167 Study Unit 9 Planning and Decision Making Contents Page Introduction 168 A. The Principles of Decision Making 168 Effective Decision-Making 168 Levels of Decision Making 169 Stages of the Decision-Making Process 171 B. Decision-Making Criteria 173 Quantitative Factors 173 Qualitative Factors 174 Thinking for Decisions 175 C. Costing and Decision Making 175 Relevant Costing 175 Differential Cost Analysis 176 Sell or Process Further 177 © ABE and RRC 168 Planning and Decision Making INTRODUCTION Earlier in the course we examined the types and sources of information which management require in order to make decisions.
Following on from that, we considered how information can be categorised in terms of cost analysis to provide management with what they require in the appropriate format to aid the decision-making process. Before looking at specific scenarios, this study unit will develop the concept of decision making by examining when and why it is required and the steps involved in it. Management decision-making is complex and requires knowledge of: management accounting principles and techniques organisational objectives and functions management techniques the relationship between an organisation, its members and its environment. THE PRINCIPLES OF DECISION MAKING We can state this quite simply as making the right decision at the right time in the right place.
While this objective is simple to state, it is far more difficult to achieve. The right decision can only be made by analysing the circumstances which relate to the decision and the purpose of making it. The right time acknowledges the fact that decisions are followed by action. Decisions must be made at the appropriate time so that effective action can be taken.
The right place ensures that decisions are made in the most effective location. This is particularly important in large organisations with extended communication channels. Frequently the right place for making decisions is where the action they relate to will be carried out. The whole point of management decision-making is that it should result in effective action.
Effective Decision-Making The effectiveness of any manager in today's business environment will depend upon his ability to make effective decisions. A business can only achieve its objectives if its managers make effective decisions that are compatible with the organisation's objectives. Example If the objective of a retail store is profit maximisation, decisions must be made on: What range of products to stock What quantity of each product to stock What price to charge for each product Where the retail outlet should be located What staffing levels are required When the store should open for business Whether premises should be rented, leased or purchased This list of decisions is only the beginning. You must appreciate that managing a business or any other type of organisation in today's environment is complex and can only be © ABE and RRC Planning and Decision Making 169 achieved by managers continuously making a series of complex decisions, all of which are interrelated.
Decision making is further complicated by the fact that the environment is changing at a very fast rate; this means that decisions made at one time may quickly become obsolete. Decisions should therefore be related to the environment, and expected changes which are likely to occur in the environment should be taken into account when decisions are made. The following factors should be taken into account when making management decisions. (a) Decisions must be compatible with the organisation's objectives.
(b) Decisions must be based upon the facts surrounding the situation. To make effective decisions a decision maker must obtain relevant information. (c) Decisions must be made before action can follow. (d) Sufficient time must be allowed so that a decision maker can assimilate the relevant information.
(e) Decisions must be expressed in clearly defined plans, standards and instructions so that the appropriate action can be executed. (f) Decisions made by a decision maker should be compatible with his responsibilities and authority. (g) Decision makers should have the expertise and ability to make the decisions for which they are responsible. (h) Information presented to decision makers should be in a form they can understand.
(i) There must be fast and effective communication channels between people involved in the decision-making process. (j) Each decision must be related to its effect on the whole organisation. This is important so that sub-optimisation is avoided. (k) Each decision must be carefully considered with regard to its effect on the environment, e.
the reaction of competitors must be considered when making marketing decisions. (l) The faster decisions can be made, the sooner action can be taken. Levels of Decision Making Decision making can be related to the hierarchy of an organisation. You can see this illustrated in Figure 9.
© ABE and RRC 170 Planning and Decision Making STRATEGIC CONTROL MANAGEMENT CONTROL OPERATIONAL CONTROL Figure 9.1 (a) Strategic Decisions These are decisions made by top management. They normally relate to the long-term future and will provide the basis upon which an organisation's long-term plans will be formulated. Strategic decisions usually affect the whole organisation and involve the expenditure of large amounts of capital. It is essential that at this level wrong decisions are not made.
Bad strategic decisions are difficult to change and may result in substantial losses. An example of strategic decision-making is when the directors of a company decide that a company should go into full-scale production of a new product. If the new product is successful the company's profitability should increase, but if the new product is a failure, substantial losses will result and the money invested in producing and marketing the new product will be lost. (b) Tactical Decisions This type of decision is made by middle management and relates to the specialist divisions within the organisation.
The divisions within an organisation will depend upon: The nature of its activities Its size The way it is structured You must note these three factors when thinking about tactical decision-making. If an organisation is structured by function, tactical decisions will relate to each specialist function, e. marketing, production, personnel and finance. If an organisation is structured by region, tactical decisions will relate to each area, e.
in the National Health Service tactical decisions will relate to each Regional Health Authority. If an organisation is structured by product type, tactical decisions will relate to each product classification. © ABE and RRC Planning and Decision Making 171 Tactical decisions have a shorter time horizon than strategic decisions and have a less far-reaching effect on the organisation. They are made on a day-to-day basis, usually on an ad hoc basis.
These decisions are dictated by events at the operating level of the organisation and are most effective when made: Quickly so that fast action can be taken. By a trained decision maker. Close to where the action is to be executed so that action can be instantly controlled by the decision maker. Frequently, operating decision-making is not effective because of a failure to apply one or more of these three criteria.
Effective operating decision-making is an essential requirement for running a service undertaking successfully. In these undertakings situations quickly deteriorate when operating problems arise and rapid decisions are needed by properly trained personnel to solve them. Operating decisions involve less capital investment than strategic and tactical decisions, but their long-term effect on an organisation is often underestimated by senior management. Operating decisions affect staff morale and/or customer goodwill.
Examples of important operating decisions are: Deciding what action to take to deal with customer complaints. Dealing with individual staff problems. Deciding how to allocate scarce resources on a day-to-day basis. Operating decisions are often needed for unpredicted events and are made as a result of feedback.
Stages of the Decision-Making Process Organisations normally initiate formal decision-making procedures which are followed by management. These procedures will vary between organisations but are likely to follow a number of stages arranged in a structured sequence. It is important that any person making an organisational decision is able to adopt a logical, structured approach. Managers cannot be trained to make specific decisions; they can only be trained to take a specific approach to decision making.
We can list the approaches to decision making as follows: Stage 1: Identifying the Objectives of the Organisation As we said earlier, decisions made by management must be compatible with the organisation's objectives. Stage 2: Defining the Purpose of the Decision Every organisational decision made should have a purpose. In any decision-making situation it is important to define the purpose of making the decision; this is normally the logical reason for taking or not taking a particular course of action. A lot of the work involved in decision making is based upon logic.
© ABE and RRC 172 Planning and Decision Making Stage 3: Identifying the Potential Courses of Action At this stage it is important to consider the potential courses of action that are dependent upon the decision. In decision-making situations it is important to establish exactly how many possible courses of action there are. Situations that arise include: Where only one course of action is considered, and the decision is whether to follow the particular course of action or not, such as in branch or departmental closure decisions. Where a number of alternative courses of action are possible but only one can be taken, such as in investment decision situations where, perhaps, four different projects are being considered, but there are only sufficient funds available for one to be selected.
Where many alternative courses of action are possible and all of them can be achieved simultaneously, such as when deciding upon the range of products to be produced and sold when resources exist to produce the whole range. When the possible courses of action are mutually exclusive. In this situation the following of one course of action automatically means that the others are not possible, e. setting a production level for a product.
Stage 4: Obtaining the Relevant Information Once the potential courses of action have been identified, the information that is relevant to them should be collected, processed and produced in a report for analysis. Management accounting techniques are widely used at this stage particularly: Relevant costing Differential costing Contribution analysis Opportunity costing Capital investment appraisal Stage 5: Evaluation of the Options At this stage each possible option must be carefully evaluated and the relevant information analysed. This evaluation must take into account the organisation's objectives and the purpose of making the decision. Care should be taken to consider all the relevant criteria including quantitative and qualitative factors.
Stage 6: Making the Appropriate Decision This is the point at which the course of action to be taken is decided upon. This should always be after the options have been evaluated. Stage 7: Action Once made, the decision should be communicated to those people responsible for carrying it out. Effective decisions should always result in effective action being taken.
Stage 8: Review The final stage of the decision-making process is to carry out a review of events after the decision has been implemented. This is done by implementing control procedures. The review will enable management to see if the original decision was effective. © ABE and RRC Planning and Decision Making 173 B.
DECISION-MAKING CRITERIA An important element of decision making is the relationship between a decision and the organisation and its environment. Decisions must be coordinated so that the whole organisation benefits from the action that follows. A decision maker has to make a number of criteria into account when making a decision. These decision-making criteria fall into two basic groups: quantitative factors and qualitative factors.
Quantitative Factors These criteria cover all those factors which can be expressed in measured units. The following is a detailed list of the quantitative factors which a management decision-maker should take into consideration.