply the rational decision making model they might think that
ìSnickerís really satisfiesî but that ìTwix is the only candy bar with the cookie crunch.î
If they went on and on like this it could take all day to buy a candy bar, not to mention the annoyance of all the people waiting in line.
So while this is fine for simple decisions, satisficing can potentially be disturbing because we know CEOs and other top level decision makers
often use this model when making big decisions like mergers, layoffs, or acquisitions.
So, there is a thin line between being overwhelmed with data in simple decisions
and not using it enough when it would helpfully aid more complicated decisions.
In the image, which of the middle circles is larger?
A lot of folks would say the one on the left.
I know I would. But in reality they are the same size.
So this suggests that we are all subject to biases and we want to be aware of them, especially common ones,
in an effort to improve our decision making on a day to day basis.
I hope this chapter has helped identify a few of the key biases that we all need to watch out for when we make personal,
business, or really any type of decision.
This chapter closes with Atlasís realization that he hasnít done a great job of managing his finances from a balanced scorecard perspective.
But this is valuable because it shows how these trials can serve as important point of problem identification.
And as I mentioned earlier this problem of noticing is one that is common to all individuals,
from college students searching for the next step in their career to CEOs who fail to notice important changes
that could effect the long-term survival of their firms.
So, I hope this chapter will give you a perspective on this challenge as well as a valuable tool in the balanced scorecard to help manage that challenge.
And of course, we all need to be on the watch for those biases that can creep up on us at any time.