Making a Decision

One of the first units that MBS runs is a subject on decision making. By putting this early in the course, MBS tries to help students come to grip with making hard decisions which is something that you have to do regularly. Whether it’s deciding which bits of material are the most relevant to a decision (I’m convinced that one of the aims of the MBA core is to give people far more information than they can process so they have to develop the skill of quickly assessing a lot of information to find what they absolutely need) or figuring out which discussion tactic to use in a class to convince the room that there’s another side to an issue, exploring what drives the decision making process is essential.

So what makes a decision “hard” to make? The general consensus is when it involves one or more of the following:

• Complexity: this can be obviously complex problems such as which school should I go to or subtly complex problems such as should I raise a contentious point in the classroom? As an engineer, I often find myself doing a lot of scenario modeling and assessment of ripple effects to try and handle this, even if it’s only a couple of seconds worth, because it’s the way I have been trained to think about problems
• Inherent Uncertainty: this can be risks that you know are present, but you aren’t sure how they will turn out (which way a coin will land when flipped) but could also be risks you had no idea you were taking (someone was flipping a coin?!?)
• Balancing Trade-offs: not so bad when you can quantify the value of the items being traded off. Much more difficult when you are trading off things that are hard to quantify (time spend with a partner vs. putting in extra time on an assignment) or when they are measured in different ways (time spent with your partner vs. the extra pay you get for doing overtime)
• Different Perspectives: this one was especially difficult for me because at times I struggle to see other peoples points of view, particularly when they are driven out of culture or experience that I haven’t shared. This has lead to one of my key learnings during the MBA, the value of diversity. Diversity isn’t just a buzzword, there’s real value to be had where people bring different viewpoints to the table but more on that in another post…

In addition to this, there are a couple more things that I think influence the decision making process. One is time: if you are under time pressure then the chances of one of those other risk factors above is more likely to cause you to make a bad decision. The other is whether you’ve seen the problem before: this is a bit of a double edged sword really. As humans, we develop habits or patterns of response to shortcut the decision making process. This is generally a good thing (we’d be paralyzed by choice otherwise) but the problem is that sometimes we get into a habit and then things change but the habit doesn’t (I’m thinking of my late-night studying 2 minute noodle addiction which was fine during undergrad when I had the metabolism of a 20 year old but during the MBA, is just making me fat!). Along side this habitual response is the idea of assumed knowledge, the fact that you are familiar with something doesn’t actually necessarily mean you are better equipped to make a decision about it which might not make a lot of sense but bear with me and I’ll give you an example.

The current dean of the Melbourne Business School, Zeger Degraeve is a professor in his own right and his primary area of expertise is risk and quality decision making (how to make good decisions). We were lucky enough to have him come in and give a two hour guest lecture and during that time, he ran an experiment to help make his point. He got a thumbtack (just a regular one, no tricky stuff) and a cup and saucer, put the thumbtack in the cup and then placed the cup upside down (with the thumbtack underneath) on the saucer. Then he shook it and asked one of the class members to make a guess: was the tack sitting on it’s flat top (with the point sticking in the air) or was it sitting on its side (with the point and the edge of the tack both touching the saucer). The reason that Zeger uses a thumbtack is because although it looks like a simple problem, in fact it’s complex (due to the uncertainty as per this previous discussion). But we all recognize a thumbtack, we’ve used them a thousand times before but despite all that knowledge we have no idea what the likelihood is of a thumbtack ending up pin up or pin down. So how do we make a decision?

At this point Zeger introduced a framework that we could use to help to sort through the information called ICACI

• Information – What do I know
• Criterion – What am I trying to get out of this decision
• Alternatives – What Choices do I have?
• Consequences – What are the possible outcomes of each alternatives
• Intuition – What do I feel. Do I trust this?

 

So we worked through the model and tried to apply logic (we tried a couple of simulations and then discussed the likelihood of pin up vs. pin down) but we still didn’t have anything that allowed us to make a better decision than when we first looked at the problem. But now the class felt like we were failing at decision making because the we’d just agreed that the most important part of being a decision maker is that if you are the responsible person, you have to understand what the likelihood of failure is and here we were making a decision based on no data, just intuition. So we moved on to trying to understand what the consequences were for being wrong (in this case, a student had made a $50 bet with Zeger about whether they’d be right or not) which meant that the decision makers job is not just to work out the likelihood of failure but also to work out if you can stand the pain if the decision is wrong and accept responsibility for the consequences.

This lead to the last lesson of the day: managing to results causes crises. If you look only at the result then you ignore decision quality and consistently good decision making gives the best chance of success. This was demonstrated when we eventually looked under the cup. The student had picked pin up as their decision as to which way the thumbtack was sitting but when the cup was raised, the pin was on it’s side. There was a general air of disappointment around the classroom but Zeger took us back to the model. We’d done everything we could to make a good decision and in the end, our decision was wrong. The fault wasn’t with the process (we couldn’t have done anything better and given those circumstances, no-one could’ve made a better choice) and so if we judge the decision based on the outcome we’ll end up punishing someone for the wrong thing.

This was really salient because when you think about it, a lot of the things we do in at work are judged based on the results, not on the way we get to the results. Someone can get lucky (or unlucky) and get a good (or bad) outcome but if we want repeatability then it’s the process that matters, and that’s what you should be judging people on.

The most useful thing I learned in Accounting class

There are a lot of reasons to do an MBA but one of my big drivers (and one I hear a lot from other people) is financial literacy. For those of us who come from a world outside of accounting and finance, our interactions have often been limited (maybe budgeting and cost tracking or maybe just small business BAS once a quarter) and self-taught through necessity.

MBS introduces accounting and finance from an external perspective, starting you off with balance sheets, cash flow and income statements and looking at the interactions between them. Internally, you’re unlikely to see these during day-to-day operations (unless you work in the accounting department) but these are also the basic tools that are used to assess a companies health and performance from the outside. When you are looking at investing in a stock this is a place that you can start. Using the Annual report of an organization, you can see the story told by the numbers. The other main component of a good annual report is the strategic plan or outline which tells you what the company plans to do to create value for shareholders. Investing is effectively betting whether or not the company can make good on the execution of this plan and the past performance and financial statements are their to help you decide whether their plan is credible or not.

There are bunch of tools that can be used for stock analysis but one that we’ve used consistently throughout the MBA is the 4 component Dupont model. This takes Return on Equity (which is a common metric for comparison of financial performance) and decomposes it to show you what the company does well and needs to improve

As you can see, the fact that all of these multiply across means that if a company has a really high value in one area (say leverage, because they’ve borrowed a lot of money) you can see how that’s skewing the ROE metric. Taking the leverage example, 4 companies in the same industry might have the same ROE but one has a much higher leverage value. As an investor you now want to ask a couple of questions: why are they underperforming on one of the other ratios (if ROE is the same for all 4 companies but leverage is high for one then that same company must have one, or several, low metrics to balance the equation) and more importantly, what are they doing with all that extra money that they borrowed (are they operating unsustainably or did they borrow to invest in a new facility that isn’t operational yet etc.)

Likewise it’s difficult to compare two companies from different industries. An industry like banking, where there are a lot of assets like branches and ATM’s and IT infrastructure is going to have a low asset turnover value as opposed to a consulting firm which needs office space & IT but not much else in terms of assets. This is why it’s important to compare banks with banks and even while you are doing that, be aware that different businesses may have different models. One bank might want to own all the branches it has where as another might only want to lease the real estate (or might operate predominantly online like ING direct here in Australia). Eitherway, drilling into this information will help you understand both performance and strategy.

That said, the Dupont model is not the most advanced tool for analyzing companies but it has been incredibly valuable to me because this was a big knowledge gap for me, pre-MBA. Although I’ll never work as a financial analyst, the point of the accounting and finance units at business school is to gain financial literacy so you can understand how companies generates revenue and how well they use what they have.

What Tim Learned at Business School – Take 2!

You may not have noticed but it’s been a while between updates! In fact, second term saw a grand total of 1 post. This is partly because things got a whole lot busier but I suspect it’s also because I wasn’t happy posting anything less than a small novella; and there damn hard to write.

I really think having this blog is valuable,

1. It forces me to be clear in what I’m trying to say. A lot of the concepts we get presented with at MBS are pretty complex but distilling these down to the most valuable chunks is a skill I’d like to work on
2. One of the big things that’s being emphasized in our program is the key role that repetition plays in learning. Not cramming stuff but rather revisiting it every couple of days until it migrates to long term memory. This blog is another tool for building that repetition into my schedule

So I’m going to try something different: I’ve been keeping a list of “2 thing’s I learned today”. These are paragraph long thoughts that come from the lectures I’m sitting in on and I thought I might use these as the basis for my posts. Hopefully that makes it a little more accessible to read as well (rather than wading through pages of my ramblings).