3 Conditions that a Decision Maker Must Face

Decision Making face three particular conditions they are; uncertainty, certainty and risk. These conditions determine the probability of an error in decision making.

In this post we will look at the there decision making conditions.

Certainty

Under conditions of certainty the manager has enough information to know the outcome of the decision before it is made.

For example, the managing director of a company has just put aside a fund of $100,000 to cover the renovation of all executive offices. This money is kept in a savings account at a local Bank that pays 7.50 percent interest.

Half of the money will be drawn out next month and the rest hen the job is completed in 90 days.

Can the managing director determine today how much interest will be earned on the money over the next 90 days?

Given the fact that the managing director knows how much is being invested, the length of investment time, and the interest rate, the answer is yes.

Investment of the funds in a local Bank branch is a decision made under conditions of certainty. The ultimate outcome in terms of interest is known today.

Risk

Most managerial decisions are made under conditions of risk. Risks exist when the individual has some information regarding the outcome of the decision but does not know everything when making decisions under conditions of risk, the manager may find it helpful to use probabilities.

To the degree that probability assignment is accurate; he or she can make good decision.

Let us consider the case of a company that has four contract proposals it is interested in bidding on. If the firm obtains any one of these contracts, it will make a profit on the undertaking.

However,

because only a limited number of personnel can devote their time to putting bids together, the firm has decided to bid on one proposal only—one that offers the best combination of profit and probability that the bid will be successful. This combination is known as the expected value.

The profit associated with each of these four contract proposals, as presented in Table 1, varies from Tk. 100,000 to Tk. 400,000. Notice that the contract offering Tk. 400,000 is the least likely to be awarded to the company, but it offers the smallest profit of the four.

On which of the proposals should the firm bid?

As the table shows, the answer is number three. It offers the greatest expected value.

Computation of Expected Values
Contract
Proposal
Profit (Tk.)Probability of Getting the ContractExpected Value (Tk.)
1100,000660,000
2200,0005100,000
3300,0004120,000
4400,000280,000

This example illustrates the importance of probability assignment when decisions are made at a risk.

If we reversed the probabilities so that proposal no.1 had a 20 percent success factor and proposal no. 4 had a 60 percent success factor, the manager would opt for the latter proposal.

The effective manager must investigate each alternative in order to be as accurate as possible in making probability assignments.

Uncertainty

Uncertainty exists when the probabilities of the various results are not known. The manager feels unable to assign estimates to any of the alternatives.

While the situation may seem hopeless, mathematical techniques have been developed to help decision makers’ deal with uncertainty.

Some of these are heavily quantitative in nature and are outside the scope of our present consideration.

Some non-mathematical approaches have been developed to supplement these techniques, however, and they do warrant brief discussion.

One is simply to avoid situations of uncertainty. A second is to assume that the future will be like the past and assign probabilities based on previous experiences.

A third is to gather as much information as possible on each of the alternatives, assuming the fact that the decision-making condition is one of risk, and assign probabilities accordingly.

Using these approaches actually requires side-stepping the uncertainty factor. It is assumed not to exist; and this can be a wise philosophy. After all, by definition, uncertainty throws a monkey wrench into decision-making.

The manager’s best approach is to withdraw from this condition either by gathering data on the alternatives or by making assumptions that allow the decision to be made under the condition of risk.

Although many managers are perfectly comfortable making decisions under conditions of risk or uncertainty, they should always try to reduce the uncertainty surrounding their decisions.

They can do so by conducting comprehensive and systematic research. The research can tell them more about their alternatives, give them a firmer basis for estimating possible outcome arid help them look at the best and worst alternatives.

Think of manager Mr. Vin Diesel who is considering whether to finance a new building by taking a fixed interest rate loan of 10 percent or a variable rate of loan that begins at 9 percent but could increase by 4 percent. Mr. Vin Diesel might consider that, for the variable rate loan the best case rate is 9 percent. The worst case rate is 13 percent.

By taking this approach, he can at least reduce some uncertainty and get firmer support for his decision.