Managers have to make either intuitive or rational decisions every day. However, the rational decision-making process is not always an option. The bounded rationality model was developed to explain making rational choices under time constraints and other pressures.
How much product should be produced? Who should be hired? Or fired? Business people are faced with decision making every day. Rational decision making is when individuals use analytics, facts and a precise step-by-step process to come to a fact-based decision. Although this might sound like the most fair way to do things, it's not always a realistic choice for organizations.
Problems with Rational Decisions
Simon Smith works as a manager in the customer service department of Blue Pool Cleaners. He grabs a cup of coffee and heads into his office to get ready for work. His boss Jane is waiting for him and asks him to make a determination within the hour of eliminating one of his employees due to a corporate layoff. Some managers make all their decisions based on gut feelings, but many aim for a more rational decision-making process in the interest of fairness.
Simon wants to use a rational process but knows that it's not always the most practical course of action. Not only does Simon have to eliminate one of his employees, but he has to complete the task within a specific time constraint. The immediacy of the task makes it very difficult to utilize a long step-by-step rational problem-solving process.
This is the main problem identified by noted psychologist Herbert Simon regarding the limitations of using the rational decision-making process. Simon created the bounded rationality model to explain why limits exist to how rational a decision maker can actually be within a decision-making environment. His model earned him a Nobel Prize in 1978 and is also known as the administrative man theory. The main thrust of his model is that there exist specific constraints that force a decision maker to be less than rational. There are four assumptions to his model:
- Managers select the first alternative that is satisfactory.
- Managers recognize that their conception of the world is simple.
- Managers are comfortable making decisions without determining all the alternatives.
- Managers make decisions by rules of thumb or heuristics.
The first assumption of the bounded rationality model deals with the term satisfice (which is the words 'satisfy' and 'suffice' combined). It means that managers select the first alternative that is good enough due to the fact that costs in time and effort to look further are too great. For example, if Simon has to quickly decide who to lay off within his department, he will select the first candidate that comes to mind who isn't performing well. The first alternative is the easiest to recommend for the layoff, and he does not have time to spend a week analyzing work performance reports to solidify a perfect decision.
Because of those same time constraints, managers also view the world as simple and usually try to make decisions based on the simplest process of determination; the multiple levels of steps that are included as part of the rational decision-making process can be too complicated and time-consuming for some managers.
Or a manager might just dread the layoff decision and want to make the simplest and easiest choice without making it into a complex analysis. This is why managers are satisfied making choices without determining all of the alternatives. This supports the theory of the third assumption.
The theory also recognizes that decisions involve using heuristic biases, or shortcuts, in making a quick decision to conserve mental activity. As a manager, Simon has numerous issues that develop and need his attention throughout the workday. He does not have the capability to spend his best thinking efforts to analyze the layoff situation when his boss wanted a name in an hour, so he employs heuristics to help make his decision for him.
Availability heuristics and representative heuristics are two types of heuristics biases that can occur. The availability bias is when people make decisions based on how easily the answer comes to mind. For example, the first employee that appeared in Simon's mind was Jared since he was the most noticeably absent this month from work. Jared might not be the poorest performer, but Simon does not have the time to research other employees.
Representative heuristics (also known as gambler's fallacy) is another bias error that can occur within rational decision making. It means that an individual is more adept at making a decision based on the expected likelihood of it occurring. An example would be a random outcome such as coin toss - if you toss a coin and it comes up heads twice in a row, you might be positive that it will come up tails next because you think 'it can't come up heads forever,' even though it's just as likely to be heads on the next flip.
Let's use Simon again for this situation. Simon recently hired a marketing representative who did not fit the ideal corporate image. He had body piercings, long hair, and facial hair. Simon felt that the new representative would probably do poorly because of the expectations associated with his image. Ironically, Simon's bet was incorrect; the new representative was very well-suited to his job and would have been one of the worst employees to lay off.
Managers have to make decisions every day through either intuition or rational options. They have to make decisions under strict time limits, risk, and pressure, which cause their ultimate choice to be more difficult to ascertain. Rational decision making is a precise, analytical process that companies use to come up with a fact-based decision. It is not always a realistic choice for organizations due to time constraints and other pressures.
The bounded rationality model was developed to explain why limits exist to how rational a decision maker can actually be within a decision-making environment. Availability and representative heuristics are two biases that can develop from using the rationality model. In the end, managers have to use a balance of intuitive and rational-based decision making depending upon their time constraints.
After viewing this video, students should be able to:
- Understand the limits of rational decision making in business
- Explain why the bounded rationality model was created
- List the four assumptions of the bounded rationality model
- Recount satisfice and its relationship with time constraints
- Describe the differences between availability and representative heuristics biases