Sunday, 25 September 2011

Distinguishing the Good from the Bad

In my work to assist companies in improving their decisions making, adding mathematical rigour and making it fact based, sooner or later my client remarks that now that Operations Research is used the quality of decisions must have improved. It’s tempting to confirm that, but that would be too single minded. While using Operations Research will have a positive influence on decision quality, it is only one of many factors in high quality decision making. In judging the quality of a decision we typically equate decision quality with the attractiveness of the result.  Don’t you feel silly when you’ve carried around your umbrella all day but there wasn’t a drop of rain to shield you from? What does it say about the quality of the decision you made that morning? Is good or bad determined by the result? And what does it tell you about the added value of the decision methodology you used in making the decision?

When we have a good result we are inclined to conclude that we’ve made a good decision.  Likewise, with a bad result, we conclude that we’ve made a bad decision. This is definitely not true. Decisions and results are two different things.  Good results are what we desire, whereas good decisions are what we can do to maximise the likelihood of good results. For decisions that are made at a high frequency (say every day/hour) quality could be measured using statistics, improving consecutive decisions. The conditions under which operational decisions lead to a result can only change slightly, given the short time span between the two. But for decisions on the tactic or strategic level it can take months or even years before achieving a result, for example in developing a new product. Using statistics to measure decision quality in that case is unrealistic. Moreover many of this kind of decisions are of the one-of-a-kind nature. When the time between decision and result increases, uncertainty will have a growing impact on the quality of the result. In the future, events can happen that cannot be controlled or foreseen.  Such events can cause good decisions to have a bad result and vice versa.  Therefore, the quality of the result is not a good indicator of decision quality and the result is irrelevant as a measure of decision quality.

How to assure good decisions then? Key in making a good decision is to have a structured decision making process. A structured decision making process starts with three ingredients:
  1. What do I know (Information) about the business opportunity under consideration and the environment in which it resides?
  2. What are the options (Alternatives) open to me?
  3. What are my preferences (Values) in deciding between the alternatives?

Central in a structured decision making process is the logic or mathematical model. It allows you to put Information, Alternatives and Values together in a logically consistent way and make a good decision. 

Because the inputs of the decision are made explicit we can establish that a good decision has been made, before the results of the decision are known. It allows discussion on all the inputs, therefore building a common view and commitment, supporting the implementation of the decision. Notice that the logic follows from all three factors, Information, Alternatives and Values. So Logic alone is not a guarantee to quality decisions.  Putting this process to work starts with framing the decision; making sure that purpose and scope of the decision is discussed and agreed upon. Next is identification of what can change and can’t be changed in making the decision, creating an explicit or implicit set of alternatives. As Michael Trick blogs, accurate data is essential in achieving high quality decisions. Without it, decisions are based on quicksand. It’s the third ingredient in the decision making process. Final step before preparing a mathematical model is deciding on the valuation principles to be used. A decision is made because it will lead to an increase in value within an organisation, like increase in share price, revenue or EBIT. So valuation needs to be explicitly considered in decision making.  With all these ingredients in place and managed right, good decisions will results.

So next time when you return home soaking wet because you left your umbrella at home given the weather forecaster was absolutely sure that it was going to be a sunny day, go back and review your decision making process that morning. Check the information base, the alternatives considered, the values and logic used before you consider yourself a fool. Chances are that it wasn’t a bad decision. The result was bad, but that’s because you can’t trust a weather forecaster. Some things can’t be changed; it’s your decision to prepare for them or not that makes your decision good or bad.