Decision Making

Management is all about making decisions. If there is no decision to be made, the

process is on "autopilot" and will take care of itself, so there is no need to pay a manager.

Management decisions are necessarily made with incomplete or imperfect information.

After all, if you knew everything about a certain process, it would be on "autopilot". This is

what makes management a challenge. Without a little uncertainty, life is boring.

All decision models are either "absolute" or "relative". In an absolute model, there

is some formula that specifies the relationship between variables. It is the manager's job

to specify the values of the variables and be able to interpret the output of the formula.

While specifying the values of the inputs may not be an easy job, it does not classify as

rocket science, either. Someone has already figured out the gist of the problem and told

you how to find the answer. Unless the inputs are particularly hard to determine, this can

get to be very dull very quickly. But the underlying assumption here is that the relationship

between the variables is simple enough to be specified.

The Economic Order Quantity equation is a good example of an absolute model.

It really does find the lowest cost for managing an inventory of products, given that the

manager can specify the relevant values. It is simple, straightforward, and can be derived

using only a few assumptions that do not seem unreasonable. This is another key aspect

of absolute modeling; there are most likely some assumptions built into the formula. A

good manager must be aware of these assumptions to know whether or not the absolute

model can be applied in a specific case.

Most processes in business are too complex to be described with an absolute

model, regardless of the level of detail of that model. Business involves people making

transactions. You are not the same person today that you were yesterday, and tomorrow

you will be someone else. This is true for every manager, employee, and customer in

every company in every country. This simple fact makes it almost impossible to model the

behavior of the transactions process. Anyone who says he or she can provide such a

model is either a whole lot smarter than everyone else ever was or is full of hot air.

The lack of absolute models does not mean that managers must work without any

decision making tools. "Relative" models are abundant, and when they are used properly

they can be quite powerful. The simplest and most prevalent form of a relative model is

breakeven analysis. Breakeven analysis is what management is all about. The idea is to

compare where you are now to where you might be if you take a specific action. If you

would be worse off, you do not take the action. If you would be better off, you take the

action. The outcome is more important than the process. Breakeven analysis is

sometimes called cost/benefit analysis, but it is the same process.

In finance, capital budgeting is a prime example of relative modeling. The analyst

compares the relative costs and benefits of pursuing an specified action, from the purchase

of a machine to a corporate merger. If the projected final state is better than the current

state, the relative model gives a "go" to the decision. A machine that costs $100 and will

generate discounted after-tax cash flows of $1,000,000 is a good deal, and relative

modeling provides the ability to make this comparison.