Management under Uncertainty Dynamic Corporate World

Question: Describe about the Management under Uncertainty for Dynamic Corporate World. Answer: Introduction In the current dynamic corporate world, firms face an unfavorable institution environment due to the uncertainty of what will occur. The uncertainties exert pressure on the firms and limit their decision-making behavior. However, regardless of all the uncertainty, the manager must still make sound decisions on how to run the company by taking advantage of market opportunities. The essay aims at analyzing management under uncertainty referring to how the finance manager in Golden cycle company, Australia branch, made his decision to purchase a fruit processing machine rather than outsource for the processing services. Part 1: Deciding in uncertainty: How the finance manager in Golden Circle made his decision (company) While working for Golden Cycle company (a food and beverage company), I observed the finance manager make a decision to buy a food processing machine rather than outsource the processing services. The finance manager was faced with a decision on whether to purchase a new fruit processing machine (to process 180 tons of fruit annually) or to outsource for the fruit processing for the financial year beginning January 1, 2014. The company, however, was not certain of the cash flows that would result from the utilization of the processing machine. According to the projections made by the finance manager, the machine's useful life was ten years with projected annual cash flows of $ 600,000 million. The cash flows, however, highly depended on the market demand and the market conditions prevailing at each financial year. How the finance manager arrived at his decision and factors influencing his decision Given the fact that the annual cash flows (cash from the sale of the juice processed) were uncertain, according to the historical trend of the past market demand and conditions, the finance manager assigned three probabilities to each cash flow per year. In this situation, the finance manager used three approaches to risk when assigning the probabilities to the cash flows. That is risk aversion, risk taking, and indifference to risk. As such, he came up with the optimistic expectation (unfavorable results), expected expectation (actual results), and optimistic expectation (favorable results). He then proceeded to attach a probability to each outcome and calculated the average cash flow in each year. With the average cash flows each year ($ 549,000 million), he compared this with the revenue less the total cost of outsourcing ($ 498,000) and arrived at his conclusion of the company purchasing the processing machine rather than outsourcing the processing services. Save for the cost incurred; several other factors served to influence the decision of the finance manager. First, the company would be able to control the quality of the processed juice if it purchased the processing machine as compared to outsourcing the machine. Second, the market demand might change for the better shortly thus enabling the company to produce more products and reduce the cost. Thirds, the company, would use the processing machine for the processing of several other fruit beverages which would not be the case if the company outsourced for the processing services. Part 2: The economic rationality model by Herbert Simon The model argues that the decision-maker is a rational being who attempts to achieve maximum advantage/benefit through the selection of the best course of action from several courses of action. According to Herbert Simon's argument, as summarized by Hallowell and Gambatese (2010), the task of the decision-maker in economic rationality model is selecting the course of action that results in the best results from all the possible consequences. The model suggests that two factors can assist the decision-maker in measuring the correctness of the decision made (Green and Armstrong, 2007). The factors are the extent to which the decision made achieves the desired/expected objectives and the efficiency with which the desired/expected results are obtained from the decision made. The model follows four main steps in reaching a conclusion on which course of action to take (Conejo et al., 2010). The first step involves listing all the alternative courses of action. For example, in Golden Cycle, the finance manager listed various alternative courses of action such as purchasing a new processing machinery, outsourcing the processing services, and leasing the processing machine. The second step involves the determination of all the consequences that would result from each of the alternative course of action. About the case summarized above, the finance manager computed all the expected cash flows that would result from the utilization of the processing machinery and the cost the company would incur if the company chose to outsource the fruit processing services. The third step involves the comparison (both the efficiency and accuracy) of the consequences of each alternative course of action and choosing the best course of action (Dequech, 2006). In our case, the f inance manager compared the cost of outsourcing the services and the cost of purchasing the processing machine and reached a conclusion that purchasing the machine would save the company some cost coupled with several another benefit that the company would reap from the asset. Finally, the fourth step involves monitoring of choice made to determine whether the desired results are achieved and the accuracy with which they are achieved/obtained. An important point to note is that the decision that a decision-maker, as a member of the organization (say a finance manager) and the decision that the same decision-maker would make in his personal capacity would be different since the personal and organizational goals differ. Assumptions of the model The model holds several assumptions. First, it holds that the decision-maker has a clear and definite objective for which he is making the decision. Second, the models assume that the decision-maker is completely aware of all the possible alternative courses of action. Third, the probabilities calculated by the decision-maker are not mysterious nor frightening. Fourth, it assumes that the decision-maker has full freedom in choosing the best course of action which he thinks will serve to optimize the decision. The model further assumes that no limit exists to the computation complexity when determining the best alternatives. Rationality of the steps in economic rationality model Inarguably, there exist three main possible outcomes in business; the expected outcome, a better outcome than the expected (optimistic), and a worse outcome than the expected (pessimistic). As such business decisions should be based on these outcomes (Furnham and Boo, 2011). By evaluating the probability of each situation occurring, the firm can calculate the expected payoff by finding the average return from all the three possible outcomes and then make a decision as the finance manager in Golden Cycle Company did. Limitations of the model Although the economic rationality model provides a clear decision-making process, it is not without some serious limitations. Jalonen (2011) argues that the model makes some unrealistic assumptions such as the decision-maker has adequate information to make a decision. The model further makes an unreasonable assumption that the decision-maker can process all the information acquired when making the decision. However, Frenken (2006) argues that according to the idea of bounded rationality, the cognitive limitations of the decision maker's mind serve as constraints in processing all the information available. Part 3: Bounded rationality and its influence in management under uncertainty The idea of bounded rationality is that in any process of decision-making, inadequate information, limited time, and the cognitive limit of a persons mind limits the rationality of the decision maker. Rationality, on the other hand, refers to the ability of an individual to make a reasonable judgment based on sound reasons and facts (Czinkota and Ronkainen, 2005). The concept of bounded rationality suggests that regardless of the level of intelligence of the decision maker, the latter have to work in an environment laced with three inescapable constraints. The first constraint is limited information. Decision makers face a serious challenge of sourcing for adequate information regarding all the possible alternative courses of action and the results/consequences of each alternative course of action. It is undeniable that the finance manager had inadequate information about all the alternative processing alternatives in the market such as leasing. He, therefore, ended up making a conclusion based on inadequate information hence probably leaving out better alternatives (Karni and Schmeidler, 2009a). For instance, rather than purchasing the processing machine, the company would have opted to lease the machine which would have saved the company some money in the form of tax shields. If the finance manager had all the necessary information, maybe he would have made a different decision based on the information. The second constraint results from the fact that human mind works in a limited capacity in evaluating and processing all the alternative courses of action available in making a decision. Undoubtedly, everything has a limit/limited capacity. Therefore, such decision makers can evaluate certain decision only up to a certain limit. As such, Frenken, (2006) notes that the decision maker either fail to analyze or they overlook certain critical factors that would otherwise influence the outcome if it were considered. For instance, the processing machine purchased by Golden Cycle Company might fail to produce the necessary amount of juice to meet the market demand hence not meeting its target cash flows. On the other side, the finance manager might have computed the probabilities incorrectly based on the past market trends which might change in future. However, given the fact that human mind works within limited capacity, the finance manager could not predict the future market conditions ac curately. Limited time to make the decision serves as the third constraint. Decision makers have limited time to make a decision given the opportunity cost of delayed decisions. Given these facts, the decision maker has to act quickly to take advantage of the new opportunities in the market (Yang, 2007) at their initial stages to ensure the company gains a competitive edge. As such, even the decision makers who usually have the intention of making rational choices based on all the material facts are forced to make satisficing decisions/choices in complex situations (Wang et al., 2006). Adequate time would enable a firm to consider all the possible courses of action, their consequences, and end up making a rational choice (Xu et al., 2006). Also, were the firm to have adequate time while facing a decision under uncertainty, it can postpone its decision until it becomes relatively clear which course of action is the best. Had the finance manager at Golden Cycle Company had enough time to analyze the market trends carefully, maybe he would the expected cash flows would have been different, thus resulting in a different decision. However, the firm would incur a huge opportunity cost for taking too long before making a decision. Given these three constraints, rational decision makers, rather than optimizing their decisions, often make satisficing decisions (Mula et al., 2006). Conclusion Given the uncertainty of the current dynamic corporate world, managers have to approach decision making with an open and alert mind. They have to balance between focus and flexibility while making sure the company does not incur huge opportunity cost nor does it sacrifice its competitive edge. References Conejo, A., Carrion, M., Morales, J., (2010). "Decision-Making Under Uncertainty in Electricity Markets, International Series in Operations Research and Management Science (153) 7: pp. 789-796 Czinkota, R., and Ronkainen, A. (2005). A forecast of globalization, international business and Trade: a report from a Delphi study." Journal of World Business, 40(2): 111-123. Dequech, D. (2006). 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