Categories
Management

Making managerial decisions in conditions of risk

Making managerial decisions in conditions of risk is necessary whenever a new innovative project is launched or when the start-up business is small and the owners risk investments.

These are exactly the conditions for entrepreneurial business.

What do the decisions of company managers in these conditions depend on?

From many factors, but when: one solution must be chosen from several possible ones; the alternatives must be evaluated and the most suitable one chosen; there is uncertainty in the sense that it is not clear how the investigated event will develop in the future; regardless of the solution, all alternatives are associated with a certain level of risk and it must be foreseen, analyzed and managed by minimizing or even eliminating it, then the theory of decisions and its inherent procedures for quantitative risk analysis through tables (matrices) and logical trees of decisions. Reference: The Qualitative Approach to Project risk assessment. The condition to apply these tools of scientific management is that decisions can be expressed in quantitative terms.

Matrix of management decisions

The table contains the following elements:

  • Alternative solutions to be analyzed Ai;
  • Results of these alternative solutions B1;
  • Probabilities that these results will be realized Si;
  • Selected initial solution Xi.

The condition is:

P1 + P2 + P3 + ……. + Pm = 1; S Pi = 1 (= 100%)

I = 1

The elements Pi and Si are uncontrollable parameters.

Classification of the conditions under which decisions are made

The possible conditions under which decisions can be made are:

  • Security decision-making (availability of complete information about the process);
  • Decision making in the conditions of risk (availability of partial information about the process);
  • Decision-making in conditions of uncertainty (availability of limited information about the process).

Deterministic approach to risk management

The so-called deterministic approach is applied when making decisions in the conditions of security and complete information about the process.

The so-called probabilistic or stochastic approach is applied when making decisions in the conditions of risk and partial information about the process. When making decisions in conditions of uncertainty and limited information about the process, the so-called uncertainty approach is applied.

When making decisions in the conditions of establishment, the following stages are passed:

  • Identify alternatives to possible action.
  • Fill in a table of decisions.
  • Making a decision.

When making management decisions in conditions of risk and uncertainty, the following stages are passed:

Identification of alternatives and possible risks and uncertainties, based on the likely consequences of the decision.

  1. Fill in a table of decisions.
  2. Determining the probabilities of occurrence of certain events.
  3. Evaluating the results of a decision.
  4. Making a decision.

When making decisions in the conditions of risk, the following stages are passed:

Identification of alternatives and possible risks and uncertainties based on the likely consequences of the decision. Reference: Assessing the Risk and Quantitative approaches to risk

  • Fill in a table of decisions.
  • Determining the probabilities of occurrence of certain events.
  • Evaluating the results of a decision.
  • Decision making.

As you can see, when making a decision in conditions of uncertainty and risk, the same sequence of steps is used, as well as the same concept of the probabilistic approach. Probability is of two types:

  1. objective probability;
  2. subjective probability.

Logical tree of entrepreneurial decisions

The probabilistic approach, in addition to making decisions through matrices (tables), is also used to construct logical decision trees. When a solution is associated with multiple interrelated events, then the so-called logical decision tree is built.

What are its advantages over other approaches?

  • gives a graphic and visual idea of ​​the individual decisions and the possible consequences of making them;
  • the results of the calculations are reflected directly on the tree.

The construction of the decision tree is carried out in the following three stages:

Construction of all the elements that make up the logical tree.
Include probabilities for individual events, thus making the logical tree a probability tree. Final construction of the tree.

The information needed to build the decision tree can be:

  • Situation: Amount of information
  • Security: A lot
  • Risk: A known amount
  • Uncertainty: A little

What are the questions that may arise regarding the information?

What is the information and is it available?

Is there time to get this information?

What is the quality of the information?

What is the value of the information?

What is the price of the information?

Is it necessary to collect this information?

The possibilities of the decision tree are greater than the decision tables, because entrepreneurs can develop the decision-making process over time. When one of the possible alternative solutions leads to a certain result, which in turn becomes the point of a new solution in a subsequent period, for example in the second year, this advantage becomes obvious.

The importance of the right management decision for the development of entrepreneurial business has been proven, but there are other management approaches that must be applied by entrepreneurs in the initial period of their practical activity.

Entrepreneurial business solution

I suggest that in order to clarify these theoretical dependencies, let’s look at a specific example, and let the example be related to one of the most difficult decisions in our country to decide which entrepreneurial business to start: trade, services, or production.

Liam James was determined to start a business and hired a new project manager for the project. The big problem for him was what kind of business to start. His difficulties in making this decision were mainly due to the economic situation in the country. He was also worried about the unfavorable legal, tax, and credit environment for business, but his predictions were that these things would one day get better. Despite optimistic long-term forecasts, his difficulties were quite serious.

The project manager must make his decision

The project manager must make his decision in an uncertain and risky economic environment, characterized by inflation, which, however, slows down and can be reduced to acceptable values. Reference: Risk Management in Project Management practices

There is, although relatively unlikely, a recession in production to be overcome. There is even an option for a revival in the economy.

Given the current uncertainty, the project manager decided to use some management techniques to reach the right solution. Thus, the project manager began by studying the probability of inflation dominating the country’s economy. According to his forecasts, this probability is 50%. Then assess the possibility of a recession and a decline in industrial production of 30%. Reference: https://stc-montreal.org/definition-and-tasks-of-production-management/

Assume that recovery in the economy is possible with a probability of 20%. Finally, determine that:

If there is inflation in the economy, his decision to start trading will bring him 55% profit, offer services 45%, and start production 5%;

If there is a decline in production and in the economy, its chances of succeeding in trade will decrease to 15% profit, in services will increase to 25% and in production will decrease to 2.5%; Reference: Production and industrial management

If there is a revival in the economy, with trade it will succeed with 10% profit, in services with 20% and in production with 50%.

Based on these considerations, he made a table of the decisions he had to analyze in order to choose one of them. Reference: Decision-making process.

The project manager multiplies each of the probabilities

The project manager then multiplied each of the probabilities (inflation, production decline, or economic recovery) by the percentage of profit for each of the solution options and obtained the probability of starting a particular entrepreneurial business. Thus, he determined that the short-term solution with the greatest relative weight is to start not with trade, as it seems at first glance, but with services.

The project manager will make a decision

In this way, the project manager will make a decision based on the amount of the highest percentage of profit, adjusted accordingly with the relative weight of the probability of the existence of the relevant business conditions. However, there is another way to make an entrepreneurial decision. This method is not based on maximum success, but on minimum failure.

Let’s see how the entrepreneur would act in this case. The project manager thinks as follows: if he does not invest in trade, but in services, and escapes only inflation, he will be at a relative loss compared to the option in which he would start trading. The magnitude of its loss would be 55% minus 45% as much as 10%. All possible options for loss of profit in the various probabilities of economic development and its impact on business the project manager reflect in a table.

However, the results of the calculations show the project manager that in both cases of starting a business in the field of services and trade, he will have the smallest amount of profit losses with different probability of realization of certain conditions of the general economic situation. I guess with this example you were able to understand how business solution tables are applied. Here is an illustration for using the decision tree based on the same example.

By Michael Young

Michael Young is the chief publisher of Libraryofmu.org and is passionate about all project management and business management disciplines from the modern education programs presented by the popular universities in the United States (USA) and the United Kingdom (UK)

Leave a Reply

Your email address will not be published. Required fields are marked *