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Strategic Management - Decisions, inertia, applications I

Updated on October 3, 2015
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1. Strategic decisions and their implementation

1.1. Strategic decisions

Strategic decision making is enormously significant and a source of failures as long it is difficult for humans to make a decision under circumstances which are not clear (uncertainty). It is challenging to estimate the outcome of a project or the consequences of a tactical decision. From a financial point of view it might be easy on the first glance. Take the project with the biggest prospect return, with the highest expected net present value. But it is more. No formula can predict future cash flows certainly. However, when it comes to decisions under uncertainty errors occur. These errors could lead to fatal consequences for a company. Also choices are not always rational and benefit maximizing. Sources of errors are emotions, limited computing performance and a lot of biases, heuristics and behavioral anomalies.

Beginning from the scratch the probably most important strategic decision is about what kind of business model do we chose. Then executing this strategy it is probably an irreversible process. There is no way back. This is why it is also the most commitment-intensive decision. The general manager and his employees, they all work for the same goal into the same direction. That’s why it is also an organization-wide decision.

1.2. Decision making errors and remedies

Nevertheless, decisions are not always absolutely rational. This is what Kahneman and Tversky tried to explain with their Prospect Theory. In a nutshell people’s risk preferences change under uncertainty. An equal to the benefits fraction of loss is perceived more emotionally than the benefit. People “suffer” more when it is about losing. This is way they are willing to take more risk compared to zone of benefit. Kahneman and Tversky also tried to explain typical systematic errors in decision making, so called biases and heuristics. In general these bias and heuristics are nothing bad. People can make a decision in a small amount of time without much effort. Sometimes it would take too long to compute the marginal benefit of each option.(Kahneman and Tversky, 1979; Tversky and Kahneman, 1992)

Value function under Prospect Theory
Value function under Prospect Theory | Source

Some common problems in decision making (Russo & Schoemaker 1989):

1. Plunging in: We start ambitiously without thinking before. We invest much time and energy in doing something. But we didn't think hard enough about it before. Why do I do this?

2. Frame ignorance: We are all framed. No one is absolutely objective. Heuristics like mental accounting or simplifications determine our thinking significantly. We are framing the big picture by ourselves, others or circumstances. Obviously this picture doesn't contain all possible aspects of a complex problem.

3. Frame uncontrolled: But for solving problems a certain frame can be helpful. We sometimes don't define this frame consciously.

4. Overconfidence: We overestimate our own abilities, especially when we were successful so far. By doing so our assumptions must be right.

5. Short sight: Convenient information are perceived as reliable information. We follow the rule of the thumb.

6. Intuitive decisions: Often we “shoot from the hip”. Without processing all available information, decisions are based on a small fraction of perceived information.

7. Group failures: Group dynamics sometimes tend to ignore “minor” critical thoughts.

8. Evaluation errors: We interpret the results wrong to protect our ego. No on likes to admit mistakes. We don't keep track of our decisions and their results, which makes analyzing and learning from it quite difficult.

9. No audit: We don't try to understand our decision making process to avoid systematic errors.

Make better decisions

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How to circumvent those problems to make better decisions?

Russo and Schoemaker recommend:

1. Frame: Structure and define the problem

2. Gather intelligence: Look for information and derive reasonable estimations.

3. Conclude: Based on frame and intelligence.

4. Learn: Learn from your results. Keep track of them. Don't protect your ego. Recognize your mistakes. Make it better.

As a way to avoid systematic errors Kahneman recommends using checklists in business decisions (Kahneman, 2012). Checklists could be used in all parts of an organization. A lot of big companies are using them to improve the internal efficiency and also to avoid mistakes. Another way is strategic planning. Write things down. Think hard and never underestimate a situation and its variables.

But there is a difference between making errors on an individual and an organizational level. On an organizational level the impact of an error increases - figuratively speaking - potentially with the number of executors or the amount of money invested. Despite to this intensity there might be no one who notices this error. In a group all do the same and orientate themselves at the group (herding behavior). This way we avoid responsibility and the “stress” and effort of thinking (Zhu, 2009). The most fatal consequence is the fall of the company.

1.3. Strategy implementation

Implementing a strategy is difficult. There are some obstacles to cope with especially with the people’s dimension – natural inertias.

As long there are more than one person involved, the other persons need to be convinced from the new strategy or should at least do what they were asked for. People don’t like changes. They want to keep everything as it is (status quo bias). So to implement new ideas in a company they have to be implemented in people’s heads first.

In the movie “Moneyball” team leader Bean (Brad Pitt) wanted to make his team win. But he didn’t get the budget to buy players, which were considered as good. Inspired by a student of economics he bought undervalued players. Combined in a team the probability of win was higher. Good idea. But Beans fellows didn’t understand this system and were absolutely against it (at the beginning)(Miller, 2011). If Bean had listen to them, they’d have won the game never.

And what comes first? Strategy or structure? There are different point of views. Porter said strategy comes first. Deducting from this we have to come to the structure. But structural changes – also when they are for a higher goal – are usually not welcome (change resistance). There are different interests. People with power want to keep their power. And they don’t give it up without fighting. Also people don’t like changes at all. It is so much more comfy if nothing changes. In “Moneyball” the fellows said: we always did it this way (Miller, 2011) (administrative heritage). But why should the new way be correct? They don’t think about. They prefer a no-change-policy. To establish changes on an organizational level it takes time and a lot of strength from the general manager. Until a new corporate culture is born there will be decreasing resistance.

Combining strategic goals with financial budgets

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Another obstacle which makes strategy implementation difficult are different temporal dimensions of thinking. While some strategic goals (e.g. milestones) are part of a short-run point of view, financial plans usually come with a long-run point of view. Beinhocker and Kaplan figured out “that in-depth discussions of strategy take time. Calendar-challenged executives may chafe, but most CEOs we interviewed claimed that they want to spend about a third of their time on strategy. That amounts to 80 days in a 240-working-day year. Against that backdrop, it doesn't seem unreasonable to spend 20 to 30 days (that is, 15 to 25 days for business units, plus 2 to 5 days for sector and corporate strategy) in intensive, well-prepared discussions of strategy.”(Beinhocker and Kaplan, 2002)


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