Decision making under uncertainty and risk: methods, strategy development

2024 Author: Howard Calhoun | [email protected]. Last modified: 2023-12-17 10:16

The work of a leader is connected with the need to constantly make decisions, they affect the success of the company, its future and stability. But, in addition to responsibility, this process is also influenced by the situation in the company, on the market, in the world, and these indicators, as you know, are highly variable and dynamic. Therefore, the development of management decisions under conditions of uncertainty is a complex, multifaceted process. Let's talk about its specifics, about what methods and criteria a manager has in making such decisions.

The concept of uncertainty and risk

Before making any decisions, people tend to evaluate the consequences, think through all the appropriate options so as not to make mistakes. And in the field of management, these assessments of the situation become critically important. After all, managerial errors can cause serious damage to a business and even lead to its collapse. BUTmodern enterprises develop in a very dynamic environment. Therefore, decision-making under conditions of uncertainty and risk is no longer something rare and out of the ordinary, but the daily activities of leaders.

Uncertainty is understood as the incompleteness or poor quality of information about the situation in which it is necessary to solve a particular problem. The source of uncertainty can be the behavior of market participants, factors of the external and internal environment, technical processes. Uncertainty usually manifests itself in relation to the various conditions in which a decision is made. Risks are the potential dangers of a negative solution to a situation. It arises from the environment in which production activities take place, as well as from the characteristics of the process in which the decision is made.

Ways to assess potential hazards

In order to overcome the complexity of decision-making under conditions of uncertainty, it is necessary to skillfully assess the risks and possible consequences. There are many methods for assessing a potential threat to a business. They are usually divided into qualitative and quantitative methods. In the group of qualitative methods, ratings, ranking, scoring are distinguished. And quantitative methods include methods based on probability theory and mathematical statistics. However, in practice, managers rarely resort to the use of scientific assessment methods, preferring to rely on their own experience, expert assessments, and statistical data. Managers strive to understand how high the degreerisk and make decisions based on that. And they often build this understanding on the subjective perception of the situation, which can lead to an increase in the percentage of erroneous decisions.

Types of risks and uncertainties

The process of developing solutions under uncertainty can vary depending on what risks are expected. There are several classifications of possible risks in management.

Risks are distinguished by the type of threat:

• natural, coming from the natural environment and not dependent on humans, for example, a tsunami or a hurricane;
• technogenic, associated with human activities and failures in various artificial systems, for example, violation of the ecological balance;
• mixed, in which the two previous types are combined, for example, an avalanche caused by human activity.

According to the areas affected by risks, they are divided into:

• social;
• political;
• commercial;
• environmental;
• professional.

Also distinguish between internal and external, simple and complex, permanent and temporary, insured and uninsured. According to the frequency of occurrence, high, medium and small risks are distinguished.

In the commercial sphere, risks are usually distinguished:

• resulting in economic losses;
• related to lost profits;
• those that, under different circumstances, lead either to economic damage or to additional profit.

There are also classifications of uncertainty:distinguish between prospective and retrospective varieties. There is also uncertainty associated with the nature, the accuracy of goals, the linguistic description of the situation, the conditions of existence. Such a wide variety of dangers and threats leads to the fact that decision-making in the face of uncertainty and risk is extremely difficult.

The concept of managerial decision

In management, a decision is understood in two senses: as a process and as a result. The process includes 8 main steps:

• gathering information;
• preparation of alternative options;
• negotiation of options;
• selection of the most suitable one;
• statement;
• implementation;
• monitoring the execution of the decision;
• assessment of results.

When making decisions under conditions of uncertainty and risk, the first two stages are of particular importance, as it is necessary to minimize threats.

The solution is characterized by a number of requirements, these include:

• feasibility - it must be possible to bring it to life;
• relevance - they should meet the requirements of the moment as much as possible;
• optimality - the implementation of the solution must meet the condition of balance of resources spent and benefits received;
• legitimate - any decision must be legitimate;
• consistency - the execution of the decision should not cause a conflict of interests of the performers;
• limited time - implementationdecisions must have a specific time horizon;
• simplicity, clarity and brevity of presentation - so that the performers do not find it difficult to implement the solution, they must understand it well.

Types of solutions

Due to the wide variety of tasks facing any manager, there are many varieties of solutions.

They may vary by:

• Predictability of occurrence. There are programmed and non-programmed solutions. The latter are often associated with solving problems under conditions of uncertainty and risk.
• Acceptance methods. Intuitive, rational, science-based solutions can be found.
• The scale of the consequences. Allocate general and particular solutions.
• Goals. Decisions are divided into strategic, tactical and operational.
• Directions. External and internal solutions stand out.
• The method of acceptance. You can divide all solutions into individual and group.
• Degrees of formalization of the adoption process. In this case, it is customary to talk about contour or algorithmic solutions. Within the framework of the first, only a general direction of activity, structured decisions is outlined, when a sequence of actions of performers is drawn up. They practically do not assume the initiative of employees. Algorithmic solutions are the toughest option, when the performer is offered a non- alternative way to implement the solution.

Decision conditions

Management technologies are associated with the definition and evaluation of all conditions that affect decisions. They may differ in origin, in this case, the conditions of the macro- and microenvironment are distinguished. Usually, external conditions cannot be corrected by the forces of the organization, and one has to adapt to them, while internal ones are subject to change.

Traditionally, management distinguishes such decision-making conditions: certainty, risk, uncertainty. Certainty is understood as the full awareness of the manager about the situation in which the decision will be implemented. In this case, you can calculate all the consequences, make forecasts, and make such decisions relatively easily. Uncertainty is a condition under which a manager does not have complete information and makes a decision based not on data, but on experience, expert advice, and intuition. Risk is the most unfavorable condition for making a decision. In this case, the manager takes responsibility for the consequences that the decision entails. However, management has accumulated certain methodological experience in solving problems associated with different types of risks.

Decisions and risk

It can be said that today almost any decision - everyday, managerial, political - is associated with risk. The modern world is becoming less and less predictable, and it is precisely the risks of the macro environment that are growing: the number of natural and man-made disasters is increasing,business conditions are changing. Therefore, decisions under conditions of uncertainty are already familiar, routine everyday life of managers of different levels. Traditionally, risk can be classified according to the degree of predictability. There are certain risks that everyone knows about in advance. In this case, it is customary to talk about the weighted average risk of the decision. The manager assesses the likelihood of a threat and, in accordance with this, solves the task. There are also uncertain risks, which few people undertake to predict. For example, no one makes a managerial decision, taking into account the possibility that alien beings will attack the Earth. Risk is precisely the factor that makes the job of a manager so challenging and demanding.

Rules and criteria for decision making under conditions of uncertainty and risk

When deciding what to do in a particular economic situation, the manager must first assess the likelihood of threats. This is the main criterion that allows you to find the optimal solution to the problem under uncertainty. Another criterion is the magnitude of the risk. There are special methods for calculating it, based on complex mathematical calculations.

Basic rules for making difficult decisions include:

• necessary to identify all kinds of factors affecting the execution of the decision, both objective and subjective;
• deep analysis of identified risk factors should be carried out;
• need to assess the financial dimension of possible risks to justify the economic feasibility of the decision;
• should decide on an acceptable risk threshold;
• in the decision execution process, actions to reduce or prevent the occurrence of risk should also be included.

In management there are also several rules for making managerial decisions under uncertainty: maxmin, maxmax, minimax. In both cases, the decision matrix is filled in. In the maxmin rule, or the Waald criteria, of all possible options, the one that, under the most unfavorable conditions, can bring maximum results is selected. The manager assumes the worst-case scenario and the maximum possible gain in this situation. And in the second case, the opposite decision is chosen, the one that will give the highest result under a favorable set of circumstances. Minimax is a rule that gives priority to a decision that allows for possible risk, but also expects a large benefit.

Basics of Risk Decision Theory

Management has developed a theory of decision making under uncertainty. The object of her study is a certain problematic situation. The starting point of this theory is the postulate that there is no better solution. It always corresponds to a given situation and a given moment in time. Another postulate of this theory is that the development of solutions under conditions of uncertainty and risk should be based on a comprehensive analysis of the context in whichthis is the solution. And another postulate of this theory suggests that the decision-making process should obey an algorithm that allows you not to miss anything significant.

Risk Decision Making Methods

Risk situations require the use of various methods that allow you to find the optimal solution to the problem problem. All decision-making methods under conditions of uncertainty are divided into three groups:

1. Quantitative. This group of methods is based on a system of mathematical calculations. These can be probabilistic, statistical and simulation models, as well as game theory, linear modeling and dynamic programming. These methods usually require the use of software and computing equipment.
2. Collective. This group of methods involves the joint work on the development of a solution by a group of specialists. This type includes brainstorming methods, the Delphi method, the method of expert assessments.
3. Informal. These are methods that are not amenable to strict regulation, they are also called heuristic. In this case, the decision is made on the basis of some internal reflections and conclusions.

These methods are associated with the ability to assess risks according to specific criteria. These assessments form the basis of the decision-making process.

Methods and criteria for finding solutions and answers to questions under conditions of uncertainty

When the risks are not clear and it is impossible to find the exact parameters for their assessment, methods such aslike:

• Building a goal tree. This method allows you to build a hierarchy of goals and determine priorities when solving a problematic task.
• Method of comparing alternatives. In this case, the decision process under conditions of uncertainty is reduced to the formulation of possible options, their evaluation and comparison according to the given parameters.
• Scenario planning. In this case, action plans are designed in one or another variant of the development of the situation. To create scenarios, various specialists and a large amount of expert and prognostic information are involved.

To develop a solution in a situation of uncertainty, various criteria can be used to find the optimal answer to the question. These criteria include: maximin (pessimistic), minimax and maximax (optimistic), as well as the sum of various criteria.