Managing Decision Under Uncertainties

Dr. Elijah EzenduFIMC, FIIAN, FBDI, FSSM, FAAFM, FCCM, MIMIS, MITD, ACIArb, ACIPM,

PhD, DocM, MBA, CWM, CBDA, CMA, MPM, PME, CSOL, CCIP, CMC, CMgr

Learning ObjectivesAt the end of the course, participants should be

able to do the following:Recognize the importance of managing

decisionIdentify effects of risks and uncertainties on

decisionsIdentify the sources and levels of uncertaintiesManipulate uncertainties effectively while

managing decisionConduct decision profiling

“Decisions under uncertainty are high-stakes gambling where factors such as human life, health, economic prosperity, or the environment are concerned.”

- Norman Shultz

“The complexity of most issues makes it impossible to completely predict what will happen if a particular decision is made or if a dispute is resolved in a particular way. This is very clear in scientific and technical disputes (on the severity or implications of greenhouse warming, for example), but it occurs in non-scientific disputes as well. (For example, how many people will lose their jobs if the government adopts a new economic policy).”

Source: Conflict Research Consortium

“Every firm deals with uncertainty in one way or another. Uncertainty is not often addressed very well in competitive strategy formulation.”

- Michael Porter

Event: Occurrence of something

Outcome: Result or consequence of event

Probability: The likelihood of an outcome

Value at Risk: Amount of loss if a negative event happens

Certainty, Risk & UncertaintyCertainty: This is a situation wherein the

outcome that will occur is known.Risk: This is a situation wherein all possible

outcomes and the probability of occurrence are known , even as one does not know which outcome shall surely occur.

Uncertainty: This is a situation wherein the possible outcomes or probability of the outcomes is unknown, or both the possible outcomes and probability of outcomes are unknown.

Positioning Uncertainty & Risk

UncertaintyRisk and

Uncertainty Risk

Probabilities[and Outcomes]

Unknown

Some KnowledgeOf Probabilities[and Outcomes]

Probabilities[and Outcomes]

Known

Source: Casavant, Kenneth, Infanger and Bridges

Differentiating Risk from Uncertainty

Risk is a state which probabilistic distributions can be assigned and expected values can be determined.

In the case of uncertainty, probabilistic distribution can’t be assigned and expected values can’t be determined

Exercise

1. Mention 5 examples of Certainty2. Mention 5 examples of Risk3. Mention 5 examples of Uncertainty

Impact of Risk and Uncertainty on Choices During Decision Making

• Lower risk and uncertainty are preferable situations: If the management of a firm fail to think about risk and uncertainty, it may end in quandary.

• As risk and uncertainty increases, some strategic choices become more valuable than others: At high levels of risk and uncertainty, the best strategic choices are those that boost an organisation’s flexibility and sustain open options.

“Uncertainty confounds the planning process by invalidating the rules of the game under which the industry has operated, without revealing obvious new rules.”

- Dennis Kennedy

Sources of Uncertainty

Source: Elijah Ezendu, Decision-Making

Demand Structure• Customer Preferences• Market Size• Price Responsiveness• Segmentation

Externalities• Industry Structure• Government Regulation• Influence of Non Governmental Organisations• Social Norms

Supply Structure• New Products• New Processes• New Technology

Competitors• Nature of Competitors• Strategies of Competitors• Behaviours of Competitors

Internal Forces

• Alignment of Ownership• Behaviour of Management• Behaviour of Employees

Time• The Rapidity of a Phenomenon

“Whether it is uncertainty, risk, or somewhere in-between there is one strategy that always improves the manager’s ability to make sound management decisions and that is information. The more information a manager has on the potential uncertainties and risks that they face, then the more they can establish probabilities of likely outcomes, evaluate the impact on the business, and evaluate risk management strategies accordingly.”

- Kevin Bernhardt

Levels of Uncertainty

Clear Trends

These are factors that are plain and can be investigated without problems, and their details are knowable, while the activities can be predictable on probing deeper therein.

For example assumptions about upward trend in the society, market and economic bloc.

Unknowns That Are Known

This second level of uncertainty is characterized by factors which when subjected to proper analysis , their probability of outcome can be known.

For example demand trends and consumer preferences.

Residual Uncertainty

This is the topmost level of uncertainty and its distinctive features are complexity and futility in every attempt of people to conduct analysis for predicting occurrence. Therefore, residual uncertainty normally cause fear, stress and discomfort to decision makers. Nevertheless, movement from one position of time to another, may be able to downgrade it to a lower level of uncertainty.

For example the effect of consumer choice on the future of financial services

Exercise

As a forward looking professional, conduct a comprehensive profile of your career and pinpoint your goals. Thereafter, identify your career certainties, career risks and career uncertainties.

Bernoulli’s Model of Different Risk Perspectives

Risk-Averse

RiskNeutral

Risk-Seeking

Utility

Money

Source: Begg, Bratvold and Campbell, Decision-Making Under Uncertainty

i. Risk-Averse: This involves preference for a certain outcome instead of a gamble with expected value of wealth. When a Risk-Averse decision-maker acts, a risky opportunity would be exchanged for one that has a definite outcome. This is characterized by diminishing marginal utility of wealth.

ii. Risk Neutral: This is indifferent between the certain outcome and gamble. The Risk Neutral attitude to decision-making focuses on expected value.

iii. Risk-Seeking: This involves preference for the gamble instead of the certain outcome. Risk-Seeking decision-maker would want to be paid an amount higher than the expected value, so as to exchange the risky decision for the certain one. This is characterized by increasing marginal utility of wealth.

Risk Perspectives in Decision Making

“Most decisions to do something positive…. Can only be taken as a result of animal spirits- of a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities.”

- John Maynard Keynes

Common Biases Hindering Effective Management of Decisions

• Availability Bias• Undue Optimism and Overconfidence• Seeing Object of Belief• Anchoring on Idea

Handling Uncertainties

Exogenous Uncertainty• Identify technological uncertainties and ascertain market

potential• Limit the firm’s exposure• Uphold flexibility

Endogenous Uncertainty• Identify optimal entry time with reference to competitor entry• Build internal teams and alliance relationships.

Limitations of Using NPV Analysis Under Uncertainties

1. Information pertaining to cash flow may not be available.

2. Assumes uncertainty and risk remains constant3. It does not track the value of future strategies that

are enabled by current strategy

The Place of Scenario Analysis in Managing Decision Under Uncertainties

• It gives room for alternative values of strategies based on alternative contributory factors

• It does not handle the second and third limitation of NPV Analysis

Limitations of Real Options in Managing Decision Under Uncertainty

1. The problem of balancing flexibility with commitment

2. Variation in responsiveness of products/opportunities to capital market assumptions

Flexibility Versus Commitment

1. When commitment become successful, it gives superior performance

2. Flexibility to go for additional options could be connected to previous commitment

3. Even if the value of flexibility is increased by uncertainty, obviously it’s not right to be totally flexible.

Decision Profiling

This is done by identifying and examining the past choices and their basis in line with standards , so as to ensure compliance of decision thrust to stated objectives.

Case Study

The Chief Executive Officer of Kestel Bank invited you as a consultant to conduct management decision profiling, so as to ascertain the veracity of their decision thrust in improving competitiveness. Explain how you would conduct it vis-à-vis the internal and external realities of the bank.

Dr. Elijah Ezendu is Award-Winning Business Expert & Certified Management Consultant with expertise in HR, OD, Competitive Intelligence, Strategy, Restructuring, Business Development, Sales & Marketing, Interim Management, CSR, Leadership, Project & Programme Management, Cost Management, Outsourcing, Franchising, Intellectual Capital, eBusiness, Social Media, Software Architecture, Cloud Computing, eLearning & International Business. He holds proprietary rights of various systems. He is currently CEO, Rubiini (UAE); Hon. President, Worldwide Independent Inventors Association; Special Advisor, RTEAN; Director, MMNA Investments Limited. He had functioned as Chair, International Board of GCC Business Council (UAE); Senior Partner, Shevach Consulting; Chairman (Certification & Training), Coordinator (Board of Fellows), Lead Assessor & Governing Council Member, Institute of Management Consultants, Nigeria; Lead Resource, Centre for Competitive Intelligence Development; Turnaround Project Director, Consolidated Business Holdings Limited; Lead Consultant/ Partner, JK Michaels; Technical Director, Gestalt; Chief Operating Officer, Rohan Group; Executive Director (Various Roles), Fortuna, Gambia & Malta; Director, The Greens; Chief Advisor/Partner, D & E; Vice Chairman, Refined Shipping; Director of Programmes & Governing Council Member, Institute of Business Development, Nigeria; Member of TDD Committee, International Association of Software Architects, USA; Member of Strategic Planning and Implementation Committee, Chartered Institute of Personnel Management of Nigeria; Adjunct Faculty, Regent Business School, South Africa; Adjunct Faculty, Ladoke Akintola University of Technology, Nigeria; Editor-in-Chief & Chairman of Editorial Board, Cost Management Journal; National Executive Council Member, Institute of Internal Auditors of Nigeria; Member, Board of Directors (Several Organizations). He holds Doctoral Degree in Management, Master of Business Administration and Fellowship of Several Professional Institutes in North America, UK & Nigeria. He is an author & widely featured speaker in workshops, conferences & retreats. He was involved in developing Specialist Master’s Degree Course Content for Ladoke Akintola University of Technology (Nigeria) and Jones International University (USA). He holds Interim Management Assignments on Boards of Companies as Non-Executive Director.

Thank You