“MAKING GREAT DECISIONS in Business and Life”

by David R. Henderson and Charles L. Hooper (2006)

I first reviewed this book for this ezine in 2007 and recently picked it up again to see how the lessons outlined would apply to the current business environment. I found it worth visiting again, this time with a different perspective on business assumptions.

The book offers tools from the field of economics and decision science to work through business and life problems. Although the book gets off to a slow start, it does offer some interesting insights into effective decision-making.

The first tool is thinking on the margin—thinking about the next increment only as opposed to the whole project or process. For example, do I hire one more employee? Or, do I want one more potato chip? Given what we already have, thinking on the margin is thinking about what we want next, rejecting all-or-nothing thinking. This tool can be particularly helpful when tackling a large project—think of it as a series of small steps and concentrate on the next one. That’s thinking on the margin—thinking about the next increment only. Decide what to do in the next step toward the goal and the subsequent steps will follow.

The authors encourage us to “think value” rather than focusing on cost. “Whether a purchase is a good deal depends solely on the difference between the value to you and the cost to you, not how much you saved over the regular cost.” (Page 34) When you choose one thing over another, you have incurred the opportunity cost of foregoing the other option and that is a relevant cost. Using the idea of thinking on the margin, you can concentrate on the next incremental cost, not the costs that have been expended, the sunk costs that cannot be recovered regardless of the next decision. The best decision is the one that looks forward, carrying the lessons from the expenditure of past costs.

Understanding a change requires looking for the change that drove the one you can observe. If the software worked perfectly for several weeks and then failed to perform as expected, you would look first to see what had changed that had a rippling effect and caused an unintended consequence. The value of knowing what changed is in being able to determine where to find the problem and to determine if the unintended consequence is worth the gain realized from the change.

Knowing what you want before making a choice enhances the efficacy of the choice. That seems obvious, doesn’t it? One point of confusion arises in business when we confuse profits with revenue and expense. To increase profit, the theory goes, we want to increase revenue and decrease cost but those two objectives may not be compatible. It may actually be necessary to increase cost in order to increase revenue and profit. Begin by determining which are the ends and which are the means; the goal is to maximize the ends without trading off the means. Revenues are the means and profitability the ends.

We each operate from our biases, creating a unique mental model of the world developed by simplifying reality to a rule. However, it may apply only part of the time but we haven’t looked far enough to know that our view is obstructed. To prevent the impact of biases, rely on objective data and, “…dig deeper and look beyond the surface explanation.” (Page 108)

Recognizing what’s important is critical to effective decision-making. There are many factors involved in making any decision but they do not all carry the same weight. Look for the constrained resource, the one that cannot be expanded, and evaluate its impact on the decision before looking at other factors. For many of us, time is the constrained resource that carries a greater weight than other resources.

Create better alternatives in order to create better decisions. Begin with clarity about what you want—the end rather than the means—and consider the alternatives that you know give you that desired outcome. Consider what you like and dislike about each alternative and then create ‘hybrid’ alternatives that take the best elements of the existing alternatives. Discard the impossible alternatives and select the best of the remaining—that would be the one that addresses your objective the best.

Risk is an inherent part of decision-making and this book provides a number of analytical tools for evaluating risk. The authors prefer a method called the Risk-Averse Expected Net Present Value Approach (REV for short), which uses a discount rate to account for the time-value of money, probabilities to calculate expected values and a risk tolerance measure. (For a technical explanation see the website: www.MakingGreatDecisions.com) If you find an alternative is too risky for you, walk away or find a way to reduce the risk by delaying the expenditure, accelerating the failure (failing earlier costs less than failing later) or share the risk with others.

Balance and proportionality are needed in decision-making so that the right amount of effort is expended on a decision and not more or less. The 80/20 rule (Pareto’s Law) states that 20% of the inputs cause 80% of the outputs. Look for the 20% of customers or employees that drive 80% of the results and determine what they do differently. Build on their uniqueness and the alternatives you select have greater power.

Information has a cost associated with it because the time involved in obtaining it has a cost. The authors offer the One-Percent Rule: “You should spend approximately one percent of the value of a decision analyzing the decision.” (Page 213) The goal is to have the right amount of the right information—not too much information about one aspect of the problem simply because that information is easy to get.

Distill the issue to its core essence and keep it simple. It’s not necessarily easy, while it is essential to keep it simple; complexity increases the risk of failure.

One way to improve profitability is to look for arbitrage opportunities in decisions. Arbitrage is the process of, “…finding resources that the market is valuing too low, hiring them at this low value, and then using them in high-value uses,” (Page 234) If a resource is undervalued in one marketplace and valued higher in another marketplace, buying it at the lower price and selling it at a higher rate to reflect the higher value creates a win-win-win because everyone has satisfied their want and need.



Return