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 INTRODUCTION TO DECISION SCIENCE

 OVERVIEW OF DECISION-MAKING PROCESS,
 RATIONALITY AND DECISION THEORY,
 TYPES OF DECISIONS AND DECISION PROBLEMS,
 DECISION TREES AND PROBABILITY THEORY.
 DECISION ANALYSIS-
 STRUCTURING DECISION PROBLEMS,

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What is Decision Science?
Decision Science is the collection of quantitative techniques used to inform
decision-making at the individual and population levels. It includes decision
analysis, risk analysis, cost-benefit and cost-effectiveness analysis, constrained
optimization, simulation modelling, and behavioural decision theory, as well as
parts of operations research, microeconomics, statistical inference, management
control, cognitive and social psychology, and computer science. By focusing on
decisions as the unit of analysis, decision science provides a unique framework
for understanding public health problems, and for improving policies to address
those problems.
How is decision science different from other research approaches?
While most fields of research focus on producing new knowledge, decision
science is uniquely concerned with making optimal choices based on available
information. Decision science seeks to make plain the scientific issues and value
judgments underlying these decisions, and to identify trade-offs that might
accompany any particular action or inaction.
What kinds of tools and methods do decision scientists use?
Decision science utilizes a variety of tools which include models for decision-
making under conditions of uncertainty, experimental and descriptive studies of
decision-making behavior, economic analysis of competitive and strategic
decisions, approaches for facilitating decision-making by groups, and
mathematical modeling techniques.
Where is decision science used?
Decision science has been used in business and management, law and
education, environmental regulation, military science, public health and public
policy. CHDS uses decision analytic methods to inform policies and practices
that improve population health by systematically integrating scientific evidence
with explicit consideration of individual and societal values for outcomes such
as mortality, quality of life, and costs.

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Decision Making Process
Introduction
Decision making is a daily activity for any human being. There is no exception
about that. When it comes to business organizations, decision making is a habit
and a process as well.
Effective and successful decisions make profit to the company and unsuccessful
ones make losses. Therefore, corporate decision making process is the most
critical process in any organization.
In the decision making process, we choose one course of action from a few
possible alternatives. In the process of decision making, we may use many
tools, techniques and perceptions.
In addition, we may make our own private decisions or may prefer a collective
decision.
Usually, decision making is hard. Majority of corporate decisions involve some
level of dissatisfaction or conflict with another party.
Let's have a look at the decision-making process in detail.
Steps of Decision-Making Process
Following are the important steps of the decision-making process. Each step
may be supported by different tools and techniques.

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 Step 1: Identification of the purpose of the decision
In this step, the problem is thoroughly analysed. There are a couple of questions
one should ask when it comes to identifying the purpose of the decision.
 What exactly is the problem?
 Why the problem should be solved?
 Who are the affected parties of the problem?
 Does the problem have a deadline or a specific time-line?
Step 2: Information gathering
A problem of an organization will have many stakeholders. In addition, there
can be dozens of factors involved and affected by the problem.
In the process of solving the problem, you will have to gather as much as
information related to the factors and stakeholders involved in the problem. For
the process of information gathering, tools such as 'Check Sheets' can be
effectively used.
Step 3: Principles for judging the alternatives
In this step, the baseline criteria for judging the alternatives should be set up.
When it comes to defining the criteria, organizational goals as well as the
corporate culture should be taken into consideration.
As an example, profit is one of the main concerns in every decision making
process. Companies usually do not make decisions that reduce profits, unless it
is an exceptional case. Likewise, baseline principles should be identified related
to the problem in hand.
Step 4: Brainstorm and analyse the different choices
For this step, brainstorming to list down all the ideas is the best option. Before
the idea generation step, it is vital to understand the causes of the problem and
prioritization of causes.
For this, you can make use of Cause-and-Effect diagrams and Pareto Chart tool.
Cause-and-Effect diagram helps you to identify all possible causes of the

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problem and Pareto chart helps you to prioritize and identify the causes with
highest effect.
Then, you can move on generating all possible solutions (alternatives) for the
problem in hand.
Step 5: Evaluation of alternatives
Use your judgement principles and decision-making criteria to evaluate each
alternative. In this step, experience and effectiveness of the judgement
principles come into play. You need to compare each alternative for their
positives and negatives.
Step 6: Select the best alternative
Once you go through from Step 1 to Step 5, this step is easy. In addition, the
selection of the best alternative is an informed decision since you have already
followed a methodology to derive and select the best alternative.
Step 7: Execute the decision
Convert your decision into a plan or a sequence of activities. Execute your plan
by yourself or with the help of subordinates.
Step 8: Evaluate the results
Evaluate the outcome of your decision. See whether there is anything you
should learn and then correct in future decision making. This is one of the best
practices that will improve your decision-making skills.
Conclusion
When it comes to making decisions, one should always weigh the positive and
negative business consequences and should favour the positive outcomes.
This avoids the possible losses to the organization and keeps the company
running with a sustained growth. Sometimes, avoiding decision making seems
easier; especially, when you get into a lot of confrontation after making the
tough decision.
But, making the decisions and accepting its consequences is the only way to
stay in control of your corporate life and time.

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 Decision theory
Decision theory (or the theory of choice; not to be confused with choice
theory) is a branch of applied probability theory and analytic
philosophy concerned with the theory of making decisions based on
assigning probabilities to various factors and assigning numerical
consequences to the outcome.[1]
There are three branches of decision theory:
1. Normative decision theory: Concerned with the identification of optimal
decisions, where optimality is often determined by considering an ideal
decision-maker who is able to calculate with perfect accuracy and is in some
sense fully rational.
2. Prescriptive decision theory: Concerned with describing observed behaviors
through the use of conceptual models, under the assumption that those making
the decisions are behaving under some consistent rules.
3. Descriptive decision theory: Analyzes how individuals actually make the
decisions that they do.
Decision theory is a broad field from management sciences and is an
interdisciplinary topic, studied by management scientists, medical researchers,
mathematicians, data scientists, psychologists, biologists,[2] social scientists,
philosophers[3] and computer scientists.
Empirical applications of this theory are usually done with the help
of statistical and discrete mathematical approaches from computer science.
Normative and descriptive
Normative decision theory is concerned with identification of optimal decisions
where optimality is often determined by considering an ideal decision maker
who is able to calculate with perfect accuracy and is in some sense
fully rational. The practical application of this prescriptive approach (how
people ought to make decisions) is called decision analysis and is aimed at

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finding tools, methodologies, and software (decision support systems) to help
people make better decisions.[4][5]
In contrast, descriptive decision theory is concerned with describing observed
behaviors often under the assumption that those making decisions are behaving
under some consistent rules. These rules may, for instance, have a procedural
framework (e.g. Amos Tversky's elimination by aspects model) or
an axiomatic framework (e.g. stochastic transitivity axioms), reconciling
the Von Neumann-Morgenstern axioms with behavioral violations of
the expected utility hypothesis, or they may explicitly give a functional form
for time-inconsistent utility functions (e.g. Laibson's quasi-hyperbolic
discounting).[4][5]
Prescriptive decision theory is concerned with predictions about behavior that
positive decision theory produces to allow for further tests of the kind of
decision-making that occurs in practice. In recent decades, there has also been
increasing interest in "behavioral decision theory", contributing to a re-
evaluation of what useful decision-making requires.[6][7]
Types of decisions
The area of choice under uncertainty represents the heart of decision theory.
Known from the 17th century (Blaise Pascal invoked it in his famous wager,
which is contained in his Pensées, published in 1670), the idea of expected
value is that, when faced with a number of actions, each of which could give
rise to more than one possible outcome with different probabilities, the rational
procedure is to identify all possible outcomes, determine their values (positive
or negative) and the probabilities that will result from each course of action, and
multiply the two to give an "expected value", or the average expectation for an
outcome; the action to be chosen should be the one that gives rise to the highest
total expected value. In 1738, Daniel Bernoulli published an influential paper
entitled Exposition of a New Theory on the Measurement of Risk, in which he
uses the St. Petersburg paradox to show that expected value theory must

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be normatively wrong. He gives an example in which a Dutch merchant is
trying to decide whether to insure a cargo being sent from Amsterdam to St
Petersburg in winter. In his solution, he defines a utility function and
computes expected utility rather than expected financial value.[8]
In the 20th century, interest was reignited by Abraham Wald's 1939
paper[9] pointing out that the two central procedures of sampling-distribution-
based statistical-theory, namely hypothesis testing and parameter estimation, are
special cases of the general decision problem. Wald's paper renewed and
synthesized many concepts of statistical theory, including loss functions, risk
functions, admissible decision rules, antecedent distributions, Bayesian
procedures, and minimax procedures. The phrase "decision theory" itself was
used in 1950 by E. L. Lehmann.[10]
The revival of subjective probability theory, from the work of Frank
Ramsey, Bruno de Finetti, Leonard Savage and others, extended the scope of
expected utility theory to situations where subjective probabilities can be used.
At the time, von Neumann and Morgenstern's theory of expected
utility[11] proved that expected utility maximization followed from basic
postulates about rational behavior.
The work of Maurice Allais and Daniel Ellsberg showed that human behavior
has systematic and sometimes important departures from expected-utility
maximization (Allais paradox and Ellsberg paradox).[12] The prospect
theory of Daniel Kahneman and Amos Tversky renewed the empirical study
of economic behavior with less emphasis on rationality presuppositions. It
describes a way by which people make decisions when all of the outcomes carry
a risk.[13] Kahneman and Tversky found three regularities – in actual human
decision-making, "losses loom larger than gains"; persons focus more
on changes in their utility-states than they focus on absolute utilities; and the
estimation of subjective probabilities is severely biased by anchoring.

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Intertemporal choice
Intertemporal choice is concerned with the kind of choice where different
actions lead to outcomes that are realised at different stages over time. [14] It is
also described as cost-benefit decision making since it involves the choices
between rewards that vary according to magnitude and time of arrival. [15] If
someone received a windfall of several thousand dollars, they could spend it on
an expensive holiday, giving them immediate pleasure, or they could invest it in
a pension scheme, giving them an income at some time in the future. What is
the optimal thing to do? The answer depends partly on factors such as the
expected rates of interest and inflation, the person's life expectancy, and their
confidence in the pensions industry. However even with all those factors taken
into account, human behavior again deviates greatly from the predictions of
prescriptive decision theory, leading to alternative models in which, for
example, objective interest rates are replaced by subjective discount rates.
Interaction of decision makers
Some decisions are difficult because of the need to take into account how other
people in the situation will respond to the decision that is taken. The analysis of
such social decisions is often treated under decision theory, though it involves
mathematical methods. In the emerging field of socio-cognitive engineering, the
research is especially focused on the different types of distributed decision-
making in human organizations, in normal and abnormal/emergency/crisis
situations.
Complex decisions
Other areas of decision theory are concerned with decisions that are difficult
simply because of their complexity, or the complexity of the organization that
has to make them. Individuals making decisions are limited in resources (i.e.
time and intelligence) and are therefore boundedly rational; the issue is thus,
more than the deviation between real and optimal behaviour, the difficulty of
determining the optimal behaviour in the first place. Decisions are also affected

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by whether options are framed together or separately; this is known as
the distinction bias.
Heuristics
Heuristics in decision-making is the ability of making decisions based on
unjustified or routine thinking. While quicker than step-by-step processing,
heuristic thinking is also more likely to involve fallacies or inaccuracies. [17] The
main use for heuristics in our daily routines is to decrease the amount of
evaluative thinking we perform when making simple decisions, making them
instead based on unconscious rules and focusing on some aspects of the
decision, while ignoring others.[18] One example of a common and erroneous
thought process that arises through heuristic thinking is the Gambler's
Fallacy — believing that an isolated random event is affected by previous
isolated random events. For example, if a fair coin is flipped to tails for a couple
of turns, it still has the same probability (i.e., 0.5) of doing so in future turns,
though intuitively it seems more likely for it to roll heads soon. [19] This happens
because, due to routine thinking, one disregards the probability and concentrates
on the ratio of the outcomes, meaning that one expects that in the long run the
ratio of flips should be half for each outcome.[20] Another example is that
decision-makers may be biased towards preferring moderate alternatives to
extreme ones. The Compromise Effect operates under a mindset that the most
moderate option carries the most benefit. In an incomplete information scenario,
as in most daily decisions, the moderate option will look more appealing than
either extreme, independent of the context, based only on the fact that it has
characteristics that can be found at either extreme.[21]
Alternatives to probability theory
The proponents of fuzzy logic, possibility theory, quantum
cognition, Dempster–Shafer theory, and info-gap decision theory maintain that
probability is only one of many alternatives and point to many examples where
non-standard alternatives have been implemented with apparent success;

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notably, probabilistic decision theory is sensitive to assumptions about the
probabilities of various events, whereas non-probabilistic rules, such
as minimax, are robust in that they do not make such assumptions.
Ludic fallacy
A general criticism of decision theory based on a fixed universe of possibilities
is that it considers the "known unknowns", not the "unknown unknowns":[22] it
focuses on expected variations, not on unforeseen events, which some argue
have outsized impact and must be considered – significant events may be
"outside model". This line of argument, called the ludic fallacy, is that there are
inevitable imperfections in modeling the real world by particular models, and
that unquestioning reliance on models blinds one to their limits.
Rationality Theory
According to Gigerenzer and Gaissmaier (2011), rationality theory
affirms the essence of economics as a subject since it forms the basis through
which different economic principles are based. It argues that the economic man
normally makes decisions that are realistic and logical and that such decisions
are made on matters that would offer the individual the greatest utility.
Moreover, individuals normally make those decisions with their self-interest as
a key point. The rational theory is a fundamental principle that most economic
concepts and understanding are based on.
As noted by Weyland (2006) Hebert Simon through the theory of
bounded rationality argued that people might have a desire to get all the relevant
information on a given phenomenon before making decisions, but that is not
normally the case. As such, people end up making decisions on limited know
how on given phenomenon. On the same note, Richard Thaler through mental
accounting proved that in some cases, people behave irrationally, and that is
evident in their preference for certain dollars over others. European Journal of
Economics, Law and Politics, ELP March 2019 edition Vol.6, No.1 ISSN 2518-
3761 23

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 As noted by Vlaev (2018) the through bounded rationality concept, it is
evident that it is not realistic for people to have all the information and process
it before making choices. In that regard, people devise means of coping and
choosing certain things. For example, they have practice, methods and standard
operating procedure (SOP) that help in the process of picking alternatives to
make decisions. An example of habit/process is making the bed in the morning
after waking up. Reading news on available products before making purchases
is an example of method or technique. SOP could be represented by rules
governing the interaction of different individuals in an organisation.

Bounded rationality postulates that even if people were given all the
information about a given phenomenon, they would not be able to act on all the
information and use them in making choices. In this regard, to predict the likely
approach that would be used to make a decision, it would not be enough to
know the quality of data used, but rather the cognitive approach used. In this
view decision making as presented by the bounded rationality principle implies
that people are influenced by their operating environment. On the same note,
they react given the situation they face within their environment, and their
reactions determine the rationality they apply to a given matter and, by
extension, the decision-making process.
The same theory affirms why people are likely to give different responses
and thoughts on certain issues due to their different conception and
internalisation of the facts of the case. While making decisions, errors may arise
because the decisions so given would hinge on the understanding of people. On
the same note, they would only go for those choices that would give them the
best satisfaction. While picking the different choices, people normally have a
bias by self-satisfaction Vlaev (2018).

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 Decision Making Types of Decisions
1. Introduction
A decision is a choice made between two or more available alternatives.
Decision making is the process of choosing the best alternative for reaching
objectives. Managers make decisions affecting the organization daily and
communicate those decisions to other organizational members. Some decisions
affect large number of organizational members, cost great deal of money to
carry out, or have long term effect on the organization. Such significant
decisions can have a major impact not only on the management system but
also on the career of the manager who makes them. Other decisions are fairly
insignificant, affecting only a small number of organization members, costing
little to carry out and producing only a short term effect on organization.
There are four basic standards that can be used deciding the nature of decision
and also the level of authority that should make the decision.
These are -
a) The degree of futurity in the decision
b) The impact of decision on whole organization
c) The number of factors involved in decision
d) The frequency of decision whether rarely or periodically taken
2. Types of decisions
Following are the main types of decisions an organization needs to take.
 Programmed and Non programmed decisions
 Organizational and Personal decisions
 Operational and Policy decisions
 Opportunity and Problem solving decision
 Routine and Strategic decisions
 Research based and Interactive decision
 Individual and Group decisions
 Major and minor decisions

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 Programmed and Non Programmed decisions- Programmed decisions are
taken in structured situation. These decisions are fairly structured and occur
with some frequency and are concerned with the problems of repetitive nature
or routine type matters. A standard procedure is followed for tackling such
problems. Decisions of this type may pertain to purchase of raw material,
granting leave to an employee, supply of goods to the employee etc. These
decisions are generally taken by lower level managers.
Non programmed decisions are pertaining to difficult situations of which there
is no easy solution. These are decisions which are taken in unstructured
situation. Non Programmed decisions occurs much less often than programmed
decisions. These are non repetitive and uncertainty involved decisions. These
decisions are unique and novel. It requires thought and creativity. These
decisions are taken by top level managers. Intuition and experience plays major
role in taking these types of decisions. Non-programmed decisions relate to
difficult situations for which there is no easy solution.
For example, opening a new branch of organization, decision regarding large
number of employees’ absenteeism, or offering education in another medium of
instruction is non programmed decisions.
 Organizational and Personal decisions- When an individual takes decision as
an executive in the official capacity it is known as organizational decision.
Manager takes the decision in the organization. The manager has to take
decision in the organization to pursue organization’s vision, mission and goals.
The manager gives direction to the employees on how to prioritize effort, which
resources can be employed and the delegation of responsibility for activities.
When the individual is taking decision in his personal capacity it is known as
personal or individual decision. Personal decisions are taken by the individual in
his day to day life. One has to take lots of decisions every day, right from what
to eat, what to wear, which stream to choose, which career to choose etc.
When an individual take decisions as an executive in the official capacity, it is

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 organizational decision. If decision is taken by an executive in his personal
capacity, thereby affecting his personal life, it is a personal decision. The
authority of taking organizational decisions may be delegated, whereas
individual decisions cannot be delegated.
 Operational and Policy decisions– Decisions pertaining to various policy
matters of the organization are policy decisions. These are taken by top
managers and have long term impact on the functioning of the organization. For
e.g. decisions regarding location of the school, Board of the school are
examples of policy decisions.
Policy decisions are long term in impact. They affect and shape the direction of
whole business. They are generally made by top level managers. The Principal
(managers) of the school need to take a strategic decision about whether to offer
education in vernacular medium or offer it in English medium as per the need of
the society will be strategic decision.
Operational decisions are related to day to day functioning or operations of
organization. Middle or lower level managers take these decisions. These
decisions have short term horizon as they are taken repetitively. These decisions
are based on facts regarding the events and do not require much of
organizational judgment.
An example may be taken to distinguish these decisions. Decisions concerning
payment of bonus to employee are a policy decision. On the other hand, if
bonus is to be given to the employees, calculation of bonus in respect of each
employee is an operational decision. Other types of operational decisions are
calculation of salary of each employee, calculating working days for the
academic year.
 Opportunity and Problem Solving decision- Many a times, decisions are
taken by the manager to grab the opportunity. These decisions are known as
Opportunity decisions. These decisions are taken by the manager for growth
and development of the organization.

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 Managers make decisions about both problems (undesirable situations) and
opportunities (desirable situations). If there is any emergency or problem occurs
in the organization, then manager has to take quick decision to come out from
that situation. These decisions are known as problem solving decisions. For this,
the manager must be a good problem solver.
 Routine and Strategic decision– Routine decisions are related to the general
functioning of the organization. The decisions are repetitive in nature. They do
not require much evaluation and analysis and can be taken quickly.
Strategic decisions affect organizational objectives, goals and other important
policy matters. These decisions usually involves huge amount of investments or
funds. These decisions are taken after careful analysis and evaluation of many
alternatives. These decisions are taken by top level managers. These decisions
have a long term implication on the organization. The manager needs to be good
visionary for taking strategic decisions. Strategic decisions look ahead to the
longer term and direct the company to its destiny. They tend to be at high risk
and high stakes. They are complex and rely on intuition supported by
information based on analysis and experience.
 Research based and Interactive decision- Research based decisions requires
lots of evidences to be collected before actual action to be taken. For this one
has to do lot of research for finding out the alternatives and asses the
consequences of those alternatives. In the context of crisis the manager has to do
lot of research to come out of that crisis.
Most of the time it is the manager who take the decisions in the organization but
there are situations where the manager alone cannot take decisions. He has to
consult, interact with other team members in this regard. These are interactive
decisions. Interactive decisions, are easier, faster, and can be more accurate.
 Individual and group decisions– When the decision is taken by single
individual it is known as individual decision. Usually routine type decisions are
taken by individuals within the broad policy framework of the organization.

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 Group decisions are taken by group of individuals constituted in the form of
committee. Generally, very important and pertinent matters for the organization
are referred to this committee. The main aim in taking group decision is the
involvement of maximum numbers of individuals in the process of decision
making. For instance, decisions pertaining to NAAC visit to the college can be
taken in group and suggestions, views and opinions of the faculties can be taken
in group decision. Different committees will be formed by the principal and
work will be delegated to different teams.
 Major and Minor decisions- Major decisions are taken by top management.
Decision pertaining to purchase of new land for a new branch of school is a
major decision. Decision pertaining to purchase of office stationary is a minor
decision which can be taken by office superintendent.
3. Approaches to Decision Making
There are several approaches to decision making which offers insight into the
process by which managers arrive at their decisions.
 Centralized and Decentralized approach
 Group and Individual approach
 Participatory and Non Participatory approach
 Democratic and Consensus based approach
Centralized and Decentralized Approach
In centralized decision making, decision making is concentrated in few hands.
All the important decisions and actions at the lower level are subject to approval
of top management, other levels are at implementation as per the direction of
top level.
Centralized decision making is easier, quicker decision making. It is easier to
coordinate and control from centre. It is more bureaucratic in nature.
In decentralized approach there is systematic delegation of authority at all levels
of management. Authority is delegated to middle and lower level of
management. The degree of centralization or decentralization depends on

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amount of authority delegated to various levels of management.
Decentralized approach is a good way of training and developing junior
management. It aims to flatter hierarchy.
When all the decisions are taken by the school principal, it is centralized
approach. When the tasks are delegated and authority is given to take decision
related to that task, it is decentralized approach.
Fast food businesses like Burger King, Pizza Hut and Mc Donald’s use
centralized approach to ensure that control is maintained over thousands of their
outlets. The need to ensure consistency of customer experience and quality of
food at every location are the main reason for this choice.
Hotel chains particularly use decentralized approach so that local hotel
managers are empowered to make on the spot decisions to handle customer
problems or complaints.
Group and Individual approach
There are several methods of group decision making that one can employ. Two
examples are consensus and consultation. Consensus decisions are taken by
making use of most popular option to make a decision. Consultation takes the
opinion of the group into consideration while making a decision. Both the
methods require group participation and call for a manager who respects the
opinion of the group in decision making.
In individual approach decisions are taken regardless of the group’s opinion.
This is more traditional decision making approach and can work effectively for
a manager when the group’s input is not required.
Participatory and Non-Participatory approach
In participatory approach employers allows or encourage employees to share or
participate in organizational decision making. Whereas in non-participatory
approach, employee’s participation is not taken in decision making process.
Participatory decisions are based on shared leadership, employee
empowerment, employee involvement, dispersed leadership. The basic concept

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 involves any power sharing arrangement in which workplace influence is shared
among individuals who are otherwise hierarchical unequal’s. Such power
sharing arrangements may result in codetermination of working conditions,
problem solving among the employees. The primary aim of participatory
decision making is for the organization to benefit from perceived motivational
effect of increased employee involvement.
Participatory decision making has positive effect on employees’ job
satisfaction, organizational commitment, perceived organizational support,
organizational citizenship behavior, labour management relations,
organizational performance and organizational profit.
Democratic and Consensus based approach
In democratic approach decisions are taken by a majority vote. In this kind of
decision discussion on problem or issue is conducted and decisions are taken by
majority votes. In this type of decision, a committee may be formed who will take
opinion of others regarding the problem and then with majority’s view is
considered in decision making.
In consensus-based approach, decisions are reached with cross functional team.
People from different departments provide their views and opinions. One has to
get everybody saying ‘’yes’’ before that decision is made. Consensus based
decision making is a group decision making process in which group members
develop and agree to support decision
in the best interest of the whole. It is acceptable resolution, one that can be
supported, even if not the favourite of each individual but is beneficial for the
whole organization.
4. How to approach decisions?
Making good decisions is critical to any organization’s success. The first step in
good decision making is to understand that not all decisions are created equal.
Decisions need to be differentiated along two dimensions: Importance and
Urgency. An important decision is one that has the potential to have impact on

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 the organization or person’s life. An urgent decision is that one must make
immediately, there is no time for further consideration.
If one considers these two dimensions together, the results are these four
types of decisions and how to approach them:
1. Neither urgent nor important
 Consider taking no action. If decision is neither urgent nor important, you may
not need to make it all.
 Delegate to others. Coach subordinates on how to think about decision making.
 Don’t delay the decision until it becomes urgent.
2. Urgent but not important
 Don’t overanalyze. Because these decisions are not important, going through a
lengthy process to make decision simply doesn’t make any sense. Many times
the cost of time spent analyzing a decision can exceed the cost of making wrong
decision.
 Use Principles. Guidelines and principles can provide a great way to make
decisions quickly and efficiently. This will ensure that decisions align with
organization’s values.
3. Both urgent and important
 Beware of urgency. Many decisions that are portrayed as urgent are not urgent.
 Reduce urgency. Consider whether you have time to make this important
decision.
 Consider option that will allow you the most flexibility later. If you can avoid it
don’t get locked in.
 Consult experts. These are the people that are most likely to have immediate
insight into the right direction to proceed.
4. Important but not urgent.
 Identify and address the right problem.
 Have the right mindset.
 Utilize appropriate analytical tools.

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 Seek the counsel of experts. Seeking help from experts is a good idea.
 Live with your decision before executing.
Good decision making is critical. Understanding the type of decision you are
taking and responding appropriately will help you to increase your
effectiveness.
5. Techniques of Decision Making
These are following techniques of Decision Making-
 Nominal Group Technique (NGT)
Nominal Group Technique is a structured method of generating list of ideas.
The major feature of NGT is that it controls the amount of personal interaction
and adds structure to the group process.
Procedures followed in this technique are-
 Introduce the question
 Ask the group to explain their understanding of question
 Generate ideas
 Ask to read one idea
 Reduce list Making Decision:
 Select ideas from list
 Rank the idea
 Total it
 Discuss findings.
Are there any surprises? Any objections? Is there anybody who wants to change
opinion?
Steps of NGT:
 Each person writes his ideas, option or solution privately without discussing
with others
 Individual present his/her ideas to group by round robin procedure
 After presentation participant may ask questions to clarify idea or proposal.
However there is no evaluation, no discussion, no debate

22
 Each person ranks idea. The results are tallied to determine the relative support
for each idea
 Example-. Students are not going to practice teaching on time. What action will
you take?
 Delphi Technique
This technique was developed by Rand Corporation to allow the benefit of
group decision making without members having to meet face to face. It allows
group decision making to be accomplished over large distances and widely
scattered members. The Delphi procedure involves series of questionnaire
distributed over time to decision making panel:
1. The questionnaire states problem and request potential solution
2. These solutions are summarized by decision co-coordinator
3. The summary is returned to the panel in a second questionnaire
4. Panel member respond again and the process is repeated until consensus is
reached and a clear decision emerge. For E.g. How many practice teaching
lessons are to be taken?
5. Manager begins the Delphi technique by identifying issues to be investigate. For
e.g. Manager wants to inquire about customer demand, or effect of locating
certain plant in region.
6. Identify participants and develop questionnaire
7. Send to experts
8. Summarizes responses and send back to participants to
9. Review feedback
10. Prioritize issue
11. Return questionnaire
12. This cycle is repeated until the information is obtained.

23
What is a Decision Tree Diagram
What is a decision tree?
A decision tree is a map of the possible outcomes of a series of related
choices. It allows an individual or organization to weigh possible actions against
one another based on their costs, probabilities, and benefits. They can can be
used either to drive informal discussion or to map out an algorithm that predicts
the best choice mathematically.
A decision tree typically starts with a single node, which branches into possible
outcomes. Each of those outcomes leads to additional nodes, which branch off
into other possibilities. This gives it a treelike shape.
There are three different types of nodes: chance nodes, decision nodes,
and end nodes. A chance node, represented by a circle, shows the probabilities
of certain results. A decision node, represented by a square, shows a decision to
be made, and an end node shows the final outcome of a decision path.

Decision trees can also be drawn with flowchart symbols, which some people
find easier to read and understand.
Decision tree symbols
Shape Name Meaning

Decision node Indicates a decision to be made

Chance node Shows multiple uncertain outcomes

Alternative Each branch indicates a possible outcome or

branches action

24
 Shape Name Meaning

Rejected alternative Shows a choice that was not selected

Endpoint node Indicates a final outcome

How to draw a decision tree

To draw a decision tree, first pick a medium. You can draw it by hand on paper
or a whiteboard, or you can use special decision tree software. In either case,
here are the steps to follow:
1. Start with the main decision. Draw a small box to represent this point, then
draw a line from the box to the right for each possible solution or action. Label
them accordingly.
2. Add chance and decision nodes to expand the tree as follows:
 If another decision is necessary, draw another box.
 If the outcome is uncertain, draw a circle (circles represent chance nodes).
 If the problem is solved, leave it blank (for now).
From each decision node, draw possible solutions. From each chance node,
draw lines representing possible outcomes. If you intend to analyze your options
numerically, include the probability of each outcome and the cost of each
action.
3. Continue to expand until every line reaches an endpoint, meaning that there
are no more choices to be made or chance outcomes to consider. Then, assign a
value to each possible outcome. It could be an abstract score or a financial
value. Add triangles to signify endpoints.

With a complete decision tree, you’re now ready to begin analyzing the decision
you face.

25
 Diagramming is quick and easy with Lucidchart. Start a free trial today to start
creating and collaborating.

Make a decision tree

Decision tree analysis example

By calculating the expected utility or value of each choice in the tree, you
can minimize risk and maximize the likelihood of reaching a desirable outcome.
To calculate the expected utility of a choice, just subtract the cost of that
decision from the expected benefits. The expected benefits are equal to the total
value of all the outcomes that could result from that choice, with each value
multiplied by the likelihood that it’ll occur. Here’s how we’d calculate these
values for the example we made above:
When identifying which outcome is the most desirable, it’s important to take the
decision maker’s utility preferences into account. For instance, some may prefer
low-risk options while others are willing to take risks for a larger benefit.
When you use your decision tree with an accompanying probability model, you
can use it to calculate the conditional probability of an event, or the likelihood
that it’ll happen, given that another event happens. To do so, simply start with
the initial event, then follow the path from that event to the target event,
multiplying the probability of each of those events together.
In this way, a decision tree can be used like a traditional tree diagram,
which maps out the probabilities of certain events, such as flipping a coin twice.
Advantages and disadvantages
Decision trees remain popular for reasons like these:
 How easy they are to understand
 They can be useful with or without hard data, and any data requires minimal
preparation
 New options can be added to existing trees

26
 Their value in picking out the best of several options
 How easily they combine with other decision-making tools
However, decision trees can become excessively complex. In such cases, a more
compact influence diagram can be a good alternative. Influence diagrams
narrow the focus to critical decisions, inputs, and objectives.
Decision trees in machine learning and data mining
A decision tree can also be used to help build automated predictive models,
which have applications in machine learning, data mining, and statistics. Known
as decision tree learning, this method takes into account observations about an
item to predict that item’s value.
In these decision trees, nodes represent data rather than decisions. This type of
tree is also known as a classification tree. Each branch contains a set of
attributes, or classification rules, that are associated with a particular class label,
which is found at the end of the branch.
These rules, also known as decision rules, can be expressed in an if-then clause,
with each decision or data value forming a clause, such that, for instance, “if
conditions 1, 2 and 3 are fulfilled, then outcome x will be the result with y
certainty.”
Each additional piece of data helps the model more accurately predict which of
a finite set of values the subject in question belongs to. That information can
then be used as an input in a larger decision making model.
Sometimes the predicted variable will be a real number, such as a price.
Decision trees with continuous, infinite possible outcomes are called regression
trees.
For increased accuracy, sometimes multiple trees are used together in ensemble
methods:
 Bagging creates multiple trees by resampling the source data, then has those
trees vote to reach consensus.

27
 A Random Forest classifier consists of multiple trees designed to increase the
classification rate
 Boosted trees that can be used for regression and classification trees.
 The trees in a Rotation Forest are all trained by using PCA (principal
component analysis) on a random portion of the data
A decision tree is considered optimal when it represents the most data with the
fewest number of levels or questions. Algorithms designed to create optimized
decision trees include CART, ASSISTANT, CLS and ID3/4/5. A decision tree
can also be created by building association rules, placing the target variable on
the right.
Each method has to determine which is the best way to split the data at each
level. Common methods for doing so include measuring the Gini impurity,
information gain, and variance reduction.
Using decision trees in machine learning has several advantages:
 The cost of using the tree to predict data decreases with each additional data
point
 Works for either categorical or numerical data
 Can model problems with multiple outputs
 Uses a white box model (making results easy to explain)
 A tree’s reliability can be tested and quantified
 Tends to be accurate regardless of whether it violates the assumptions of source
data
But they also have a few disadvantages:
 When dealing with categorical data with multiple levels, the information gain is
biased in favor of the attributes with the most levels.
 Calculations can become complex when dealing with uncertainty and lots of
linked outcomes.
 Conjunctions between nodes are limited to AND, whereas decision graphs allow
for nodes linked by OR.

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What Is Probability Theory?
Probability theory External link: open_in_new is a branch of mathematics
focusing on the analysis of random phenomena. It is an important skill for data
scientists using data affected by chance. 
With randomness existing everywhere, the use of probability theory
allows for the analysis of chance events. The aim is to determine the likelihood
of an event occurring, often using a numerical scale of between 0 and 1, with
the number “0” indicating impossibility and “1” indicating certainty. 
A classic example of this is a coin toss, where there can be two possible
options: heads or tails. Here the possibility of flipping a head or a tail on a
single toss is 50%. When conducting your own experiment you may find that
the outcomes can vary. But if you continue flipping the coin, the outcome grows
closer to 50/50. 
Probability plays a vital role External link: open_in_new in many areas of
scientific research. Researchers can integrate uncertainty into their research
models as a way of describing their findings. This allows for a predictive
distribution of findings tied to what may have been observed in the past.
Randomness and uncertainty are popular themes tied to probability. In
Nassim Taleb’s bestselling books The Black Swan and Fooled By
Randomness, the claim is made that rare events typically hold more importance
than common ones because their effect size is not as restricted. Also, because of
their rarity, results are unlikely to be determined. 
Taleb popularized what he calls a “black swan” event, External link:
open_in_new one that is rare, has a catastrophic impact when it does occur and
can be explained in hindsight in a way that leads many to believe that it was
actually predictable. 

29
Practical Uses for Probability Theory
Probability is commonly used by data scientists to model situations where
experiments, conducted during similar circumstances, yield different results (as
in the case of throwing dice or a coin).
It also has many practical uses in the business world. Take for example
the insurance industry, where actuarial records chart life expectancy of
individuals of a certain age. Instead of predicting what will happen to any one
individual, the aim is to capture a collective result encompassing a large number
of people. 
Similar approaches have been taken in where assessing the likelihood of a
genetic disease is tied to frequency of occurrence as opposed to predictions
about a specific individual. 
Another common application of probability is also commonly applied in
clinical trials where new disease treatments, drugs or surgical treatments are
being sought. In assessing whether a treatment can be deemed a success or
failure, the clinical trial aims to determine whether the new treatment is more
successful than a prevailing treatment standard.
An example here is testing the efficacy of a new vaccine, such as
the poliomyelitis testing done for the Salk vaccine in 1954 involving almost two
million children. Organized by the U.S. Public Health Service, the vaccine
nearly eliminated polio as a health problem in the industrialized world. 
What Are the 3 Types of Probability?
There are three types of probability commonly used External link:
open_in_new to gather statistical inference data. These are: 
Classical
Also known as the axiomatic method, this type of probability involves a
set of axioms (rules) attached to it. For example, you could have a rule that the
probability must be greater than 0.5% in order for it to be valid. 

30
Relative Frequency
This involves looking at the occurrence ratio of a singular event in
comparison to the total number of outcomes. This type of probability is often
used after data from an experiment has been gathered to compare a subset of
data to the total amount of collected data. 
Subjective Probability
When using the subjective approach, probability is the likelihood of
something happening based on one’s experiences or personal judgment. Here
there are no formal calculations for subjective probability for it is based on
one’s beliefs, judgment and personal reasoning.
By way of example, during a sporting event, fans of one team share who
they are rooting for. This is based on facts or opinions they personally hold
regarding the game, the two teams playing and the odds of the team winning.
Probability Theory Examples
Probability theory is a tool employed by researchers, businesses, investment
analysts and countless others for risk management and scenario analysis.
Epidemiology
Take epidemiology, which is the science of disease distribution.
Researchers in this field study disease frequency, assessing how the probability
differs across groups of people. A present-day example of this is the use of
probability by epidemiologists to assess the cause-effect relationship between
exposure and illness to the coronavirus.
Probability theory is often used to unlock key factors denoting the relationship
between exposures and health risks. The aim here is to quantify uncertainty.
This knowledge can fuel a course of action based on best outcomes for those
affected by various diseases. 
Insurance
The who are often employed in the insurance industry make primary use
of probability, statistics and other data science tools to calculate the probability

31
of uncertain future events occurring over a period of time. They then apply
other data concepts to determine the amount of money that needs to be set aside
to pay for future losses. 
Small Business
Then there’s the small-business world where owners cannot always turn
to their hunches and instincts to run a successful company. In today’s
competitive business environment, probability analysis can provide
entrepreneurs with key metrics pointing the way to the most profitable and
productive paths. This analysis offers a controlled way to anticipate potential
results. 
For example, if a business enterprise expects to receive between $500,000
and $750,000 in revenue each month, the graph will begin with $500,000 at the
low end and $750,000 at the high end. For a typical probability distribution, the
graph will resemble a bell curve, where the least likely outcomes fall nearer the
extreme ends of the range and the most likely nearer to the midpoint of the
extremes.
Meteorology
A weather forecast serves as another example of probability theory. The
probability for precipitation or severe weather is tied to a specific geographic
location. As a result, forecasting can be viewed as the combination of the
chance of a weather occurrence and the coverage of that event. According to
an information statement of the American Meteorological Society. 
“A probability forecast includes a numerical expression of uncertainty
about the quantity or event being forecast.  Ideally, all elements (temperature,
wind, precipitation, etc.) of a weather forecast would include information that
accurately quantifies the inherent uncertainty. Surveys have consistently
indicated that users desire information about uncertainty or confidence of
weather forecasts. The widespread dissemination and effective communication
of forecast uncertainty information is likely to yield substantial economic and

32
social benefits, because users can make decisions that explicitly account for this
uncertainty.” 
Advantages and Disadvantages of Probability Theory 
For data scientists, there are a number of advantages and disadvantages with
probability that need to be considered.  
Classical
The classical method of probability is used when all probable outcomes
have an equal likelihood of happening and every outcome is known in advance.
The coin toss example above uses the classical approach to probability. The
classical approach offers a simple approach to real-world examples that is easy
to digest for those not possessing a math or science background. 
With respect to limitations, the classical approach is unable to handle
projects where an infinite number of possible outcomes exist. It’s also
ineffective in scenarios where each outcome is not equally likely, as in the case
of tossing a weighted die. These limitations affect the ability of this approach to
handling more complicated tasks. 
Relative Frequency
Unlike the classical approach, relative frequency offers the advantage of
being able to handle scenarios where outcomes have different theoretical
probability (or likelihood) of occurring. This approach can also manage a
probability situation where possible outcomes are unknown. 
Although you can use relative frequency probability in more diverse
situations and settings than classical probability, it has several limitations. The
first limitation to relative frequency involves the problem of “infinite
repetitions.” This is where experiments possessing an infinite number of times
cannot be analyzed with this theory. So while a large number of trials can be
conducted, that number can’t be infinite. 

33
Subjective
Problems that benefit from subjective probability are those that require
some level of belief to make possible. For example, a candidate who may be
down in the polls may use subjective probability to make a case for staying in
the race. 
Subjective probability also benefits from what is known as the reference
class problem. External link: open_in_new In a reference class problem,
assigning a probability to a certain event might require that event to be
classified. That classification can be subjective, and thus changing the
classification can change the probability of the event. 
For example, if you want to determine the probability of a person
contracting an infectious disease like COVID-19, we need to begin with
assessing which classes of people are relevant to the problem. It’s here where
various reference classes can be established. A broad class such as “all U.S.
residents” could be used. Or it could be narrowed down to, say, “all residents of
the states of X, Y and Z, where 80% of the deaths are occurring.” In other
words, depending on the reference class chosen, different probabilities will
emerge. 
How Data Scientists Use Probability Theory
Probability allows data scientists to assess the certainty of outcomes of a
particular study or experiment. An experiment is a planned study that is
executed under controlled conditions. When a result is not already
predetermined, the experiment is referred to as a chance experiment.
Conducting a coin toss twice is an example of a chance experiment. 
Today’s data scientists need to have an understanding of the foundational
concepts of probability theory including key concepts involving probability
distribution, statistical significance, hypothesis testing and regression. Learn
more statistics concepts that data scientists use regularly; probability
distribution is only one of them.

34
35
 CO 2

 DECISION CRITERIA AND UTILITY THEORY,

 MULTI-CRITERIA DECISION ANALYSIS,
 SENSITIVITY ANALYSIS AND RISK ASSESSMENT.
 DATA AND UNCERTAINTY-
 SOURCES OF UNCERTAINTY AND RISK,
 PROBABILITY DISTRIBUTIONS AND STATISTICAL
INFERENCE,

36
Decision Criteria: Definition, Importance and Categories
When making decisions, professionals often deliberately or
subconsciously consider several factors that form the basis of their decision.
This is known as decision criteria. Understanding different types of decision
criteria can help when making effective and logical decisions. In this article, we
define decision criteria, discuss their importance, explore different categories of
decision criteria, provide examples and review some tips for selecting criteria to
make decisions.
What are decision criteria?
Decision criteria are the factors and principles on which we base our
decision. In a business setting, these are the variables that are important to the
organization. For example, while hiring for a sales position, a company may
evaluate candidates against different factors like qualification, sales skills,
relevant experience and salary expectations. These factors become the decision
criteria in this case since they help the company compare several candidates and
make an effective hiring decision.
Why is having decision criteria important?
Having decision criteria is important because it can help businesses in a number
of ways, such as :
Improves the effectiveness of decisions
Decision criteria make it easier to make decisions. They provide us with
different alternatives on which we can evaluate the effectiveness of the decision.
Having decision criteria adds speed, quality and consistency to the decision-
making process. Decisions made after evaluating and comparing various
qualitative and quantitative criteria are more likely to give the desired outcome.
Increases the acceptability of decisions
In addition to being right, business decisions also need to be fair and
acceptable. Having decision criteria adds logic and transparency to the decision-
making process. It lets the stakeholders know how their interests are considered

37
in specific decisions. This adds an element of perceived fairness to the decision
and increases its acceptability.
Helps in standardizing purchase decisions
Specifying decision criteria for your purchases can help in standardizing
and automating purchase decisions. For example, if you're purchasing
computers, you can specify different criteria, such as configuration,
specifications, warranty period and price. You can then shortlist vendors
meeting all the criteria except price, and purchase from the vendor that offers
the lowest price.
Helps in increasing sales
Customers may base their buying decisions on certain criteria. Sometimes
these criteria may be clearly specified in formal documents like RFQ (request
for quotation). Understanding and influencing your customers' decision criteria
can help you increase sales.
Helps in deciding product offerings
It's important to align your product offerings to the needs and preferences
of your target market. Learning what customers want and choosing your
decision criteria based on those factors can help you offer meaningful products.
For example, if your company sells cars, you can first conduct a market survey
to find out how much importance people give to different features and
characteristics like style, mileage, speed, comfort and price. You can then decide
on offering cars based on those criteria.
Categories of decision criteria
Although there's no standard categorization of decision criteria, we can
group them into the following broad categories:
Economic criteria
Managers often consider the viability of decisions from an economic
perspective. They compare the cost involved with the benefits an organization

38
gets from a certain decision. Here are some examples of common economic
criteria:
Cost
It involves assessing how much an item may cost and whether it's within
the budget of the organization. As a general rule, lower-cost always gets a
higher preference. For example, companies may have the policy to procure
goods from a vendor that quotes the lowest price, unless the goods are likely to
be of low quality.
Opportunity cost
When you spend money on a certain product, you forgo the benefits of
using that money elsewhere. This notional cost of the lost opportunity is known
as opportunity cost. For example, when you're thinking about advertising your
products, assess the benefits you may derive by using that money on training the
sales team instead.
Return on investment
This is the amount you expect to earn from your investment within a
given period. It's usually expressed as a percentage of the invested amount. For
example, if you're making an investment of $10,000, and your minimum
expected return on investment is 10% per year, you may want to consider only
those opportunities where you can earn at least $1,000 per year.
Resources
It's essential to consider the resources required and the resources you
have or can use when you choose a certain course of action. For example, an
alternative marketing plan may help you increase sales, but it may require you
to open multiple offices at different locations. You may not yet be ready to
invest in multiple offices and may ignore this plan due to resource constraints.
Technical criteria
These are the factors related to the features and characteristics of a
product or service. A decision can be useful only if it meets the technical

39
requirements of the company. Here are some examples of common technical
criteria:
Usability
Usability is the assessment of how well a product accomplishes its
intended use. This factor seeks to ensure that the product you buy is easy to use
and offers a good service. For example, you may buy a software tool only if it
has a usability rating of five stars.
Reliability
You may want a product to meet a certain standard of reliability. For
example, a company may consider only those web hosting providers that
guarantee a minimum uptime of 99.9%. Similarly, a company installing a solar
panel system may consider battery backup as an essential requirement.
Convenience
This factor considers the ease of implementation, use or modification of a
product. For example, you may prefer a training facility within walking distance
of the company. Similarly, you may prefer buying a car with an automatic
transmission system.
Comfort
You may also want to consider the level of comfort a product offers. For
example, while booking a hotel room for a company officer, you may
specifically look for rooms that have an air conditioner and a TV. Similarly, you
may prefer a chair that's comfortable to sit on over one that looks stylish.
Performance
This factor considers how fast or well a product performs. For example,
you may be looking for a courier service that can deliver within 24 hours, and
exclude the slower ones from your consideration. Similarly, if you're looking to
prepare a quick dinner, you may focus on items that can be prepared within 30
minutes.
Efficiency

40
 Efficient products can perform more with less amount of energy.
Efficiency can be an important consideration, especially while buying an
electric product, such as an air conditioning system. Efficiency can also
influence hiring decisions because efficient people can help a company save
time and resources.
Risk
Decision-makers often try to minimize the risk factors. For example, you
may prefer using nonplastic containers for storing food items to avoid health
risks. Similarly, a traveler may choose to fly only in reputed airlines with good
safety standards.
Personal criteria
These are the factors related to the personality and personal preferences
of the decision-maker. Following are some examples of personal factors that can
influence the decision-making process:
Effort: Decision-makers may prefer solutions that involve less physical and
mental effort.
Stress: Decision-makers may avoid a course of action that causes stress, hassles
or discomfort.
Style: Decision-makers may be attracted to a certain style, such as antique-
looking furniture as opposed to modern-style furniture.
Terms of use: Decision-makers may prefer to avoid products with certain legal
terms, such as one that allows banks to share clients' data with credit rating
agencies.
Quality of life: Decision-makers may prefer solutions that improve their quality
of life, such as an employee looking to rent a house in the surrounding area of
their office building to avoid a long commute.
Social criteria
Sometimes, social considerations may influence an organization's
decision. Companies may decide to pursue a course of action even though it

41
 doesn't offer any direct monetary benefits. Corporate social responsibility is a
common example of social criteria, wherein a company follows a business
model that makes it accountable toward the environment and the community.
For example, a company may save huge amounts of money by using a coal-
fired plant, but it may choose to use solar and wind power instead to reduce its
carbon footprint.
Tips for selecting decision criteria
The effectiveness of your decision depends on how well you select the decision
criteria. Here are some important tips to keep in mind while selecting decision
criteria:
 If you're making decisions in a group setting, involve your team in
brainstorming the decision criteria.
 Include only those criteria that are relevant to the issue you're trying to solve.
 Choose decision criteria that are measurable or comparable with other criteria.
 If some of your decision criteria are immeasurable, assign a lower weight to
them.
 Consider the interests of all stakeholders while choosing decision criteria.
 Include the applicable legal requirements in your decision criteria.
UTILITY THEORY
Utility theory in consumer behavior studies states that consumers have a rank
order of preferences for items in their choice range. This theory is relevant to
psychology and economics as it concerns individual behavior and interaction
with the market.
Utility Theory as a Positive Theory
This theory can be called a positive theory within economics. Positive theories
are concerned with 'how things are,' as opposed to normative theories, which
focus on 'how things should be.' Thus utility theory talks about how consumers
act rather than how they should. This theory can be represented analytically
using a utility function or a mathematical formulation that ranks the individual's

42
preferences in terms of satisfaction different consumption bundles provide.
Thus, under the assumptions of utility theory, we can assume that people
behaved as if they had a utility function and acted according to it.
Ordinality of Utility Theory
When faced with a purchase decision, the consumer must choose from bundles
of options. The theory propounds that items within these bundles are ranked
from 'most preferred' to 'least preferred' and thus assume a preference gradient.
This indicates that these items have ordinal utility as opposed to the cardinal
utility, which states that items hold values regardless of the context and
conditions in which they exist.
Assumptions of Utility Theory
The theory has several underlying assumptions that are important to understand
to measure utility accurately.

43
 The first assumption is that individuals have a consistent and transitive
preference. This means that individuals' preferences remain constant over
time, and they can rank different options logically. For example, if an
individual prefers option A over option B and option B over option C, they
must prefer option A over option C.
 The second assumption is that individuals have complete information about
their options. This means that individuals have all the necessary information
about each option and can make informed decisions. In reality, this
assumption is often violated as individuals need complete information about
the goods and services they are considering.
 The third assumption is that individuals are rational and make decisions that
maximize their overall satisfaction. This means that individuals make
decisions that increase their overall happiness and well-being. In reality,
individuals may make decisions that are not in line with their preferences or
may not fully understand them.
 The fourth assumption is that individuals have a continuous and
differentiable utility function. This means that the satisfaction individuals
derive from consuming a good or service can be measured, and the rate of
change can be calculated. In reality, individuals may not be able to measure
their satisfaction accurately, and the relationship between consumption and
satisfaction may not be continuous or differentiable.
Multiple Criteria Decision Analysis?
Operations research is a branch of applied science that involves using advanced
analytical concepts to enhance decision-making. Multiple criteria decision
analysis is a method within operations research that you can use to analyze
multiple conflicting options to determine which is best for you. If you're
responsible for high-level decision-making in your organization, it's important
to understand how multiple criteria decision analysis can help you find the most
valuable solutions for your needs.

44
What is a multiple criteria decision analysis?
Multiple criteria decision analysis, or MCDA, is a structured process for
evaluating options with conflicting criteria and choosing the best solution.
MCDA is similar to a cost-benefit analysis but evaluates numerous criteria,
rather than just cost.
As a practice, MCDA has applications in a number of fields, including
business, government and everyday life. For example, if you're responsible for
procurement at a company, you can use MCDA to decide between vendors or to
select equipment that meets all of the company's needs.
Benefits of a multiple criteria decision analysis
Conducting an MCDA aims to help you determine which options are
most effective, increasing the efficiency of the decision-making process. In
addition to providing you with an ordered list of alternatives, it addresses the
social aspects of decision-making to encourage discussion between different
decision-makers. Here are some additional benefits of this analysis:
Acts as a means of communication: A MCDA can help further
communication between different stakeholders, ensuring that everyone involved
in the decision gets the opportunity to address the issue.
Provides useful insights: By visualizing the values of your alternatives
using an MCDA, you can discover useful insights that you might otherwise
miss, allowing you to make the most informed decision possible.
Uses a systematic approach: All MCDAs use a systematic approach to
identifying and comparing different options by assessing their impacts,
performances, advantages and disadvantages, which can help you ensure your
decision-making is consistent, regardless of the issue.
How to conduct a multiple criteria decision analysis
Follow these steps to conduct a multiple criteria decision analysis effectively:
1. Define your objective

45
Your objective is what you want to achieve, and it considers the contextual
factors for your analysis. To define your objective clearly, determine the need
you hope to fill and who your key stakeholders are.
For example, if you're a procurement manager, your job may involve finding
suppliers for office furniture. Your need is to secure contracts with suppliers
who can provide the best value, and the stakeholders are your employer and the
departments that use the furniture. It's a good idea to consult with the
stakeholders to determine their requirements.
2. Define your criteria
After defining your objective, you can begin developing your criteria to
represent the standards for your different options. Your criteria refer to the
measures you deem important in determining the most valuable choice.
Common criteria are price, durability and quality. In the example of office
furniture, other criteria might be building material and size.
3. Determine the weight of each criterion
Weight is how important each criterion is to your decision, represented as a
percentage. For example, if you have a limited budget for office furniture, the
price may have significantly more priority than the other criteria.
If the objective is to get furniture with high potential for long-term use, quality
and durability are important for balancing out the price. After consulting with
your relevant stakeholders, assign a weight percentage to each of your criteria.
4. List your choices
The next step is to find choices that meet your criteria to a certain degree. For
example, you could use the criteria you developed to search for office furniture
suppliers that offer affordable furniture with high-quality and durable
characteristics. Analyze your choices and try to develop a list of your top three
to five options.

Related: Decision Tree: How It Works

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5. Determine your performance values
Each criterion is likely to have its own performance value or the measure you
can use for ranking it in comparison to other criteria. A price criterion uses a
numeric performance value. More subjective criteria such as quality and
durability often use different measures, such as "high," "above average,"
"average," "below average" and "low."
6. Rate your choices
Rating your choices involves determining how each option compares to your
criteria. A criterion such as price is a non-beneficial criterion, meaning that a
lower value is preferable.
For example, if you’re deciding between suppliers, you likely prefer a supplier
offering lower prices. In your rating, the lowest price would have the highest
rank. In comparison, criteria such as quality and durability are beneficial
criteria, meaning that higher values are better and directly proportional to the
rank.
7. Normalize the performance values
Normalization refers to the act of adjusting your values so that they operate on a
common scale. To do this, you can perform mathematical operations to convert
the values. For non-beneficial criteria, divide the lowest value by the
performance value.
For example, if the least expensive office furniture is $200, you would divide
that figure by each value in the cost category. If the prices you're evaluating are
$400, $350, $300, $250 and $200, the normalized performance values would be
0.50, 0.57, 0.67, 0.80 and 1.00, respectively.

For beneficial criteria, you first convert your values using a conversion scale. In
the furniture example, there are five values to describe quality and durability, so
the lowest rank would correspond to the numeral one and the highest would
correspond to five.

47
After converting your performance values, divide each by the maximum value
to normalize the scale. For instance, if you have two high-quality furniture
suppliers, two average suppliers and one below-average supplier, you'd have
normalized values of 1.00, 1.00, 0.60, 0.60 and 0.40.
8. Multiply values by weight
Using your normalized values, multiply each by the weight you assigned to the
corresponding criterion, represented as a decimal. Taking the above figures for
price and assigning a weight of 50% for this criterion, your highest-ranked price
value would have a weighted normalized value of 0.50. In descending order, the
other values would be 0.40, 0.34, 0.29 and 0.25. Perform the same operation for
your other criteria.
9. Calculate the performance scores
Finally, for each option, add together the weighted normalized values within
each criterion to calculate the performance scores. For example, if the first
option for furniture suppliers has weighted values of 0.4, 0.25 and 0.25, the
performance score would be 0.9.
Once you calculate the performance score for each option, you can compare the
scores. The option with the highest score would provide you with the most
value, according to your criteria.
Example of a multiple criteria decision analysis
Consider the following example to gain a better understanding of MCDA:
A shopper is in an electronics shop. Their objective is to purchase a new mobile
phone. Their criteria are price, screen size, storage space and appearance, with
price, storage space and screen size as the non-beneficial values and appearance
being a beneficial value that the shopper evaluates using a five-point scale. To
this shopper, all the criteria are equal in value, so each has a weight of 25%.
They've reduced their choices to three phones with the following ratings:
Phone A: $600, 6.2 inches, 32 GB, average looks (3 out of 5)
Phone B: $900, 5.8 inches, 64 GB, excellent looks (5 out of 5)

48
Phone C: $750, 6.0 inches, 64 GB, above-average looks (4 out of 5)
Since price and screen size are non-beneficial criteria, the shopper takes the
lowest value for these criteria and divides it by each performance value. For the
other two criteria, they divide each by the maximum value.
To calculate the weighted normalized values, they multiply each by 0.25. Since
phone B has the highest performance score after the calculation, it’s the best
choice of mobile phone for the shopper, according to MCDA:
Phone A: 0.25 + 0.235 + 0.125 + 0.15 = 0.76
Phone B: 0.168 + 0.25 + 0.25 + 0.25 = 0.918
Phone C: 0.208 + 0.243 + 0.25 + 0.20 = 0.901

Sensitivity analysis and risk assessment

What Is Sensitivity Analysis?
Sensitivity analysis determines how different values of an independent variable
affect a particular dependent variable under a given set of assumptions. In other
words, sensitivity analyses study how various sources of uncertainty in a
mathematical model contribute to the model's overall uncertainty. This
technique is used within specific boundaries that depend on one or more input
variables.
Sensitivity analysis is used in the business world and in the field of economics.
It is commonly used by financial analysts and economists and is also known as
a what-if analysis.
KEY TAKEAWAYS
 Sensitivity analysis determines how different values of an independent
variable affect a particular dependent variable under a given set of
assumptions.
 This model is also referred to as a what-if or simulation analysis.
 Sensitivity analysis can be used to help make predictions in the share
prices of publicly traded companies or how interest rates affect bond

49
 prices.
 Sensitivity analysis allows for forecasting using historical, true data.
 While sensitivity analysis determines how variables impact a single
event, scenario analysis is more useful to determine many different
outcomes for more broad situations.
How Sensitivity Analysis Works
Sensitivity analysis is a financial model that determines how target variables are
affected based on changes in other variables known as input variables. It is a
way to predict the outcome of a decision given a certain range of variables. By
creating a given set of variables, an analyst can determine how changes in one
variable affect the outcome.
Both the target and input—or independent and dependent—variables are fully
analyzed when sensitivity analysis is conducted. The person doing the analysis
looks at how the variables move as well as how the target is affected by the
input variable.
Sensitivity analysis can be used to help make predictions about the share prices
of public companies. Some of the variables that affect stock prices include
company earnings, the number of shares outstanding, the debt-to-equity ratios
(D/E), and the number of competitors in the industry. The analysis can be
refined about future stock prices by making different assumptions or adding
different variables. This model can also be used to determine the effect that
changes in interest rates have on bond prices. In this case, the interest rates are
the independent variable, while bond prices are the dependent variable.
Sensitivity analysis allows for forecasting using historical, true data. By
studying all the variables and the possible outcomes, important decisions can be
made about businesses, the economy, and making investments.
Investors can also use sensitivity analysis to determine the effects different
variables have on their investment returns.
Usefulness of Sensitivity Analysis

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Financial models that incorporate sensitivity analysis can provide management
a range of feedback that is useful in many different scenarios. The breadth of the
usefulness of sensitivity analysis includes but is not limited to:
Understanding influencing factors. This includes what and how different
external factors interact with a specific project or undertaking. This allows
management to better understand what input variables may impact output
variables.
Reducing uncertainty. Complex sensitivity analysis models educate users on
different elements impacting a project; this in turn informs members on the
project what to be alert for or what to plan in advance for.
Catching errors. The original assumptions for the baseline analysis may have
had some uncaught errors. By performing different analytical iterations,
management may catch mistakes in the original analysis.
Simplifying the model. Overly complex models may make it hard to analyze
the inputs. By performing sensitivity analysis, users can better understand what
factors don't actually matter and can be removed from the model due to its lack
of materiality.
Communicating results. Upper management may already be defensive or
inquisitive about an undertaking. Compiling analysis on different situations
helps inform decision-makers of other outcomes they may be interested in
knowing about.
Achieving goals. Management may lay long-term strategic plans that must meet
specific benchmarks. By performing sensitivity analysis, a company can better
understand how a project may change and what conditions must be present for
the team to meet its metric targets.
Because sensitivity analysis answers questions such as "What if XYZ
happens?", this type of analysis is also called what-if analysis.
Sensitivity vs. Scenario Analysis

51
In finance, a sensitivity analysis is created to understand the impact a range of
variables has on a given outcome. It is important to note that a sensitivity
analysis is not the same as a scenario analysis. As an example, assume an equity
analyst wants to do a sensitivity analysis and a scenario analysis around the
impact of earnings per share (EPS) on a company's relative valuation by using
the price-to-earnings (P/E) multiple.
The sensitivity analysis is based on the variables that affect valuation, which a
financial model can depict using the variables' price and EPS. The sensitivity
analysis isolates these variables and then records the range of possible
outcomes.
On the other hand, for a scenario analysis, an analyst determines a certain
scenario such as a stock market crash or change in industry regulation. The
analyst then changes the variables within the model to align with that scenario.
Put together, the analyst has a comprehensive picture and now knows the full
range of outcomes, given all extremes, and has an understanding of what the
outcomes would be, given a specific set of variables defined by real-life
scenarios.
Advantages and Limitations of Sensitivity Analysis
Conducting sensitivity analysis provides a number of benefits for decision-
makers. First, it acts as an in-depth study of all the variables. Because it's more
in-depth, the predictions may be far more reliable. Secondly, It allows decision-
makers to identify where they can make improvements in the future. Finally, it
allows for the ability to make sound decisions about companies, the economy,
or their investments.
There are some disadvantages to using a model such as this. The outcomes are
all based on assumptions because the variables are all based on historical data.
Very complex models may be system-intensive, and models with too many
variables may distort a user's ability to analyze influential variables.

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Pros
 Provides management different output situations based on risk or
changing variables
 May help management target specific inputs to achieve more specific
results
 May easily communicate areas to focus on or greatest risks to control
 May identify mistakes in the original benchmark
 Generally, reduces the uncertainty and unpredictability of a given
undertaking
Cons
 Heavily relies on assumptions that may not become true in the future
 May burden computer systems with complex, intensive models
 May become overly complicated which distorts an analysts ability to
 May not accurately integrate independent variables (as one variable may
not accurately the impact of another variable)
Data
Since the invention of computers, people have used the term data to refer to
computer information, and this information was either transmitted or stored.
But that is not the only data definition; there exist other types of data as well.
So, what is the data? Data can be texts or numbers written on papers, or it
can be bytes and bits inside the memory of electronic devices, or it could be
facts that are stored inside a person’s mind.
What is Data?
is data” is that data is different types of information usually formatted in a
particular manner. All software is divided into two major categories:
programs and data. We already know what data is now, and programs are
collections of instructions used to manipulate data.
We use data science to make it easier to work with data. Data science is
defined as a field that combines knowledge of mathematics, programming

53
skills, domain expertise, scientific methods, algorithms, processes, and
systems to extract actionable knowledge and insights from both structured
and unstructured data, then apply the knowledge gleaned from that data to a
wide range of uses and domains.
So, now that we have a little better understanding of what data and data
science are, let’s check out some interesting facts. But first, what do we
mean by “information?” Let’s backtrack a little and look at the fundamentals.
What is Information?
Information is defined as classified or organized data that has some
meaningful value for the user. Information is also the processed data used to
make decisions and take action. Processed data must meet the following
criteria for it to be of any significant use in decision-making:
Accuracy: The information must be accurate.
Completeness: The information must be complete.
Timeliness: The information must be available when it’s needed.
Types and Uses of Data
Growth in the field of technology, specifically in smartphones has led to text,
video, and audio is included under data plus the web and log activity records
as well. Most of this data is unstructured.
The term Big Data is used in the data definition to describe the data that is in
the petabyte range or higher. Big Data is also described as 5Vs: variety,
volume, value, veracity, and velocity. Nowadays, web-based eCommerce has
spread vastly, business models based on Big Data have evolved, and they
treat data as an asset itself. And there are many benefits of Big Data as well,
such as reduced costs, enhanced efficiency, enhanced sales, etc.
The meaning of data has grown beyond the processing of data in the field of
computer applications. For instance, we’ve already touched upon what data
science is. Accordingly, finance, demographics, health, and marketing also
have different definitions of data, which ultimately results in different

54
answers to the persistent question, “What is data?”. Let us figure out how do
we typically store data first.
How is Data Stored?
Computers represent data (e.g., text, images, sound, video), as binary values
that employ two numbers: 1 and 0. The smallest unit of data is called a “bit,”
and it represents a single value. Additionally, a byte is eight bits long.
Memory and storage are measured in units such as megabytes, gigabytes,
terabytes, petabytes, and exabytes. Data scientists keep coming up with
newer, larger data measurements as the amount of data our society generates
continues to grow.
Data can be stored in file formats using mainframe systems such as ISAM
and VSAM, though there are other file formats for data conversion,
processing, and storage, like comma-separated values. These data formats
are currently used across a wide range of machine types, despite more
structured-data-oriented approaches gaining a greater foothold in today’s IT
world.
The field of data storage has seen greater specialization develop as the
database, the database management system, and more recently, relational
database technology, each made their debut and provided new ways to
organize information.
What’s the Data Processing Cycle?
Data processing is defined as the re-ordering or re-structuring of data by
people or machines to increase its utility and add value for a specific
function or purpose. Standard data processing is made up of three basic
steps: input, processing, and output. Together, these three steps make up the
data processing cycle. You can read more detail about the data processing
cycle here.
Input: The input data gets prepared for processing in a convenient form that
relies on the machine carrying out the processing.

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Processing: Next, the input data’s form is changed to something more
useful. For example, information from timecards is used to calculate pay
checks.
Output: In the final step, the processing results are collected as output data,
with its final form depending on what it’s being used for. Using the previous
example, output data becomes the employees’ actual pay checks.
So how do data analysts and scientists analyze data in the first place?
How Do We Analyze Data?
Ideally, there are two ways to analyze the data:
Data Analysis in Qualitative Research
Data Analysis in Quantitative Research
1. Data Analysis in Qualitative Research
Data analysis and research in subjective information work somewhat better
than numerical information since the quality of information consist of words,
portrayals, pictures, objects, and sometimes images. Getting knowledge from
such entangled data is a daunting task, so it’s usually used for exploratory
research in addition to being employed in data analysis.
Finding Patterns in the Qualitative Data
Although there are a few different ways to discover patterns in printed data,
a word-based strategy is the most depended on and broadly utilized global
method for research and analysis of data. Significantly, the process of data
analysis in qualitative research is manual. Here the specialists, as a rule, read
the accessible information and find repetitive or frequently utilized words.
2. Data Analysis in Quantitative Research
Preparing Data for Analysis
The primary stage in research and analysis of data is to do it for the
examination with the goal that the nominal information can be changed over
into something important. The preparation of data comprises the following.
Data Validation

56
Data Editing
Data Coding
For quantitative statistical research, the utilization of descriptive analysis
regularly gives supreme numbers. However, the analysis is never adequate to
show the justification behind those numbers. Still, it is important to think
about the best technique to be utilized for research and analysis of data
fitting your review survey and what story specialists need to tell.
Consequently, enterprises that are prepared to work in today’s
hypercompetitive world must have a remarkable capacity to investigate
complex research information, infer noteworthy bits of knowledge, and
adjust to new market needs.

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Co 3

 Monte Carlo simulation and bootstrapping.

 Decision-making Frameworks
 Cost-benefit analysis and net present value,
 Decision-making under risk and uncertainty,
 Game theory and strategic decision making.

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Effective Decision Making – A Framework
See also: Decision Making
Our page on Making Decisions discusses some of the issues around decision-
making.
This page describes one possible framework for making effective decisions. It is
a seven-stage model, and was originally designed for use in groups and
organisations. However, there is no reason why you cannot use the same
method, or a simplified form, for decisions at home.
The important aspect is to go through all the stages in turn, even if only to
decide that they are not relevant for the current situation.
1. Listing Possible Solutions/Options
To come up with a list of all the possible solutions and/or options available it is
usually appropriate to use a group (or individual) problem-solving process. This
process could include brainstorming or some other 'idea-generating' process.
See our pages on Problem Solving, Creative Thinking and Brainstorming
Techniques for more information.
This stage is important to the overall decision making processes as a decision
will be made from a selection of fixed choices.
Always remember to consider the possibility of not making a decision or doing
nothing and be aware that both options are actually potential solutions in
themselves.

2. Setting a Time Scale and Deciding Who is Responsible for the Decision
In deciding how much time to make available for the decision-making process,
it helps to consider the following:
 How much time is available to spend on this decision?
 Is there a deadline for making a decision and what are the consequences
of missing this deadline?
 Is there an advantage in making a quick decision?

59
  How important is it to make a decision?  How important is it that the
decision is right?
 Will spending more time improve the quality of the decision?
Remember that sometimes a quick decision is more important than ‘the
right’ decision, and that at other times, the reverse is true.
Also see our page: Time Management.
Responsibility for the Decision
Before making a decision, you need to be clear who is going to take
responsibility for it.
Remember that it is not always those making the decision who have to assume
responsibility for it. Is it an individual, a group or an organisation?
This is a key question because the degree to which responsibility for a decision
is shared can greatly influence how much risk people are willing to take.
If the decision-making is for work, then it is helpful to consider the structure of
the organisation.
 Is the individual responsible for their decisions or does the organisation
hold ultimate responsibility?
 Who has to carry out the course of action decided?
 Who will it affect if something goes wrong? 
 Are you willing to take responsibility for a mistake?
Finally, you need to know who can actually make the decision. When helping a
friend, colleague or client to reach a decision, in most circumstances the final
decision and responsibility will be taken by them.
Whenever possible, and if it is not obvious, it is better to agree formally
who is responsible for a decision.
This idea of responsibility also highlights the need to keep a record of how any
decision was made, what information it was based on and who was involved. 
Enough information needs to be kept to justify that decision in the future so

60
that, if something does go wrong, it is possible to show that your decision was
reasonable in the circumstance and given the knowledge you held at the time.
3. Information Gathering
Before making a decision, all relevant information needs to be gathered.
If there is inadequate or out-dated information then it is more likely that a
wrong decision might be made. If there is a lot of irrelevant information, the
decision will be difficult to make, and it will be easier to become distracted by
unnecessary factors.
You therefore need up-to-date, accurate information on which to make
decisions.
However, the amount of time spent on information-gathering has to be weighed
against how much you are willing to risk making the wrong decision. In a group
situation, such as at work, it may be appropriate for different people to research
different aspects of the information required. For example, different people
might be allocated to concentrate their research on costs, facilities, availability,
and so on.
You may find the pages in our Study Skills and Research Methods sections
useful during the information gathering stage of decision making. Our
pages Effective Reading and Note-Taking may be of particular relevance.
4. Weighing up the Risks Involved
One key question is how much risk should be taken in making the decision?
Generally, the amount of risk an individual is willing to take depends on:
 The seriousness of the consequences of taking the wrong decision.
 The benefits of making the right decision.
 Not only how bad the worst outcome might be, but also how likely that
outcome is to happen.
It is also useful to consider what the risk of the worst possible outcome
occurring might be, and to decide if the risk is acceptable.  The choice can be
between going ‘all out for success’ or taking a safe decision.

61
For more about risk, see our page on Risk Management.

5. Deciding on Values
Everybody has their own unique set of values: what they believe to be
important. The decisions that you make will, ultimately, be based on your
values. That means that the decision that is right for you may not be right for
someone else.
If the responsibility for a decision is shared, it is therefore possible that one
person might not have the same values as the others.
In such cases, it is important to obtain a consensus as to which values are to be
given the most weight. It is important that the values on which a decision is
made are understood because they will have a strong influence on the final
choice.

6. Weighing up the Pros and Cons

It is possible to compare different solutions and options by considering the
possible advantages and disadvantages of each.
Some organisations have a formal process that is required at this stage,
including a financial assessment, so check beforehand if you are making a
decision at work.

One good way to do this is to use a 'balance sheet', weighing up the pros and
cons (benefits and costs) associated with that solution. Try to consider each
aspect of the situation in turn, and identify both good and bad.
For example, start with costs, then move onto staffing aspects, then perhaps
presentational issues.

62
Having listed the pros and cons, it may be possible to immediately decide which
option is best. However, it may also be useful to rate each of the pros and cons
on a simple 1 to 10 scale (with 10 - most important to 1 - least important).
In scoring each of the pros and cons it helps to take into account how important
each item on the list is in meeting the agreed values. This balance sheet
approach allows this to be taken into account, and presents it in a clear and
straightforward manner.

7. Making the Decision

Finally, it’s time to actually make the decision!
Your information-gathering should have provided sufficient data on which to
base a decision, and you now know the advantages and disadvantages of each
option. It is, as the television programme Opportunity Knocks had it, ‘Make
Your Mind Up Time’.
Warning!

You may get to this stage, and have a clear ‘winner’ but still feel uncomfortable.
If that is the case, don’t be afraid to revisit the process. You may not have listed
all the pros and cons, or you may have placed an unsuitable weighting on one
factor.
Your intuition or ‘gut feeling’ is a strong indicator of whether the decision is
right for you and fits with your values.
If possible, it is best to allow time to reflect on a decision once it has been
reached.  It is preferable to sleep on it before announcing it to others. Once a
decision is made public, it is very difficult to change.
For important decisions it is worth always keeping a record of the steps you
followed in the decision-making process. That way, if you are ever criticised for
making a bad decision you can justify your thoughts based on the information
and processes you used at the time. Furthermore, by keeping a record and

63
engaging with the decision-making process, you will be strengthening your
understanding of how it works, which can make future decisions easier to
manage.
Having Made the Decision...
Finally, and perhaps most importantly, once you have made a decision,
don’t waste your time thinking about ‘what ifs’. If something does go
wrong, and you need to revisit the decision, then do. But otherwise, accept
the decision and move on.

COST-BENEFIT ANALYSIS: MEANING, PROCESS, AND EXAMPLES

Cost-benefit analysis: Meaning Cost-benefit analysis: Steps1. Design a
framework for the analysis2. Estimate your project’s costs3. Determine your
project’s benefits4. Discount costs and benefits to obtain present values. 5.
Calculate net present values (NPVs)6. Make a decision Cost-benefit analysis:
Methods Net Present Value method (NPV)Benefit-Cost Ratio method
(BCR)Cost-benefit analysis: Examples Key Takeaways on cost-benefit analysis
Prudent managers proceed with an investment decision after conducting a
thorough _cost-benefit analysis _of all the alternatives available.
A cost-benefit analysis enables firms to compare several projects based on their
net monetary benefits, prompting them to invest in the project yielding the
highest cost-benefit.
Cost-benefit analysis: Meaning
A cost-benefit analysis is a process used by firms to project the potential net
rewards of undertaking a project. It involves the estimation of the benefits of an
investment that have been reduced for its associated costs after accounting for
the time value of money.
The main purpose of doing a cost-benefit analysis is to determine which
projects should be undertaken. A higher cash inflow projection will indicate that
investing in the project will yield a favourable outcome.

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Cost-benefit analysis: Steps
There is no standardised process for undertaking a cost-benefit analysis in
project management. But generally, the following steps can be followed for
performing a cost-benefit analysis:
1. Design a framework for the analysis
The first step in conducting a cost-benefit analysis is to take stock of the current
situation and identify how it can be improved with a new project. For instance,
do you need to spend on marketing to drive new sales in existing markets, or do
you want to expand into new markets for higher sales?
To do this, create a framework that clearly defines the goals, costs, limitations,
timeline, and performance parameters associated with the project. At this
planning stage, you should additionally consider whether you have adequate
resources and staff to conduct a cost-benefit analysis.
2. Estimate your project’s costs
After defining the scope of your project, calculate the costs of undertaking the
project, classifying them further into fixed and variable costs. Some of the costs
to identify are:
 Direct costs, such as labour costs, raw material pricing, inventory costs,
and manufacturing overheads.
 Indirect costs, including renting, utilities, administration, and
management expenses.
 Intangible costs, i.e., non-financial expenses with a significant business
impact in the form of customer reaction, employee morale, and brand
reputation.
 Opportunity costs, or the costs of not undertaking alternative investment
opportunities.
 Potential costs stemming from changes in peer competition or regulation.

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3. Determine your project’s benefits
The next step in a cost-benefit analysis is to identify the benefits of undertaking
the project, including the intangible benefits of higher employee morale and any
competitive advantages.
However, it is best to keep these estimates conservative as projections involve
several assumptions about market conditions, consumer demand, and the state
of the economy.
4. Discount costs and benefits to obtain present values.
Given the project’s duration, firms must determine reasonable discount rates,
which can then be applied to costs and benefits to estimate their present values.
Sensitivity analysis can also be used to analyse the impact of different discount
rates on these cash flow projections.
5. Calculate net present values (NPVs)
Follow up by computing the net present values by subtracting the present value
of cash outflows (costs) from cash inflows (benefits). At this stage, some firms
also use a cost-benefit ratio to get a better picture of the project’s dynamics.
6. Make a decision
Finally, summarise all the projections of the project’s costs and benefits. If the
estimates yield net benefits, i.e., cash inflows exceed cash outflows, then
undertaking the project investment will usually make for a sensible decision.
But such decisions may be limited by resource constraints or higher risks.
Cost-benefit analysis: Methods
A cost-benefit analysis is primarily conducted via the Net Present Value (NPV)
and the Benefit-Cost Ratio (BCR) methods. We outline them below.
Net Present Value method (NPV)
The NPV model calculates the difference between the present value of cash
inflows (benefits) and cash outflows (costs). As long as the NPV > 0, the project
is suitable for investment. But when faced with capital restrictions, companies
can opt for the project with the highest NPV.

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The cost-benefit analysis formula in the case of the NPV method is as follows:
NPV = ∑ PV of benefits (cash inflows) – ∑ PV of costs (cash outflows)
Benefit-Cost Ratio method (BCR)
The benefit-cost ratio model computes the relative benefits and costs of a
project. It is the ratio of the PV of benefits to the related costs, with a value
exceeding 1 denoting net rewards. When deciding between different investment
options, this method favours the project with the highest BCR.
The formula for cost-benefit analysis under BCR is: BCR = ∑ PV of Benefits
(cash inflows) / ∑ PV of costs (cash outflows)
Cost-benefit analysis: Examples
Example 1: A firm wishes to evaluate whether it makes sense to purchase
equipment for £50,000. It estimates annual cost savings of £20,000 over five
years. Assuming a 5% discount rate, this investment’s cost-benefit analysis will
be as follows:
NPV = PV of costs (initial investment) – the sum of PV of benefits (cost savings)
NPV = -£50,000 + (£20,000 / (1+0.05) ^1) + (£20,000 / (1+0.05) ^2) +
(£20,000 / (1+0.05) ^3) + (£20,000 / (1+0.05) ^4) + (£20,000 / (1+0.05) ^5)
NPV = £6,477.43
Since the NPV is positive, the firm can go ahead with the investment as it is
likely to be profitable.
Example 2: A company needs to make a decision between two projects using
the following cost-benefit analysis template:

Project A Project B

PV of costs £70,000 £50,000

PV of benefits £150,000 £120,000

NPV £150,000 - £70,000 = £80,000 £120,000 - £50,000 = £70,000

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 Project A Project B

BCR £150,000 / £80,000 = 1.875 £120,000 / £50,000 = 2.4

Here, both projects yield net benefits, with project A showcasing a higher NPV.
However, using the BCR method, project B signals superior results, with 2.4
being higher than 1.875 for project A.
Key Takeaways on cost-benefit analysis
Firms conduct a cost-benefit analysis to determine the feasibility, soundness,
and justiciability of their new investments. By forecasting cash flows and
adjusting the projected net benefits for time value through this analysis,
companies evaluate whether an investment will be profitable for their
businesses.
Decision-making under risk and uncertainty,
We all see decision-making as one of the leadership qualities. A good leader
will take decisions that are oriented toward goals and commitments. It is not
that the decisions you make all the time give you positive outcomes. There are
times in which you take hasty decisions and would have experienced tough
times due to one bad decision. Decision-making is not as simple and easy as it
feels, it is an art! Now, let’s get deeper into discussing decision-making under
various circumstances.
1. Decision-making under certainty
Before going ahead let’s know what certainty actually means. When you take
up a decision after acquiring all the required information and are aware of the
possible outcomes it is less likely that you fail or go wrong. In this case,
decision-making becomes easy and you are sure to succeed. But the sad thing is,
that you will not be in a place to implement this approach in all the scenarios.
Decision-making changes with various factors that affect your business. It is

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wise to stay updated and discuss things with your clients and colleagues.
Certainty builds a strong, foolproof network.
2. Decision-making under risk
There is risk involved in many actions you do and decisions you take. What
does it mean to make decisions at risk? Many businesses were operating at risk
during the pandemic and had no idea or knowledge of what risk the outcome
could bring them. Here, you probably know what the outcome is but are
uncertain of the risk involved. In such a case, the best approach is to have other
options and alternatives that can be brought into immediate effect. Work out
new ways and strategies, implement them during risky times or uncertainty and
find out which does the job for you. Remember, it is important to make the right
decisions at the right time. Make use of your experience, expertise, and
everything possible to enjoy success.
3. Decision-making under uncertainty
Uncertainty! The word that keeps you alarming. You definitely wouldn’t want
to face this situation but your business doesn’t leave you that easy. It would
want to teach you decision-making under uncertainty, which is, by far, the most
complex thing to handle. Yes, uncertainty simply means you have no
knowledge about the outcome. You just take up a decision and start the game
according to your plan, but the outcomes are completely unknown to you or
unpredictable. You definitely cannot think of an action plan that will act as an
alternative or solution to your problem. The consequences can be even worse
than you think. During uncertainty, make assumptions, and utilize your
strengths, experience, and instincts that will pay off.
Conclusion
As mentioned at the start of this article, decision-making is an art and not
everyone is an artist! Before taking up any decision get all the required data,
make a study and devise a plan that suits the best for your business model.
During certainty, your decisions and plans will not affect you or your business,

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but it is more vital to look at decisions taken when in uncertainty or huge risk,
as it affects the performance and credibility of your firm. Think of alternatives,
get suggestions from others and keep yourself equipped to face the challenges
or obstacles that come your way. We, Springbord, are committed to our clients
and would be happy to help during uncertainty.
What Is Game Theory?
Game theory is a theoretical framework for conceiving social situations among
competing players. In some respects, game theory is the science of strategy, or
at least the optimal decision-making of independent and competing actors in a
strategic setting.
Game Theory
How Game Theory Works
The key pioneers of game theory were mathematician John von Neumann and
economist Oskar Morgenstern in the 1940s.1 Mathematician John Nash is
regarded by many as providing the first significant extension of the von
Neumann and Morgenstern work.
The focus of game theory is the game, which serves as a model of an
interactive situation among rational players. The key to game theory is that one
player's payoff is contingent on the strategy implemented by the other player. 
The game identifies the players' identities, preferences, and available strategies
and how these strategies affect the outcome. Depending on the model, various
other requirements or assumptions may be necessary.
Game theory has a wide range of applications, including psychology,
evolutionary biology, war, politics, economics, and business. Despite its many
advances, game theory is still a young and developing science.
According to game theory, the actions and choices of all the participants affect
the outcome of each. It's assumed players within the game are rational and will
strive to maximize their payoffs in the game.2

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Useful Terms in Game Theory
Any time we have a situation with two or more players that involve known
payouts or quantifiable consequences, we can use game theory to help
determine the most likely outcomes. Let's start by defining a few terms
commonly used in the study of game theory:
 Game: Any set of circumstances that has a result dependent on the
actions of two or more decision-makers (players)
 Players: A strategic decision-maker within the context of the game
 Strategy: A complete plan of action a player will take given the set of
circumstances that might arise within the game
 Payoff: The payout a player receives from arriving at a particular
outcome (The payout can be in any quantifiable form, from dollars
to utility.)
 Information set: The information available at a given point in the game
(The term information set is most usually applied when the game has a
sequential component.)
 Equilibrium: The point in a game where both players have made their
decisions and an outcome is reached
The Nash Equilibrium
Nash equilibrium is an outcome reached that, once achieved, means no player
can increase payoff by changing decisions unilaterally. It can also be thought of
as "no regrets," in the sense that once a decision is made, the player will have
no regrets concerning decisions considering the consequences.
The Nash equilibrium is reached over time, in most cases. However, once the
Nash equilibrium is reached, it will not be deviated from. After we learn how to
find the Nash equilibrium, take a look at how a unilateral move would affect
the situation. Does it make any sense? It shouldn't, and that's why the Nash
equilibrium is described as "no regrets." Generally, there can be more than one
equilibrium in a game.

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However, this usually occurs in games with more complex elements than two
choices by two players. In simultaneous games that are repeated over time, one
of these multiple equilibria is reached after some trial and error. This scenario
of different choices overtime before reaching equilibrium is the most often
played out in the business world when two firms are determining prices for
highly interchangeable products, such as airfare or soft drinks.
Ever seen an opposing coach call a timeout right before the other team's kicker
is to attempt a game-winning field goal? Th
Impact of Game Theory
Game theory is present in almost every industry or field of research. Its
expansive theory can pertain to many situations, making it a versatile and
important theory to comprehend. Here are several fields of study directly
impacted by game theory.
Economics
Game theory brought about a revolution in economics by addressing crucial
problems in prior mathematical economic models. For instance, neoclassical
economics struggled to understand entrepreneurial anticipation and could not
handle the imperfect competition. Game theory turned attention away from
steady-state equilibrium toward the market process.
Economists often use game theory to understand oligopoly firm behavior. It
helps to predict likely outcomes when firms engage in certain behaviors, such
as price-fixing and collusion.
Business
In business, game theory is beneficial for modeling competing behaviors
between economic agents. Businesses often have several strategic choices that
affect their ability to realize economic gain. For example, businesses may face
dilemmas such as whether to retire existing products or develop new ones or
employ new marketing strategies. 

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Businesses can often choose their opponent as well. Some focus on external
forces and compete against other market participants. Others set internal goals
and strive to be better than previous versions of itself. Whether external or
internal, companies are always competing for resources, attempting to hire the
best candidates away from their rivals, and gather the attention of customers
away from competing goods.
Game theory in business may most resemble a game tree as shown below. A
company may start in position one and must decide upon two outcomes.
However, there are continually other decisions to be made; the final payoff
amount is not known until the final decision has been processed.
Example of Game Tree.
Internet Encyclopedia of Philosophy
Project Management
Project management involves social aspects of game theory as different
participants may have different influences. For example, a project manager
may be incentivized to successfully complete a building development project.
Meanwhile, the construction worker may be incentivized to work slower for
safety or delay the project to incur more billable hours.
When dealing with an internal team, game theory may be less prevalent as all
participants working for the same employer often have a greater shared interest
for success. However, third-party consultants or external parties assisting with
a project may be incentivized by other means separate from the project's
success.
Consumer Product Pricing
The strategy of Black Friday shopping is at the heart of game theory. The
concept holds that should companies reduce prices, more consumers will buy
more goods. The relationship between a consumer, a good, and the financial
exchange to transfer ownership plays a major part in game theory as each
consumer has a different set of expectations.

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Outside from sweeping sales in advance of the holiday season, companies must
utilize game theory when pricing products for launch or in anticipation of
competition from rival goods. The company must balance pricing a good too
low and not reaping profit, yet pricing a good too high may scare customers
away towards a substitute good.
Types of Game Theories
Cooperative vs. Non-Cooperative Games
Although there are many types (e.g., symmetric/asymmetric,
simultaneous/sequential, etc.) of game theories, cooperative and non-
cooperative game theories are the most common. Cooperative game theory
deals with how coalitions, or cooperative groups, interact when only the
payoffs are known. It is a game between coalitions of players rather than
between individuals, and it questions how groups form and how they allocate
the payoff among players.
Non-cooperative game theory deals with how rational economic agents deal
with each other to achieve their own goals. The most common non-cooperative
game is the strategic game, in which only the available strategies and the
outcomes that result from a combination of choices are listed. A simplistic
example of a real-world non-cooperative game is rock-paper-scissors. 
Zero-Sum vs. Non-Zero Sum Games
When there is a direct conflict between multiple parties striving for the same
outcome, this type of game is often a zero-sum game. This means that for every
winner, there is a loser. Alternatively, it means that the collective net benefit
received is equal to the collective net benefit lost. Almost every sporting event
is a zero-sum game in which one team wins and one team loses.
A non-zero-sum game is one in which all participants can win or lose at the
same time. Consider business partnerships that are mutually beneficial and
foster value for both entities. Instead of competing and attempting to "win",
both parties benefit.

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Investing and trading stocks is sometimes considered a zero-sum game. After
all, one market participant will buy a stock and another participant sell that
same stock for the same price. However, because different investors have
different risk appetites and investing goals, it may be mutually beneficial for
both parties to transact.
Simultaneous Move vs. Sequential Move Games
Many times in life, game theory presents itself in simultaneous move
situations. This means each participant must continually make decisions at the
same time their opponent is making decisions. As companies devise their
marketing, product development, and operational plans, competing companies
are also doing the same thing at the same time.
In some cases, there is intentional staggering of decision-making steps in which
one party is able to see the other party's moves before making their own. This
is usually always present in negotiations; one party lists their demands, then the
other party has a designated amount of time to respond and list their own.
One Shot vs. Repeated Games
Last, game theory can begin and end in a single instance. Like much of life, the
underlying competition starts, progresses, ends, and cannot be redone. This is
often the case with equity traders that must wisely choose their entry point and
exit point as their decision may not easily be undone or retried.
On the other hand, some repeated games continue on and seamlessly never end.
These types of games often contain the same participants each time, and each
party has the knowledge of what occurred last time. For example, consider rival
companies trying to price their goods. Whenever one makes a price adjustment,
so may the other. This circular competition repeats itself across product cycles
or sale seasonality.
In the example below, a depiction of the Prisoner's Dilemma (discussed in the
next section) is shown. In this depiction, after the first iteration occurs, there is

75
no payoff. Instead, a second iteration of the game occurs, bringing with it a
new set of outcomes not possible under one shot games.
Example of Repeated Game.
Internet Encyclopedia of Philosophy
Examples of Game Theory
There are several "games" that game theory analyzes. Below, we will just
briefly describe a few of these.
The Prisoner's Dilemma
The Prisoner's Dilemma is the most well-known example of game
theory. Consider the example of two criminals arrested for a crime. Prosecutors
have no hard evidence to convict them. However, to gain a confession, officials
remove the prisoners from their solitary cells and question each one in separate
chambers. Neither prisoner has the means to communicate with each
other. Officials present four deals, often displayed as a 2 x 2 box.
1. If both confess, they will each receive a five-year prison sentence. 
2. If Prisoner 1 confesses, but Prisoner 2 does not, Prisoner 1 will get three
years and Prisoner 2 will get nine years. 
3. If Prisoner 2 confesses, but Prisoner 1 does not, Prisoner 1 will get 10
years, and Prisoner 2 will get two years. 
4. If neither confesses, each will serve two years in prison. 
The most favorable strategy is to not confess. However, neither is aware of the
other's strategy and without certainty that one will not confess, both will likely
confess and receive a five-year prison sentence. The Nash equilibrium suggests
that in a prisoner's dilemma, both players will make the move that is best for
them individually but worse for them collectively.
The expression "tit for tat" has been determined to be the optimal strategy for
optimizing a prisoner's dilemma. Tit for tat was introduced by Anatol
Rapoport, who developed a strategy in which each participant in an iterated
prisoner's dilemma follows a course of action consistent with their opponent's

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previous turn. For example, if provoked, a player subsequently responds with
retaliation; if unprovoked, the player cooperates.
The image below depicts the dilemma where the choice of the participant on
the column and the choice of the participant in the row may clash. For example,
both parties may receive the most favorable outcome if both choose
row/column 1. However, each faces the risk of strong adverse outcomes should
the other party not choose the same outcome.
Example of Static Two-Person Game.
Internet Encyclopedia of Philosophy
Dictator Game 
This is a simple game in which Player A must decide how to split a cash prize
with Player B, who has no input into Player A’s decision. While this is not a
game theory strategy per se, it does provide some interesting insights into
people’s behavior. Experiments reveal about 50% keep all the money to
themselves, 5% split it equally, and the other 45% give the other participant a
smaller share.
The dictator game is closely related to the ultimatum game, in which Player A
is given a set amount of money, part of which has to be given to Player B, who
can accept or reject the amount given. The catch is if the second player rejects
the amount offered, both A and B get nothing. The dictator and ultimatum
games hold important lessons for issues such as charitable giving
and philanthropy.
Volunteer’s Dilemma
In a volunteer’s dilemma, someone has to undertake a chore or job for the
common good. The worst possible outcome is realized if nobody volunteers.
For example, consider a company in which accounting fraud is rampant, though
top management is unaware of it. Some junior employees in the accounting
department are aware of the fraud but hesitate to tell top management because

77
it would result in the employees involved in the fraud being fired and most
likely prosecuted.
Being labeled as a whistleblower may also have some repercussions down the
line. But if nobody volunteers, the large-scale fraud may result in the
company’s eventual bankruptcy and the loss of everyone’s jobs.
The Centipede Game
The centipede game is an extensive-form game in game theory in which two
players alternately get a chance to take the larger share of a slowly increasing
money stash. It is arranged so that if a player passes the stash to their opponent
who then takes the stash, the player receives a smaller amount than if they had
taken the pot.
The centipede game concludes as soon as a player takes the stash, with that
player getting the larger portion and the other player getting the smaller
portion. The game has a pre-defined total number of rounds, which are known
to each player in advance.
 
Game theory exists in almost every facet of life. Because the decisions of other
people around you impact your day, game theory pertains to personal
relationships, shopping habits, media intake, and hobbies.
Types of Game Theory Strategies
Game theory participants can decide between a few primary ways to play their
game. In general, each participant must decide what level of risk they are
wiling to take and how far they are wiling to go to pursue the best possible
outcome.
Maximax Strategy
A maximax strategy involves no hedging. The participant is either all in or all
out; they'll either win big or face the worst consequence. Consider new start-
up companies introducing new products to the market. Their new product may
result in the company's market cap increasing fifty-fold. On the other hand, a

78
failed product launch will leave the company bankrupt. In either situation, the
participant is willing to take a chance on achieving the best outcome even if the
worst outcome is possible.
Maximin Strategy
A maximin strategy in game theory results in the participant choosing the best
of the worst payoff. The participant has decided to hedge risk and sacrifice full
benefit in exchange for avoiding the worst outcome. Often, companies face and
accept this strategy when considering lawsuits. By settling out of court and
avoid a public trial, companies agree to an adverse outcome. However, that
outcome could have been worse due to the exploits of the trial or even worse
judicial finding.
Dominant Strategy
In a dominant strategy, a participant performs actions that are the best outcome
for the play irrespective of what other participants decide to do. In business,
this may a situation where a company decides to scale and expand to a new
market whether or not a competing company has decided to move into the
market as well. In Prisoner's Dilemma, the dominant strategy would be to
confess.
Pure Strategy
Pure strategy entails the least amount of strategic decision-making, as pure
strategy is simply a defined choice that is made regardless of external forces or
actions of others. Consider a game of rock-paper-scissors in which one
participant decides to throw the same shape each trial. As the outcome for this
participant is well-defined in advance (outcomes are either a specific shape or
not that specific shape), the strategy is defined as pure.
Mixed Strategy
A mixed strategy may seem like random chance, but there is much thought that
must go into devising a plan of mixing elements or actions. Consider the
relationship between a baseball pitcher and batter. The pitcher cannot throw the

79
same pitch each time; otherwise, the batter could predict what would come
next. Instead, the pitcher must mix its strategy from pitch to pitch to create a
sense of unpredictability in which it hopes to benefit from.
Limitations of Game Theory
The biggest issue with game theory is that, like most other economic models, it
relies on the assumption that people are rational actors that are self-interested
and utility-maximizing. Of course, we are social beings who do cooperate often
at our own expense. Game theory cannot account for the fact that in some
situations we may fall into a Nash equilibrium, and other times not, depending
on the social context and who the players are.
In addition, game theory often struggles to factor in human elements such as
loyalty, honesty, or empathy. Though statistical and mathematical
computations can dictate what a best course of action should be, humans may
not take this course due to incalculable and complex scenarios of self-sacrifice
or manipulation. Game theory may analyze a set of behaviors but it can not
truly forecast the human element.
What Are the Games Being Played in Game Theory?
It is called game theory since the theory tries to understand the strategic actions
of two or more "players" in a given situation containing set rules and outcomes.
While used in several disciplines, game theory is most notably used as a tool
within the study of business and economics.
The "games" may involve how two competitor firms will react to price cuts by
the other, whether a firm should acquire another, or how traders in a stock
market may react to price changes. In theoretic terms, these games may be
categorized as prisoner's dilemmas, the dictator game, the hawk-and-dove, and
Bach or Stravinsky.
What Are Some of the Assumptions About These Games?
Like many economic models, game theory also contains a set of strict
assumptions that must hold for the theory to make good predictions in practice.

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First, all players are utility-maximizing rational actors that have full
information about the game, the rules, and the consequences. Players are not
allowed to communicate or interact with one another. Possible outcomes are
not only known in advance but also cannot be changed. The number of players
in a game can theoretically be infinite, but most games will be put into the
context of only two players.
What Is a Nash Equilibrium?
The Nash equilibrium is an important concept referring to a stable state in a
game where no player can gain an advantage by unilaterally changing a
strategy, assuming the other participants also do not change their strategies.
The Nash equilibrium provides the solution concept in a non-cooperative
(adversarial) game. It is named after John Nash who received the Nobel Prize
in 1994 for his work.3
Who Came Up with Game Theory?
Game theory is largely attributed to the work of mathematician John von
Neumann and economist Oskar Morgenstern in the 1940s and was developed
extensively by many other researchers and scholars in the 1950s.1 It remains
an area of active research and applied science to this day.
The Bottom Line
Game theory is the study of how competitive strategies and participant actions
can influence the outcome of a situation. Relevant to war, biology, and many
facets of life, game theory is used in business to represent strategic interactions
in which the outcome of one company or product depends on actions taken by
other companies or products.

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CO4

 Behavioural Decision Making-

 Cognitive biases and heuristics-
 Prospect theory and loss aversion-
 Framing and its effect on decision making-
 Data Analytics and Decision Making.
 introduction to data analytics and machine learning,
 Regression analysis and predictive modeling,
 Decision trees and random forests.
 Ethics and Social Responsibility and Decision
 Ethical considerations in decision making,
 Decision making and social responsibility,
 Sustainability and decision making

82
cognitive bias
What is cognitive bias?
Cognitive bias is a systematic thought process caused by the tendency of the
human brain to simplify information processing through a filter of personal
experience and preferences. The filtering process is a coping mechanism that
enables the brain to prioritize and process large amounts of information quickly.
While the mechanism is effective, its limitations can cause errors in thought.     
Essentially, cognitive biases help humans find mental shortcuts to assist in the
navigation of daily life, but may often cause irrational interpretations and
judgments.
Cognitive biases often stem from problems related to memory, attention and
other mental mistakes. They're often unconscious decision-making processes
that make it easy for individuals to be affected without intentionally realizing it.
The filtering process and coping mechanism used to process large amounts of
information quickly is called heuristics.
Cognitive bias as a concept was first introduced by Amos Tversky and Daniel
Kahneman in 1972. It may not be possible to completely eliminate the brain's
predisposition to taking shortcuts but understanding that biases exist can be
useful when making decisions.

83
 Alth
ough it may be impossible to eliminate the human brain's predisposition to
taking shortcuts, cognitive biases can be useful for the decision-making process.
Types of cognitive bias
A continually evolving list of cognitive biases has been identified over the last
six decades of research on human judgment and decision-making in cognitive
psychology, social psychology and behavioral economics. They include the
following: 
 Actor-observer bias. The tendency for an individual to credit their
own situation to external causes while ascribing other people's
behaviors to internal causes.
 Anchoring bias. The tendency for the brain to rely too much on the
first information it received when making decisions.
 Attentional bias. The tendency for an individual to pay attention to a
single object or idea while deviating from others.
 Availability bias. The tendency for the brain to conclude that a known
instance is more representative of the whole than is actually the case.

84
 Availability heuristic. The tendency to use information that comes to
the mind quickly when making decisions based on the future.
 Bandwagon effect. The tendency for the brain to conclude that
something must be desirable because other people desire it.
 Bias blind spot. The tendency for the brain to recognize another's bias
but not its own.
 Clustering illusion. The tendency for the brain to want to see a
pattern in what is actually a random sequence of numbers or events.
 Confirmation bias. The tendency for the brain to value new
information that supports existing ideas.
 The Dunning-Kruger effect. The tendency for an individual with
limited knowledge or competence in a given field to overestimate
their own skills in that field.
 False consensus effect. The tendency for an individual to
overestimate how much other people agree with them.
 Framing effect. The tendency for the brain to arrive at different
conclusions when reviewing the same information, depending on how
the information is presented.
 Functional fixedness. The tendency to see objects as only being used
in one specific way.
 Group think. The tendency for the brain to place value on consensus. 
 Halo effect. The tendency for a person's impression in one area to
influence an opinion in another area.
 Hindsight bias. The tendency to interpret past events as more
predictable than they actually were.
 Misinformation effect. The tendency for information that appears
after an event to interfere with the memory of an original event.
 Negativity bias. The tendency for the brain to subconsciously place
more significance on negative events than positive ones.

85
  Proximity bias. Proximity bias is the subconscious tendency to give
preferential treatment to people that are physically close. A physical
worker being considered for a raise before a remote worker because
they are in the immediate vicinity of their superior is an example of
proximity bias.
 Recency bias. The tendency for the brain to subconsciously place
more value on the last information it received about a topic.
 Self-serving bias. The tendency for an individual to blame external
forces when bad events happen but give themselves credit when good
events happen.
 Sunk cost effect. Also called the sunk cost fallacy, this is the
tendency for the brain to continue investing in something that clearly
isn't working in order to avoid failure.
 Survivorship bias. The tendency for the brain to focus on positive
outcomes in favor of negative ones. A related phenomenon is the
ostrich effect, in which people metaphorically bury their heads in the
sand to avoid bad news.
Signs and effects of bias
Because cognitive bias is often an unconscious process, it's easier for an
individual to recognize a bias in someone other than themself. However, some
ways to recognize bias include the following: 
 if an individual attributes a success to themselves, while attributing
other's successes to luck;
 if an individual assumes they have more knowledge than they actually
have on a topic;
 if an individual insists on blaming outside factors instead of themself;
 if an individual is only paying attention to what confirms their
opinions; and
 if an individual assumes everyone shares their own opinions.

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Individuals should try their best to stay away from these signs, as they all affect
-- at a base rate -- how that person interprets the world around them. Even if an
individual is objective, logical and can accurately evaluate their surroundings,
they still should be wary of adapting any new unconscious cognitive biases.
Impact of cognitive bias on software development data analytics
Cognitive biases can affect individuals by changing their world views or
influencing their work. For example, in the technical field, cognitive biases can
affect software data analytics and machine learning models.
Being aware of how human bias can obscure analytics is an important first step
toward preventing it from happening. While data analytics tools can help
business executives make data-driven decisions, it's still up to humans to select
what data should be analyzed. This is why it's important for business managers
to understand that cognitive biases that occur when selecting data can cause
digital tools used in predictive analytics and prescriptive analytics to generate
false results.
As an example, data analysts could use predictive modeling without first
examining data for bias, which could lead to unexpected results. These biases
could also influence developer actions. Some examples of cognitive bias that
can inadvertently affect algorithms are stereotyping, the bandwagon effect,
priming, selective perception and confirmation bias.
Cognitive bias can also lead to machine learning bias, which is a phenomenon
that occurs when an algorithm produces systemically prejudiced results due to
assumptions made in the machine learning process. Machine learning bias often
originates from poor or incomplete data that results in inaccurate predictions.
Bias may also be introduced by individuals who design and train the machine
learning systems, as these algorithms can reflect the unintended cognitive biases
of the developers. Some example types of biases that affect machine learning
include prejudice bias, algorithm bias, sample bias, measurement bias and
exclusion bias.

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Tips for overcoming and preventing bias
To prevent cognitive bias and other types of bias caused by it, organizations
should check the data being used to train machine learning models for lack of
comprehensiveness.
Data scientists developing the algorithms should shape data samples in a way
that minimizes algorithmic and other types of machine learning bias, and
decision-makers should evaluate when it is appropriate, or inappropriate, to
apply machine learning technology. Data revolving around people should be
representative of different races, genders, backgrounds and cultures that could
be adversely affected.
Awareness and good governance are two main ways that can help prevent
machine learning bias. This means the following actions should be taken:
 Appropriate training data should be selected.
 Systems should be tested and validated to ensure the results don't
reflect bias.
 Systems should be monitored as they perform their tasks.
 Additional tools and resources should be used, such as Google's What-
If Tool or IBM's AI Fairness 360 open source toolkit.
Organizations can mitigate for bias using both automated and human action, but
they may not be able to remove it all. But not all bias is inherently damaging.
Algorithmic bias, for example, is the process an algorithm uses to determine
how to sort and organize data. It's important to ensure that the type of bias isn't
inherently harmful and makes sense for the task at hand.
What Are Heuristics?
These mental shortcuts can help people make decisions more efficiently
Heuristics are mental shortcuts that allow people to solve problems and make
judgments quickly and efficiently. These rule-of-thumb strategies shorten
decision-making time and allow people to function without constantly stopping
to think about their next course of action.

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However, there are both benefits and drawbacks of heuristics. While heuristics
are helpful in many situations, they can also lead to cognitive biases. Becoming
aware of this might help you make better and more accurate decisions.
Press Play for Advice On Making Decisions
Hosted by therapist Amy Morin, LCSW, this episode of The Verywell Mind
Podcast shares a simple way to make a tough decision. Click below to listen
now.
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The History and Origins of Heuristics
Nobel-prize winning economist and cognitive psychologist Herbert Simon
originally introduced the concept of heuristics in psychology in the 1950s. He
suggested that while people strive to make rational choices, human judgment is
subject to cognitive limitations. Purely rational decisions would involve
weighing all the potential costs and possible benefits of every alternative.1
But people are limited by the amount of time they have to make a choice as well
as the amount of information they have at their disposal. Other factors such as
overall intelligence and accuracy of perceptions also influence the decision-
making process.
During the 1970s, psychologists Amos Tversky and Daniel Kahneman
presented their research on cognitive biases. They proposed that these biases
influence how people think and the judgments people make.
As a result of these limitations, we are forced to rely on mental shortcuts to help
us make sense of the world. Simon's research demonstrated that humans were
limited in their ability to make rational decisions, but it was Tversky and
Kahneman's work that introduced the study of heuristics and the specific ways
of thinking that people rely on to simplify the decision-making process.
How Heuristics Are Used
Heuristics play important roles in both problem-solving and decision-making, as
we often turn to these mental shortcuts when we need a quick solution.

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Here are a few different theories from psychologists about why we rely on
heuristics.
 Attribute substitution: People substitute simpler but related questions in
place of more complex and difficult questions.
 Effort reduction: People use heuristics as a type of cognitive laziness to
reduce the mental effort required to make choices and decisions.2
 Fast and frugal: People use heuristics because they can be fast and
correct in certain contexts. Some theories argue that heuristics are
actually more accurate than they are biased.3
In order to cope with the tremendous amount of information we encounter and
to speed up the decision-making process, our brains rely on these mental
strategies to simplify things so we don't have to spend endless amounts of time
analyzing every detail.
You probably make hundreds or even thousands of decisions every day. What
should you have for breakfast? What should you wear today? Should you drive
or take the bus? Fortunately, heuristics allow you to make such decisions with
relative ease and without a great deal of agonizing.
There are many heuristics examples in everyday life. When trying to decide if
you should drive or ride the bus to work, for instance, you might remember that
there is road construction along the bus route. You realize that this might slow
the bus and cause you to be late for work. So you leave earlier and drive to work
on an alternate route.
Heuristics allow you to think through the possible outcomes quickly and arrive
at a solution.
Are Heuristics Good or Bad?
Heuristics aren't inherently good or bad, but there are pros and cons to using
them to make decisions. While they can help us figure out a solution to a
problem faster, they can also lead to inaccurate judgments about other people or
situations.

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 Mental Sets and Problem-Solving Ability
Types of Heuristics
There are many different kinds of heuristics. While each type plays a role in
decision-making, they occur during different contexts. Understanding the types
can help you better understand which one you are using and when.
Availability
The availability heuristic involves making decisions based upon how easy it is
to bring something to mind. When you are trying to make a decision, you might
quickly remember a number of relevant examples. Since these are more readily
available in your memory, you will likely judge these outcomes as being more
common or frequently occurring.
For example, if you are thinking of flying and suddenly think of a number of
recent airline accidents, you might feel like air travel is too dangerous and
decide to travel by car instead. Because those examples of air disasters came to
mind so easily, the availability heuristic leads you to think that plane crashes are
more common than they really are.
Familiarity
The familiarity heuristic refers to how people tend to have more favorable
opinions of things, people, or places they've experienced before as opposed to
new ones. In fact, given two options, people may choose something they're
more familiar with even if the new option provides more benefits.4
Representativeness
The representativeness heuristic involves making a decision by comparing the
present situation to the most representative mental prototype. When you are
trying to decide if someone is trustworthy, you might compare aspects of the
individual to other mental examples you hold.
A soft-spoken older woman might remind you of your grandmother, so you
might immediately assume that she is kind, gentle, and trustworthy. However,

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this is an example of a heuristic bias, as you can't know someone trustworthy
based on their age alone.
Affect
The affect heuristic involves making choices that are influenced by the
emotions that an individual is experiencing at that moment. For example,
research has shown that people are more likely to see decisions as having
benefits and lower risks when they are in a positive mood. Negative emotions,
on the other hand, lead people to focus on the potential downsides of a decision
rather than the possible benefits.5
Anchoring
The anchoring bias involves the tendency to be overly influenced by the first bit
of information we hear or learn. This can make it more difficult to consider
other factors and lead to poor choices. For example, anchoring bias can
influence how much you are willing to pay for something, causing you to jump
at the first offer without shopping around for a better deal.
Scarcity
Scarcity is a principle in heuristics in which we view things that are scarce or
less available to us as inherently more valuable. The scarcity heuristic is one
often used by marketers to influence people to buy certain products. This is why
you'll often see signs that advertise "limited time only" or that tell you to "get
yours while supplies last."6
Trial and Error
Trial and error is another type of heuristic in which people use a number of
different strategies to solve something until they find what works. Examples of
this type of heuristic are evident in everyday life. 7 People use trial and error
when they're playing video games, finding the fastest driving route to work, and
learning to ride a bike (or learning any new skill).

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Difference Between Heuristics and Algorithms
Though the terms are often confused, heuristics and algorithms are two distinct
terms in psychology.
Algorithms are step-by-step instructions that lead to predictable, reliable
outcomes; whereas heuristics are mental shortcuts that are basically best
guesses. Algorithms always lead to accurate outcomes, whereas, heuristics do
not.
Examples of algorithms include instructions for how to put together a piece of
furniture or a recipe for cooking a certain dish. Health professionals also create
algorithms or processes to follow in order to determine what type of treatment
to use on a patient.8
How Heuristics Can Lead to Bias
While heuristics can help us solve problems and speed up our decision-making
process, they can introduce errors. As in the examples above, heuristics can lead
to inaccurate judgments about how commonly things occur and about how
representative certain things may be.
Just because something has worked in the past does not mean that it will work
again, and relying on a heuristic can make it difficult to see alternative solutions
or come up with new ideas.
Heuristics can also contribute to stereotypes and prejudice.9 Because people use
mental shortcuts to classify and categorize people, they often overlook more
relevant information and create stereotyped categorizations that are not in tune
with reality.
 How the Status Quo Bias Influences Decisions
How to Make Better Decisions
While heuristics can be a useful tool, there are ways you can improve your
decision-making and avoid cognitive bias at the same time.

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Slow Down
We are more likely to make an error in judgment if we are trying to make a
decision quickly or are under pressure to do so.10 Whenever possible, take a few
deep breaths. Do something to distract yourself from the decision at hand. When
you return to it, you may find you have a fresh perspective, or notice something
you didn't before.
Identify the Goal
We tend to focus automatically on what works for us and make decisions that
serve our best interest. But take a moment to know what you're trying to
achieve. Are there other people who will be affected by this decision? What's
best for them? Is there a common goal that can be achieved that will serve all
parties?11
Process Your Emotions
Fast decision-making is often influenced by emotions from past experiences that
bubble to the surface.12 Is your decision based on facts or emotions? While
emotions can be helpful, they may affect decisions in a negative way if they
prevent us from seeing the full picture.
Recognize All-or-Nothing Thinking
When making a decision, it's a common tendency to believe you have to pick a
single, well-defined path, and there's no going back. In reality, this often isn't
the case.
Sometimes there are compromises involving two choices, or a third or fourth
option that we didn't even think of at first. Try to recognize the nuances and
possibilities of all choices involved, instead of using all-or-nothing thinking.
Prospect Theory
What is the Prospect Theory?
Prospect theory refers to the theory explaining people’s choices influenced by
biases like loss aversion. People are more loss averse than profit devoted. In

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simple terms, it indicates a preference for less risky or profits certain options
compared to the options containing losses.
It’s a Nobel prize-winning work explaining people’s decision-making process
under complex and uncertain situations. People analyze the situations and think
in terms of gains and losses. It reflects the influence of emotions and attitudes
more intense than the logical and rational thinking in the decisions produced.
People of any age, gender, or culture can exhibit behavior explained by the
theory.
Prospect Theory Explained
“Prospect Theory: An Analysis of Decision under Risk,” the journal article by
Daniel Kahneman and Amos Tversky, presented the concept in 1979 as an
alternative model to expected utility theory. The theory explains the irrational
human behavior influenced by various biases like risk-averse and risk-seeking
behaviors. For example, people are likely to choose a more secure option than
take a high-risk option with high-profit potential when the outcome is unknown.
In contrast, expected utility theory explains the rational choice made by
selecting the option with the highest expected utility.
The prospect theory in psychology explains biases influencing the decisions of
individuals. The main three biases are a certainty, isolation effect, and loss
aversion.
Certainty
Prospect theory has two certainties: certainty of gain and loss. First, it postulates
that when given a choice between an assured profit and a greater profit but with
a risk factor, people will go with the first one avoiding any form of risk at all. In
contrast, people also take greater risks to prevent the certainty of loss.
Isolation Effect
It is also known as the Von Restroff Effect and was introduced by German
psychiatrist and pediatrician Hedwig von Restorff. It is the behavior of people
who tend to point out differences than similarities between the given choices.

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While comparing alternatives, people tend to give more importance to the
differences than common factors in making decisions. Hence it is included in
the explanation of prospect theory.
Loss Aversion
A critical aspect of individual behavior states that everyone has a certain fear of
loss, which is always bigger than the joy of winning. In other words, when
given a chance, people will tend to minimize their losses than maximize gains,
and they remember loss more significantly than a profit. It is a type of survival
mechanism.
Examples
 There are two options for Anna. The first option has a 100% probability
of gaining $1000 and the second option presents a 50% chance of gaining
$2000. Therefore, according to the theory, Anna will become risk-averse
and chooses the safe option presenting a certain gain of $1000. she
forgoes the second option that has the potential to produce double the
return because there is a 50% chance of losing by selecting the second
option.
 To avoid the pain of incurring loss at certain times, investors decide not to
sell stocks in a downtrend. Instead, they willingly remain in a risky stock
position, hoping for a trend reversal exhibiting an uptrend. 
 There are two options: one with a 100% chance of incurring a loss and
the second with an equal chance to obtain gain or loss. Both cases contain
loss elements and one with a certain loss. In this case, both options may
lead to a loss, and choosing the second option present a 50% chance of
making a gain hence the individual making the decision can become risk-
seeking to avoid losses. 

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How to Overcome?
 Compare the options rationally; the options may be equal, but their
portrayal can make them look different; hence people should scrutinize
all options giving them equal importance.
 In the field of investing, investors can overcome the influence of biases
by understanding biases, being aware of biases, studying past trends
using historical data, and exercising cognitive control.
 Before making any decision, ensure the combination of subjective and
objective data as input in the decision-making process
What is the Framing Effect?
The framing effect is when our decisions are influenced by the way information
is presented. Equivalent information can be more or less attractive depending on
what features are highlighted.
Framing effect
Where this bias occurs
Most of us work & live in environments that aren’t optimized for solid decision-
making. We work with organizations of all kinds to identify sources of cognitive
bias & develop tailored solutions.
LEARN ABOUT OUR WORK
Consider the following hypothetical: John is shopping for disinfectant wipes at
his local pharmacy. He sees several options, but two containers of wipes are on
sale. One is called “Bleachox” and the other is called “Bleach-it.”

Both of the disinfectant wipes Jon is considering are the same price and contain
the same number of wipes. The only difference Jon notices, is that the Bleachox
wipes claim to “kill 95% of all germs,” whereas the “Bleach-it” wipes say:
“only 5% of germs survive.” After comparing the two, John chooses the
Bleachox wipes. He doesn’t like the sound of germs ‘surviving’ on his kitchen
counter.

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John’s decision to buy the Bleachox over Bleach-it wipes was informed by the
framing effect. Although both products were equally effective at fighting germs,
and essentially claimed the same thing, their claims were framed differently.
Bleachox highlighted the percentage of germs it did kill (a positive attribute),
whereas Bleach-it highlighted how many germs it did not kill (a negative
attribute).
Individual effects
Decisions based on the framing effect are made by focusing on the way the
information is presented instead of the information itself. Such decisions may be
sub-optimal, as poor information or lesser options can be framed in a positive
light. This may make them more attractive than options or information are
objectively better, but cast in a less favourable light.

Think of someone who unwisely chooses a high-risk investment portfolio

because their broker emphasized the upside instead of the potential downside, or
a citizen who votes for a protectionist candidate because media coverage has
only highlighted the negative repercussions of past trade agreements.

Systemic effects
The framing effect can have considerable influence on public opinion. Public
affairs and other events that draw attention from the public can be interpreted
very differently based on how they are framed. Sometimes, issues or positions
that benefit the majority of people can be seen unfavorably because of negative
framing. Likewise, policy stances and behaviour that do not further the public
good may become popular because their positive attributes are effectively
emphasized.1

For example, there is an overwhelming amount of evidence showing that

climate change will result in enormous costs further down the line, and that

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those costs will be disproportionately borne by low income communities.2
Despite this, there are a significant number of voters in North America who
deny climate change and believe policies such as carbon taxes will disadvantage
the average citizen. This may be because climate change has been framed as a
scientifically contentious issue by some media outlets and politicians, who also
often highlight the short-term financial costs of environmental policy.

Why it happens
Our choices are influenced by the way options are framed through different
wordings, reference points, and emphasis. The most common framing draws
attention to either the positive gain or negative loss associated with an option.
We are susceptible to this sort of framing because we tend to avoid loss.

We avoid loss
The foundational work of psychologists Daniel Kahneman and Amos Tversky
explains framing using what they called “prospect theory.” According to this
theory, a loss is perceived as more significant, and therefore more worthy of
avoiding, than an equivalent gain.3 A sure gain is preferred to a probable one,
and a probable loss is preferred to a sure loss. Because we want to avoid sure
losses, we look for options and information with certain gain. The way
something is framed can influence our certainty that it will bring either gain or
loss. This is why we find it attractive when the positive features of an option are
highlighted instead of the negative ones.

Our brain uses shortcuts

Processing and evaluating information takes time and energy. To make this
process more efficient, our mind often uses shortcuts or “heuristics.” The
availability and affect heuristic may contribute to the framing effect. The
availability heuristic is our tendency to use information that comes to mind

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quickly and easily when making decisions about the future. Studies have shown
that the framing effect is more prevalent in older adults who have more limited
cognitive resources, and who therefore favour information that is presented in a
way that is easily accessible to them.4 Because we favour information is easily
understood and recalled, options that are framed in this way are favoured over
those that aren’t.

The affect heuristic is a shortcut whereby we rely heavily upon our emotional
state during decision-making, rather than taking the time to consider the long-
term consequences of a decision. This may be why we favor information and
options that are framed to elicit an immediate emotional response. Research has
shown that framing relies on emotional appeals and can be designed to have
specific emotional reactions.5 Picture this: most of us would be more willing to
listen and vote for a political candidate that presents their platform in an
emotional speech framed at inspiring change, over a candidate with the same
platform that is presented it in a dreary report.

Why it is important
The framing effect can have both positive and negative impacts on our lives. As
mentioned above, it can impair our decision-making by shedding a positive light
on poor information or lesser options. In other words, overvaluing how
something is said (its framing) can cause us to undervalue what is being said,
which is usually more important. As a result, we may choose worse options that
are more effectively framed over better options or information that is framed
badly. This holds true in the smaller decisions we make as consumers and
citizens, as well as more significant decisions in our personal and professional
lives.
However, we should also be aware of this effect because it can be harnessed to
our advantage. Understanding that people are influenced by framing can make

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us focus on how we present information we want others to accept and act on.
Knowing that people are drawn to framing that highlights certain gains can help
us present our work in this fashion, making it more attractive and effective.
When managing or collaborating with other people, it is important to remember
the importance of how we present our message or position. More effective
framing may allow us to better leverage our point of view.
What exactly does it mean to “frame” or “reframe” an issue? Think about the
metaphor behind the concept. A frame focuses attention on the painting it
surrounds. Different frames draw out different aspects of the work. Putting a
painting in a red frame brings out the red in the work; putting the same painting
in a blue frame brings out the blue. How someone frames an issue influences
how others see it and focuses their attention on particular aspects of it. Framing
is the essence of targeting a communication to a specific audience.
How to avoid it
There are a few strategies for reducing the framing effect. Research has shown
that people who are more “involved” on an issue are less likely to suffer from
framing effects surrounding it. Involvement can be thought of as how invested
you are in an issue. A 2010 study found that “people who are involved with an
issue are more motivated to systematically process persuasive messages and are
more interested in acquiring information about the product than people who are
less involved with the issue.” More involved individuals were found to be less
susceptible to the framing effect, whereas those who were less involved were
more susceptible.

What we can take from these findings, is that we should think through our
choices concerning an issue and try to become more informed on it. Indeed, the
authors posit that previous literature has found that “framing bias would be
mitigated or eliminated if individuals thought more carefully about their

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choices” and that “when older adults examined more information relevant to the
decision, they made more effective decisions”.7
A more specific strategy that falls in line with this more general approach is to
provide rationales for our choices. A 1997 study found this reduced framing
effects in participants as it forced them to engage in more detailed mental
processing.8 This makes sense: If we really think through why we selected an
option or relied on certain information, we might realize that the way in which it
was presented influenced our decision too much.
Data Analytics and Decision Making
How Data Analysis Influence Decision Making in Business
Contents
The frantic pace of the modern world is dictating new game rules for business.
Where once you could rely on luck, intuition, and feeling, now it’s data that
helps you achieve maximum efficiency at minimum cost and risk that’s coming
to the fore. It’s time to reshape how organizations make informed decisions
based on data.
David Stodder, senior director at TDWI, in his TDWI Best Practices
Report: Visual Analytics for Making Smarter Decisions Faster, suggests that
business users are indeed ready to leave tables and standard BI reports behind.
He explains how visual analytics can help professionals process data in a more
complete and personalized way and make informed decisions based on the
information they receive.
This tendency is quite reasonable. However, it is not the availability of data that
determines the effectiveness of decisions. It is the process that the decision-
maker follows based on the data collected and transformed. So in this article,
we want to talk about data-driven decision-making in more detail.
What is Data-Driven Decision Making?
Data-Driven Decision-Making is a strategy where decisions are made based on
what you think is the best choice. When you implement DDDM, information is

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gathered to analyze trends and make decisions for the future. Everything is
based on what has worked in the past, not on feelings, opinions, or experiences.
Companies that practice data DDDM focus their work around data. Information
is the core of such companies. But to get real value, it has to be accurate and fit
for purpose. 
You can use the data to address financial issues, enterprise growth, marketing
and sales, and customer service. There’re some key characteristics of a
streamlined, data-driven approach to decision-making:
 KPI tracking. Use key performance indicators (KPIs) aligned with
strategy. Be attentive to vanity metrics and simple metrics.
 Keep a record of the rationale. Write down why you made the decision,
and what justified it.
 Learning from mistakes. Analyze the outcomes of bad and good
decisions, creating learning and improvement cycles.
When choosing metrics for measurement, a company usually follows several
criteria. For example, there should not be many, about 3-5 for each analyzed
stage. The metrics should be similar for comparison with the indicators of
previous periods. They should also be expressed in relative terms. 
Benefits of Data-Driven Decision Making
Increasing transparency and accountability
One of the benefits of the data-driven decision-making approach is increased
transparency and accountability of the organization. DDDM aims to improve
teamwork and employee engagement. This is how the organization deals with
threats and risks, improving overall performance. It leads to making the right
decisions about their operations.
There are fewer mistakes because misunderstandings are less likely to occur.
Employees know exactly what’s going on, and what their role is, and are more
likely to suggest improvements and changes. All because they understand the
current state of the business and long-term goals.

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Objective data helps organizations collect data, use it for record-keeping and
compliance, and be accountable for managing it correctly. Therefore, data-
driven decision-making in business ensures that every piece of information is
prioritized and the goal is specific.
Continuous improvement
Data-driven decision-making leads to continuous improvement of the
organization. They gradually implement changes, monitor metrics, and make
further changes based on the results. This increases the overall productivity and
effectiveness of the organization.
Increases consistency
The use of data in decision-making processes ensures that the business agrees
on results. This approach helps people understand how decisions are made.
They can determine the implications of the data being collected and analyzed,
and take appropriate action. When everyone participates in data-driven decision
management, they gain the necessary skills and thereby increase consistency.
Practice plays a vital role in every business. This is how workers can understand
if sales are up or down or if customers are happy. In this way the company stays
informed, constantly developing loyalty, engagement, and accountability.
Cost saving
An organization that just uses data will not reduce costs. But you can use
collected data to identify possible cost-cutting measures. Maybe most of the
budget is directed to an ineffective marketing strategy. Or conversely, one
product returns more profit than any other. Data can be used to evaluate a
product and also to identify and solve problems. The more effectively data is
used in decision-making, the more agile the organization becomes. This
characteristic allows a business to outsmart competitors and increase revenue.
Companies using big data have seen an 8-10% increase in profits and a 10%
decrease in total costs.

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And based on a survey of Fortune 1000 executives conducted by NewVantage
Partners for Harvard Business Review, businesses can invest in a big data
initiative to become more data-driven in their processes.  
Flexibility and quick adaptation
Predicting market trends and responding quickly will give a business an edge
over its competitors. An organization that researches the market and provides a
marketable product is considered an industry leader. Once a company receives
and analyzes data, it makes decisions. Truly agile organizations are more likely
to achieve high financial performance than the average business.
Feedback for market research
Data-driven decision-making provides feedback that gives insight into what
customers like and don’t like. It’s how organizations create new products and
services, plus it helps identify trends before they happen. By studying data,
companies learn what to expect shortly and what to change to improve
performance. In this way, companies maintain a good relationship with their
customers.
How to Use Data to Make Business Decisions
Before you start analyzing information, it’s better, to begin with, an action plan.
It should detail how you will find the right data and how you will interpret this
data to make the right business decisions. Look at your goals and prioritize
them. Any decision you make should start with your core business goals.
Define the goal
The first thing to do is to define business goals to understand the key and
subsequent goals of the company. These can be as specific as increasing sales,
or as abstract as increasing brand awareness. A goal set in advance will help
select key performance indicators and metrics that influence data-driven
decisions later in the process.

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Data search and preparation
After defining the goal you need to solve and the solution you want to make, it’s
time to find and use the relevant data. Collect and prepare all necessary
information. However, access to quality and reliable data can be a big obstacle
if your business information is stored in many disparate sources. You should
start by preparing data sources with high impact and low complexity. For
example, you can prioritize data sources with the largest audience. Don’t spend
hours collecting and analyzing data that won’t affect your final decision. Collect
only those that are relevant to your goal.
Data review and development plan creation
The next step is to review and examine the data. Visualizing them is critical to
making effective data-driven decisions. Visual representation of ideas increases
the chances of influencing the decisions of senior management and other
employees. So, look at the data collected, and try to identify patterns or trends
that are present in it.
If you can use data to prove that your decisions will have a positive impact on
business growth, it’s worth taking the time to analyze the data in your CRM,
customer service reports, and other means of storing information about the
processes in your business. Also, share it with other employees for effective
work. Highlighting key messages with informative text and interactive
visualizations can influence audience decisions. This will help them make more
informed decisions in their daily work.
How can Data Analysis Influence Decision Make?
As stated earlier, data analytics helps companies make better decisions to
improve productivity and efficiency. First and foremost, making data-driven
decisions will help ensure a better customer experience. Data analytics allows
you to understand employee and customer interactions, and work with your IT
department to improve those interactions. As IT connects with the marketing
teams, it helps achieve audience results and goals. So the company better

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allocates budgets based on customer response. A deep understanding of
customers allows for forming the right messages to the right audience at the
right time.
The role of data in business decisions is to demonstrate a vision of what a
company using data to make decisions looks like in reality. This approach helps
clarify the business’s mission statement and get insights that make analytics and
data real to people without analytics experience. Advanced data technologies
through AI and machine learning become understandable to the broader
community when used for predictive analysis of sales, equipment depreciation,
and asset risk. Plus it improves overall business performance. Data analytics can
help understand what areas an individual or the entire department needs to
improve.
It’s consistent and continuous growth. Companies are creating new business
opportunities, generating more revenue, forecasting future trends, and
optimizing current operational efforts. Working with data helps make actionable
business insights from data analysis and understanding the current state,
direction, and intent of the business evident. Data analytics allows a company to
do better risk assessment and management, whether structured or unstructured,
and collaboration with the IT department can improve the forecasting of
potential problems. 
Examples of How Companies Use Analytics
Google
Google is paying attention to what it calls “people analytics.” In one of its
people analytics initiatives, Project Oxygen, Google mined data from 10,000
performance reviews and compared it to employee retention rates. The company
used the information to identify the general behavior of effective managers and
created training programs to develop competencies. 

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Amazon
The company has access to a huge amount of its customers’ data, such as
names, addresses, payments, and search history. Amazon uses this information
to improve customer relationships and serve customers faster and more
efficiently. 
Burberry
Burberry uses big data and artificial intelligence to improve productivity, sales,
and customer satisfaction.
Their customers use loyalty programs in their mobile apps. And for those who
use such services, the company asks them to share data and then uses the
information to provide recommendations for online and offline products.
Employees in offline stores can see a customer’s purchase history, preferences,
and social media activity through a tablet. They can use this data to provide a
more personalized experience to increase sales.
All items in Burberry stores have unique RFID tags. And when customers visit
the store, the mobile app will communicate directly with them about different
products.
American Express
A company, like Amazon, uses big data to analyze and predict consumer
behavior. They use predictive models instead of traditional retrospective
reporting based on business intelligence. This is how American Express more
accurately predicts potential churn and customer loyalty. 
Netflix
The service has a lot of data and analytics to understand the viewing habits of
international consumers. They use the data to order original programming
content that appeals worldwide. Also to buy the rights to movies and TV series.
So actor Adam Sandler has proven to be unpopular in the U.S. and U.K. in
recent years. Netflix released four new movies with the actor in 2015, as
previous work with the actor was successful in Latin America.

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The North Face
Thanks to IBM’s Watson, the company uses artificial intelligence and machine
learning to deliver personalized customer experiences. It does this through a
mobile app. The system works just like a human salesperson. It tells them about
different questions and shopping experiences and then provides personalized
recommendations. 
We took a comment from MegaResearch, a marketing agency, and this is what
they told us:
Making Data-Driven Decisions with the Right Data
The right data can help you make more informed decisions and optimize your
strategy to increase profits. But how do you get the right data? Getting reliable,
trustworthy data can be a challenge, but with the right approach, it doesn’t have
to be. Let’s explore some of the most effective ways to get data for making
data-driven decisions.
1. Internal Data Analysis
The most logical place to start when gathering data for decision-making is
within your own company. All businesses have access to internal data sources
such as customer records, sales histories, and inventory levels that can provide
insights into customers’ needs and preferences as well as trends in sales and
other areas of operations. Analyzing this internal data can help businesses make
better decisions about pricing, product development, marketing strategies, and
more.
2. Market Research
For external sources of information, market research is one of the best ways to
gather reliable data on consumer trends and preferences. Market research can
take many forms including surveys, interviews, focus groups, and observational
studies that will provide valuable insights into consumer attitudes and behaviors
that can inform decision-making on everything from pricing strategies to
product development.

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3. Social Media Monitoring
Social media has become an invaluable source of customer feedback since it
gives you direct insight into what people are saying about your brand or
products in real-time. This makes it possible to quickly identify potential issues
or opportunities before they become major problems or missed opportunities for
your business. Regularly monitoring social media channels will also give you
insight into current trends in customer behavior that can inform strategic
planning and decision-making processes in your business.
4. Web Scraping
Collecting data manually is an incredibly labor-intensive process — which is
why web scraping API has become so popular in recent years. Web scraping
enables businesses to quickly collect vast amounts of data that can be used to
inform product development and marketing decisions.
Web scraping provides businesses with numerous benefits, including:
 Making data collection easier
 Increasing efficiency
 Lowering costs
 Improving accuracy
 Providing insights
 Uncovering new opportunities
Conclusion
A data-driven approach will help you respond quickly to market challenges. It
will help companies make decisions based on real numbers and predict
outcomes in different areas of the business with greater accuracy. It’s the kind
of tool you need to drive growth, beat the competition and attract loyal
customers. So, if you can use data to prove that the decisions you make can
have a positive impact on business growth, it’s worth taking the time to analyze
it. 
introduction to data analytics and machine learning

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Data Analytics and Machine Learning: Let’s Talk Basics
By Addie Lawrence
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As consumer data grows, so too do the opportunities to better understand and
target customers and prospects.
To capitalize on this data, businesses must frame their approach strategically.
After all, having the data is not enough to:
1. Interpret and understand the story it’s telling.
2. Determine which data is most relevant to which audience.
3. Instill a culture of data discovery in employees, especially when
acting on hunches can be habitual.
Business leaders understand the value of data that’s tailored to each function
and the role analytics tools play in the overall employee experience of accessing
that data.
In this sense, analytics software that organically promotes data-driven
decision-making provides a competitive advantage.
The advent of AI analytics has changed the premise of the conversation. With
the automation and augmentation capabilities of AI, analytics tools are no
longer facilitators of data analysis but are capable of performing the actual labor
that was once unique to humans.
These advancements mean that businesses have an incredible opportunity to
capitalize on data (as we’ve mentioned), but they must do so with an eye toward
scale, change management, and curiosity culture.
In this article, we’ll specifically discuss the advantages of machine learning
analytics and how it fits into the larger picture of AI in business intelligence.
×Learn more about the state of AI in business intelligence with this in-depth
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The difference between traditional data analytics and machine learning
analytics
Data analytics is not a new development. From the beginning of business
intelligence (BI), analytics has been a key aspect of the tools employees use to
better understand and interact with their data.
However, the scale and scope of analytics has drastically evolved. Let’s discuss
these differences in more detail.
Data Analytics
Traditional data analytics platforms typically revolve around dashboards.
Dashboards are constructed of visualizations and pivot tables that illustrate
trends, outliers, and pareto, for example. Technical team members like data
analysts and data scientists play a role in constructing these dashboards;
generally, the humans are still performing the bulk of the analysis, and the
software helps facilitate the results.
Current state analysis with traditional data analytics software looks
something like this:
1. The data analyst starts with a core question, likely sourced from a
business team. In this case, the question is “how did market share do
last quarter?”
2. The data analyst accesses different spreadsheets from different
locations.
3. The data analyst merges multiple spreadsheets manually.
4. The data analyst conducts analysis by filtering data based on their
hypotheses around market share’s performance. This process is
constrained by time restrictions, so the analyst can’t fully test every
scenario. As the analyst iterates on their hypotheses, they may need to
access data again.
5. The analyst presents the story, or the findings from their analyses.
While these stories can be well-researched and accurate, they’re not a

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 complete picture of what’s happening in the data and rely on the
analyst’s initial assumptions.
This process is labor-intensive, time-consuming, and often frustrating. Data
analysts have advanced skill sets that they can’t use effectively when they’re
spending their time stuck in a cycle of routine reports.
The limitations of this process have paved the way for machine learning to take
hold in analytics.
Machine Learning Analytics
Machine learning analytics is an entirely different process.
Machine learning automates the entire data analysis workflow to provide
deeper, faster, and more comprehensive insights.
How does this work?
Machine learning is a subset of AI that leverages algorithms to analyze vast
amounts of data.
These algorithms operate without human bias or time constraints, computing
every data combination to understand the data holistically. Further, machine
learning analytics understands boundaries of important information.
If asked to identify changes in sales figures, the machine can learn the
difference between a $200 fluctuation and a $200,000 increase, only reporting
the latter because that’s the info that actually impacts the company.
In other words, machine learning also tests out hypotheses to answer key
business questions — but it can test all of them in a much shorter timespan.
Think seconds instead of weeks. Then, it tells a data story that’s accurate,
exhaustive, and relevant to the person asking questions.
Practically, machine learning is invoked in techniques like:
 Clustering — The machine determines commonalities between
different data to understand how certain things, like customers, are
alike. These customers can be grouped together in ways that may not

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 be immediately apparent or intuitive to a person performing the same
exercise.
 Elasticity — The machine determines causes behind results. If many
factors are changing simultaneously, how do you determine which
factor is credited with which outcome? This technique tells employees
that an increase in household income resulted in boosted sales, rather
than product promotions, for example.
 Natural language — The machine maps phrases like “sales” to their
coding language counterparts. In this way, business people don’t have
to understand R or Python to perform deep analysis. They can simply
ask everyday questions like “what were sales in Q2?” and the machine
translates those words.
With these techniques, machine learning analytics determines the drivers
beneath the data and the opportunities to grow the most.
Significantly, machine learning that invokes natural language is also targeted
toward business users who can perform the analysis themselves (a development
known as augmented analytics).
Machine learning analytics are taking off…but why now?
The amount of data that companies have access to is much greater now than it
has ever been before.
This data is a goldmine for businesses as it can inform the decision-making
process, assist with targeting customers and prospects, and deepen the level of
analysis that can be performed.
However, as the amount of data grows, so too do the challenges with harnessing
its power:
 The roles and functions that make data-driven decisions are often
removed from the data itself. CMOs, brand managers, sales teams,
and other business-driven roles need data to act, but don’t have the
time or training to divulge insights from the data without user-friendly

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 tools or support from technical team members like data scientists and
analysts.
 The data itself is more complex. Businesses need to invest resources
into data cleaning, structuring, and maintenance to ensure that data
pipelines are supported properly.
 The value of data is becoming more apparent. As more businesses
invest in syndicated data sources, how do businesses gain a
competitive advantage, especially when competitors are accessing the
same data?
In tandem with this growth in data is a growth in computational processing
power.

Cloud computing, the technology that ultimately supports this data, is becoming
more advanced, and machines have more processing power than they have
previously.
Companies are investing in both big data and cloud infrastructure.
According to SVP Pete Reilly in this CGT webinar, they’re investing toward an
AI-driven end:
“They’ve got all this data available, and now they’re saying, what are the big
business problems we could apply this to that would have a huge impact?”

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After all, at the intersection between the expansion of data and
computational power is machine learning.
Machine learning is essentially what you do with these resources to leverage
them as business assets. Without machine learning, companies simply have a
sea of disparate information. With machine learning, companies have a
hierarchical structure of the information that’s most specific, relevant, and
important to each role and function.
As indicated in Reilly’s quote, specific business problems can focus the
implementation of machine learning.
Key considerations for data analytics and machine learning
The potential gains from machine learning have enormous appeal, and
companies are looking to invest in advanced analytics solutions.
Yet — as with the larger conversation around AI in business — the
pathway to successful implementation of machine learning is not as easy as
it may appear. Change management strategies are critical for ensuring that
employees use machine learning analytics effectively.
Machine learning is new in most industries, and its benefits aren’t necessarily
obvious to employees who haven’t been exposed to the larger conversation.
This is especially true when employees are concerned about being replaced by
automation.
A good implementation strategy is key.
This strategy should be driven by:
 Specific business outcomes that clarify what machine learning
analytics will accomplish and automate.
 Alignment between tech and business teams, so that both parties
understand the benefits of workforce augmentation.
 Accurate data, supported by system maintenance and AI expertise.
 Change management fundamentals, which are often lost in the
excitement of new technology.

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These considerations will help ensure that machine learning analytics take root
in the business and help employees become more effective in their jobs.
Regression Analysis
You probably know by now that whenever possible you should be making data-
driven decisions at work. But do you know how to parse through all the data
available to you? The good news is that you probably don’t need to do the
number crunching yourself (hallelujah!) but you do need to correctly understand
and interpret the analysis created by your colleagues. One of the most important
types of data analysis is called regression analysis.
To better understand this method and how companies use it, I talked with
Thomas Redman, author of Data Driven: Profiting from Your Most Important
Business Asset. He also advises organizations on their data and data-quality
programs.
What is Regression Analysis?
Redman offers this example scenario: Suppose you’re a sales manager trying to
predict next month’s numbers. You know that dozens, perhaps even hundreds of
factors — from the weather to a competitor’s promotion to the rumor of a new
and improved model — can impact the numbers. Perhaps people in your
organization even have a theory about what will have the biggest effect on sales.
“Trust me. The more rain we have, the more we sell.” “Six weeks after the
competitor’s promotion, sales jump.”
Regression analysis is a way of mathematically sorting out which of those
variables does indeed have an impact. It answers the questions: Which factors
matter most? Which can we ignore? How do those factors interact with one
another? And, perhaps most important, how certain are we about all these
factors?
In regression analysis, those factors are called “variables.” You have
your dependent variable — the main factor that you’re trying to understand or
predict. In Redman’s example above, the dependent variable is monthly sales.

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And then you have your independent variables— the factors you suspect have
an impact on your dependent variable.
How Does it Work?
To conduct a regression analysis, you gather the data on the variables in
question. (Reminder: You likely don’t have to do this yourself, but it’s helpful
for you to understand the process your data analyst colleague uses.) You take all
your monthly sales numbers for, say, the past three years and any data on the
independent variables you’re interested in. So, in this case, let’s say you find out
the average monthly rainfall for the past three years as well. Then you plot all
that information on a chart that looks like this:

See more HBR charts in Data & Visuals 

The y-axis is the amount of sales (the dependent variable, the thing you’re
interested in, is always on the y-axis), and the x-axis is the total rainfall. Each
blue dot represents one month’s data—how much it rained that month and how
many sales you made that same month.

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Glancing at this data, you probably notice that sales are higher on days when it
rains a lot. That’s interesting to know, but by how much? If it rains three inches,
do you know how much you’ll sell? What about if it rains four inches?
Now imagine drawing a line through the chart above, one that runs roughly
through the middle of all the data points. This line will help you answer, with
some degree of certainty, how much you typically sell when it rains a certain
amount.

See more HBR charts in Data & Visuals 

This is called the “regression line,” and it’s drawn (using a statistics program
like SPSS or STATA or even Excel) to show the line that best fits the data. In
other words, explains Redman, “The red line is the best explanation of the
relationship between the independent variable and dependent variable.”
In addition to drawing the line, your statistics program also outputs a formula
that explains the slope of the line and looks something like this:
y = 200 + 5x + error term

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Ignore the error term for now. It refers to the fact that regression isn’t perfectly
precise. Just focus on the model:
y = 200 + 5x
This formula is telling you that if there is no x then y = 200. So, historically,
when it didn’t rain at all, you made an average of 200 sales and you can expect
to do the same going forward, assuming other variables stay the same. And in
the past, for every additional inch of rain, you made an average of five more
sales. “For every increment that x goes up one, y goes up by five,” says
Redman.
Now let’s return to the error term. You might be tempted to say that rain has a
big impact on sales if for every inch you get five more sales, but whether this
variable is worth your attention will depend on the error term. A regression line
always has an error term because, in real life, independent variables are never
perfect predictors of the dependent variables. Rather the line is an estimate
based on the available data. So, the error term tells you how certain you can be
about the formula. The larger it is, the less certain the regression line.
The above example uses only one variable to predict the factor of interest — in
this case, rain to predict sales. Typically you start a regression analysis wanting
to understand the impact of several independent variables. You might include
not just rain but also data about a competitor’s promotion. “You keep doing this
until the error term is very small,” says Redman. “You’re trying to get the line
that fits best with your data.” Although there can be dangers in trying to include
too many variables in a regression analysis, skilled analysts can minimize those
risks. And considering the impact of multiple variables at once is one of the
biggest advantages of regression analysis.
How Do Companies Use It?
Regression analysis is the “go-to method in analytics,” says Redman. And smart
companies use it to make decisions about all sorts of business issues. “As

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managers, we want to figure out how we can affect sales, retain employees, or
recruit the best people. It helps us figure out what we can do.”
Most companies use regression analysis to explain a phenomenon they want to
understand (for example, Why did customer service calls drop last month?);
predict things about the future (for example, What will sales look like over the
next six months?); or to decide what to do (for example, Should we go with this
promotion or a different one?).
A note about “correlation is not causation”: Whenever you work with
regression analysis or any other analysis that tries to explain the impact of one
factor on another, you need to remember the important adage: Correlation is not
causation. This is critical. Here’s why: It’s easy to say that there is a correlation
between rain and monthly sales. The regression shows that they are indeed
related. But it’s an entirely different thing to say that rain caused the sales.
Unless you’re selling umbrellas, it might be difficult to prove that there is cause
and effect.
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Sometimes factors that are so obviously not connected by cause and effect are
correlated, but more often in business, it’s not so obvious. When you see a
correlation from a regression analysis, you can’t make assumptions, says
Redman. Instead, “you must go out and see what’s happening in the real world.
What’s the physical mechanism that’s causing the relationship?” Observe
consumers buying your product in the rain, talk to them, and find out what is
actually causing them to make the purchase. “A lot of people skip this step, and
I think it’s because they’re lazy. The goal is not to figure out what is going on in
the data but to figure out is what is going on in the world. You must pound the
pavement,” he says.

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Redman wrote about his own experiment and analysis in trying to lose
weight and the connection between his travel and weight gain. He noticed that
when he traveled, he ate more and exercised less. Was his weight gain caused
by travel? Not necessarily. “It was nice to quantify what was happening, but
travel wasn’t the cause. It may be related,” he says, but it’s not like his being on
the road put those extra pounds on. He had to understand more about what was
happening during his trips. “I’m often in new environments, so maybe I’m
eating more because I’m nervous.” He needed to look more closely at the
correlation. And this is his advice to managers: Use the data to guide more
experiments, not to make conclusions about cause and effect.
What Mistakes Do People Make When Working with Regression Analysis?
As a consumer of regression analysis, you need to keep several things in mind.
First, don’t tell your data analysts to figure out what is affecting sales. “The way
most analyses go haywire is the manager hasn’t narrowed the focus on what he
or she is looking for,” says Redman. It’s your job to identify the factors that you
suspect are having an impact and ask your analyst to look at those. “If you tell a
data scientist to go on a fishing expedition, or to tell you something you don’t
know, then you deserve what you get, which is bad analysis,” he says. In other
words, don’t ask your analysts to look at every variable they can possibly get
their hands on all at once. If you do, you’ll probably find relationships that don’t
really exist. It’s the same principle as flipping a coin: Do it enough times and
you’ll eventually think you see something interesting, like a bunch of heads all
in a row.
Also keep in mind whether you can do anything about the independent variable
you’re considering. You can’t change how much it rains, so how important is it
to understand that? “We can’t do anything about weather or our competitor’s
promotion, but we can affect our own promotions or add features, for example,”
says Redman. Always ask yourself what you will do with the data. What actions
will you take? What decisions will you make?

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Second, “analyses are very sensitive to bad data,” so be careful about the data
you collect and how you collect it, and know whether you can trust it. “All the
data doesn’t need to be correct or perfect,” explains Redman, but consider what
you will be doing with the analysis. If the decisions you’ll make as a result
don’t have a huge impact on your business, then it’s OK if the data is “kind of
leaky.” But “if you’re trying to decide whether to build 8 or 10 of something
and each one costs $1 million to build, then it’s a bigger deal,” he says. The
chart below explains how to think about whether to act on the data.

See more HBR charts in Data & Visuals 

Redman says that some managers who are new to understanding regression
analysis make the mistake of ignoring the error term. This is dangerous because
they’re making the relationship between something more certain than it is.
“Oftentimes the results spit out of a computer and managers think, ‘That’s great,

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let’s use this going forward.’” But remember that the results are always
uncertain. As Redman points out, “If the regression explains 90% of the
relationship, that’s great. But if it explains 10%, and you act like it’s 90%, that’s
not good.” The point of the analysis is to quantify the certainty that something
will happen. “It’s not telling you how rain will influence your sales, but it’s
telling you the probability that rain may influence your sales.”
The last mistake that Redman warns against is letting data replace your
intuition.
“You always have to lay your intuition on top of the data,” he explains. Ask
yourself whether the results fit with your understanding of the situation. And if
you see something that doesn’t make sense, ask whether the data was right or
whether there is indeed a large error term. Redman suggests you look to more-
experienced managers or other analyses if you’re getting something that doesn’t
make sense. And, he says, never forget to look beyond the numbers to what’s
happening outside your office: “You need to pair any analysis with real-world
study. The best scientists — and managers — look at both.”
Predictive Modeling Explained
Predictive modeling is a predictive analysis tool. It is widely used by companies to determine
the viability of a new venture, project, or proposal. It applies statistical and analytical tools
for analyzing current data and historical data and determines future outcomes.
Businesses employ this tool to forecast earnings, sales, expenses, commercial success,
and economic growth. This tool facilitates the identification of future risks and the
formulation of corrective measures to limit the damage.
Some of the common predictive models used by analysts are as follows:
1. Clustering Model: This method groups gathered data into clusters based on similar
attributes or characteristics. Analysts analyze the behavior of the whole group to
determine future outcomes.
2. Classification Model: Analysts classify new data into a similar pre-defined category
to predict results. 
3. Outliers Model: In the outlier model, analysts check whether certain data falls
outside the usual pattern of behavior to detect frauds and abnormal behaviors.

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 4. Forecast Model: It is one of the most common predictive analytics models; analysts
perform various mathematical calculations and scan through historical records to
predict future outcomes.
5. Time Series Model: Time series models look at historical data and identify patterns
in the past data to arrive at a point in the future. Since historical data show patterns, it
becomes evident that future data must also depict a pattern. A time series is used to
crack future patterns; to ensure minimal deviance between calculations and real-world
outcomes.
The biggest challenge in predictive analytics is gathering relevant data. It involves extensive
analysis of the available information—analysts require advanced skills, adequate experience,
and constant learning. It is important to note that forecasts are prone to human error and
personal bias.
Techniques
The following techniques are used in predictive modeling:
1. Linear Regression: When two continuous variables depict a linear relationship,
a linear regression can be used to determine the value of the dependent variable—
based on the independent variable.
2. Multiple Regression: This is similar to linear regression, except the value of
the dependent variable is evaluated by analyzing multiple independent variables.
3. Logistic Regression: It is used for ascertaining dependent variables when the data set
is large—requiring categorization.
4. Decision Tree: This method is commonly used for data mining. A flowchart
representing an inverted tree is formulated. Here the internal node splits into branches
that list out two or more possible decisions, and each decision is further subdivided—
to show other possible outcomes. This technique helps in selecting the best option.
5. Random Forest: It is a popular regression and classification model. It is used for
solving machine learning algorithms. It comprises multiple decision trees—not
correlated to each other. These decision trees collectively facilitate the analysis.
6. Boosting: As the name suggests, this method facilitates learning from the results of
other models—decision tree, logistic regression, neural network, and support vector
machine.
7. Neural Networks: It is a problem-solving mechanism used in machine learning and
artificial intelligence. It develops a set of algorithms for a computational learning
system. These algorithms comprise three layers—input, processing, and output.

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Examples
Let us look at some examples to understand predictive modeling.
#1 – Insurance Sector
Insurance companies use various predictive techniques to evaluate premium values,
maximize profits, identify frauds, and improve claim settlement processes. For instance, a
vehicular insurance company analyzes vehicles’ conditions and applies various algorithms to
determine the applicable premium amount.
#2 – Finance and Banking Industry
Before extending a loan, banks use prediction models to review borrowers’ credit scores—to
verify credibility, background, and previous defaults. It helps predict the chances of fraud,
misrepresentation, and risks involved with a particular client.
#3 – Marketing and Retail Sector
When a business runs a marketing campaign, it uses predictive modeling techniques to
anticipate campaign success. Predictive analysis also gauges target audience and future sales.
In the retail sector, predictive analyses provide, forecasts based on which businesses decide
the required inventory for each certain product. Projections help decide how much stock
volume is required to meet future demands—pertaining to a particular product.
#4 – Weather Forecast
Predictive modeling methods like a decision tree and linear regression forecast weather
changes and natural calamities—thunderstorms, cyclones, and tsunamis. These models can
ascertain the wind direction and wind speed of storms. Thus, these models are used to alert
inhabitants of an area.
Frequently Asked Questions (FAQs)
What are predictive modeling techniques?
These techniques discover future trends, behaviors, or future patterns based on the study of
present and past information. Cecision tree, linear regression, multiple regression, logistic
regression, data mining, machine learning, and artificial intelligence are some common
examples of predictive analytics techniques.
How does predictive modeling work?
These prediction models apply analytical and data mining techniques to historical data and
current data and determine future outcomes.
Is predictive modeling machine learning?
Predictive modeling is not the same as machine learning. Predictive analysis is a process that
uses mathematical techniques to anticipate future outcomes. Machine learning, on the other

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hand, applies cognitive learning techniques to develop computer science models and complex
algorithms.
How is predictive analytics used in business?
Predictive analytics is an essential tool used in financial forecasts. Companies use these
projections to ascertain the financial viability of long-term projects. Businesses also use
predictive analysis to forecast future sales, future profits, and future expenses. Based on these
projections, crucial managerial decisions are taken. Moreover, these methods are used to
foresee potential risks and uncertainties in the future to minimize loss.
Decision Trees and Random Forests
Decision trees are a type of model used for both classification and regression.
Trees answer sequential questions which send us down a certain route of the tree
given the answer. The model behaves with “if this than that” conditions
ultimately yielding a specific result. This is easy to see with the image below
which maps out whether or not to play golf.

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The flow of this tree works downward beginning at the top with the outlook. The
outlook has one of three options: sunny, overcast, or rainy. If sunny, we travel
down to the next level. Will it be windy? True or false? If true, we choose not to
play golf that day. If false we choose to play. If the outlook was changed to
overcast, we would end there and decide to play. If the outlook was rainy, we
would then look at the humidity. If the humidity was high we would not play, if
the humidity is normal we would play.
Tree depth is an important concept. This represents how many questions are
asked before we reach our predicted classification. We can see that the deepest
the tree gets in the example above is two. The sunny and rainy routes both have
a depth of two. The overcast route only has a depth of one, although the overall
tree depth is denoted by its longest route. Thus, this tree has a depth of two.
Advantages to using decision trees:
1. Easy to interpret and make for straightforward visualizations.
2. The internal workings are capable of being observed and thus make it possible
to reproduce work.
3. Can handle both numerical and categorical data.
4. Perform well on large datasets
5. Are extremely fast
Disadvantages of decision trees:
1. Building decision trees require algorithms capable of determining an optimal
choice at each node. One popular algorithm is the Hunt’s algorithm. This is a
greedy model, meaning it makes the most optimal decision at each step, but does
not take into account the global optimum. What does this mean? At each step the
algorithm chooses the best result. However, choosing the best result at a given
step does not ensure you will be headed down the route that will lead to the
optimal decision when you make it to the final node of the tree, called the leaf
node.

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2. Decision trees are prone to overfitting, especially when a tree is particularly
deep. This is due to the amount of specificity we look at leading to smaller
sample of events that meet the previous assumptions. This small sample could
lead to unsound conclusions. An example of this could be predicting if the
Boston Celtics will beat the Miami Heat in tonight’s basketball game. The first
level of the tree could ask if the Celtics are playing home or away. The second
level might ask if the Celtics have a higher win percentage than their opponent,
in this case the Heat. The third level asks if the Celtic’s leading scorer is
playing? The fourth level asks if the Celtic’s second leading scorer is playing.
The fifth level asks if the Celtics are traveling back to the east coast from 3 or
more consecutive road games on the west coast. While all of these questions
may be relevant, there may only be two previous games where the conditions of
tonights game were met. Using only two games as the basis for our classification
would not be adequate for an informed decision. One way to combat this issue is
by setting a max depth. This will limit our risk of overfitting; but as always, this
will be at the expense of error due to bias. Thus if we set a max depth of three,
we would only ask if the game is home or away, do the Celtics have a higher
winning percentage than their opponent, and is their leading scorer playing. This
is a simpler model with less variance sample to sample but ultimately will not be
a strong predictive model.
Ideally, we would like to minimize both error due to bias and error due to
variance. Enter random forests. Random forests mitigate this problem well. A
random forest is simply a collection of decision trees whose results are
aggregated into one final result. Their ability to limit overfitting without
substantially increasing error due to bias is why they are such powerful models.
One way Random Forests reduce variance is by training on different samples of
the data. A second way is by using a random subset of features. This means if we
have 30 features, random forests will only use a certain number of those features
in each model, say five. Unfortunately, we have omitted 25 features that could

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be useful. But as stated, a random forest is a collection of decision trees. Thus, in
each tree we can utilize five random features. If we use many trees in our forest,
eventually many or all of our features will have been included. This inclusion of
many features will help limit our error due to bias and error due to variance. If
features weren’t chosen randomly, base trees in our forest could become highly
correlated. This is because a few features could be particularly predictive and
thus, the same features would be chosen in many of the base trees. If many of
these trees included the same features we would not be combating error due to
variance.
With that said, random forests are a strong modeling technique and much more
robust than a single decision tree. They aggregate many decision trees to limit
overfitting as well as error due to bias and therefore yield useful results.
Social Responsibility and Ethics
Volunteers erect a wooden frame structure.
From increased productivity to attracting top talent, there are numerous benefits
to adding social responsibility initiatives within an organization. It also allows
you to improve your organization's overall reputation, which can open doors for
unlimited new opportunities. Choosing which initiative is most appropriate for
your organization requires careful consideration, as the endeavor can become
costly.
In this article, we discuss social responsibility, how social responsibility and
ethics are closely connected and the advantages and disadvantages of social
responsibility. We also cover a variety of examples of social responsibility that
many companies are choosing to initiate.
Key takeaways:
Social responsibility refers to an individual or corporate accountability to fulfill
their civic duty and take actions that will benefit society.
Socially responsible company managers make decisions that maximize profits
and protect the interests of the community and society as a whole.

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Providing time for employees to support their own social initiatives can also
build pride, loyalty and motivation among team members.
What is social responsibility?
Social responsibility is an ethical framework in which individuals or
corporations are accountable for fulfilling their civic duty and taking actions
that benefit society. If a company or person considers taking actions that could
harm the environment or society, those actions are considered socially
irresponsible. According to this concept, managers must make decisions that
maximize profits and protect the interests of the community and society as a
whole.
Social responsibility and ethics
Ethics refers to a set of moral principles that govern a company's or person's
behavior. Companies should incorporate ethics into their daily actions,
particularly those decisions that affect other people or the environment. A code
of social responsibility and ethical conduct should be applied within an
organization and during interactions with others outside the company. As long
as a company upholds strong ethical standards and maintains social
responsibility, the environment and employees are held as equals to the focus on
profitability. However, government interference is often necessary if the
company ignores its ethical standards and takes socially irresponsible actions,
such as disregarding environmental regulations to increase profitability.
Hand holds a representation of the earth with 8 circles surrounding it
Advantages of social responsibility
There are several advantages when a company chooses to be socially
responsible, such as:
Gives a company a competitive edge
Most customers agree that social responsibility is a top criterion when choosing
a company to shop with or do business with. Being a socially responsible
company is a message you can use in your brand position and marketing.

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Attracts strong candidates and increases retention
Your company's success is strongly impacted by the people who work for you.
If you consistently provide a socially responsible culture for your employees
and have a reputation for doing so, you can attract and retain top talent to your
organization.
Human Resources: Definition and How It Works
Makes your business attractive to investors
Investors generally believe that a commitment to social change is a great way to
position a company for long-term success. While there must be a balancing act
between focusing on the profitability of an organization and social initiatives,
doing so successfully can create endless opportunities for companies.
Improves business culture
Your employees are likely to be more motivated and have a greater commitment
to the organization if they see the social initiatives are in place. Providing time
for employees to support their social initiatives can also build pride, loyalty and
motivation among team members. This, in turn, makes everyone more engaged
and productive.
Related: Tips To Demonstrate Work Ethic
Increases customer loyalty and advocacy
Consumers are drawn to companies with a reputation for being good corporate
citizens. Moreover, customer advocacy is key to attracting new customers. As
your loyal customers talk to people they know about your product and share
positive reviews, they will drive more business your way.
Improves company reputation
If your organization is continually participating in social initiatives, it gives an
impression to customers, investors and the world as a whole that your
organization is financially viable. This, in turn, can attract new investors and
investors alike.
Improves profitability and value

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Companies often find that when they introduce more energy-efficient methods
and begin recycling, they cut operational costs and benefit the environment.
Social responsibility also increases transparency with investment analysts,
shareholders and community members, improving the company's reputation and
increasing the overall value.
Disadvantages of social responsibility
While corporate social responsibility is generally advantageous for
organizations, there are a few drawbacks. Here are the primary disadvantages to
consider:
Costs money to implement
While large organizations can afford to allocate a budget to corporate social
responsibility reporting, this can be financially taxing on smaller organizations.
While smaller companies can use social media to share any social responsibility
policies or initiatives with customers and community members, monitoring
these channels takes time and resources. It may require the company to hire
extra employees to manage the process effectively, which can be challenging for
small businesses.
Impacts profitability
A company has a fiduciary duty to its shareholders and costly social
responsibility initiatives can impact this directly. This conflict can be
challenging for managers, who may feel compelled to choose between socially
responsible decisions or initiatives and focusing on the company's profitability.
Greenwashing
In some cases, social responsibility initiatives have been used to improve a
company's image even though no real change has been made. For this reason,
it's important to consider what social responsibility initiatives you will take and
evaluate the impact they will have on the organization.
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Examples of social responsibility in corporations
Here are a few examples of corporate social responsibility initiatives that
companies have taken:
Charitable giving and volunteer efforts: Companies give employees time off for
volunteering every year and donate portions of revenue to a charitable
organization.
Changes to company policies to improve or benefit the environment:
Companies are holding tree-planting events, minimizing paper waste, switching
to energy-saving bulbs, setting up recycling bins and allowing remote work to
reduce the negative impact of commuter traffic.
Improving labor policies and embracing fair trade: Brands are striving to
improve working conditions and the well-being of employees. They are giving
parents significant periods of paid leave, unlimited vacation time, more natural
lighting, soft seating and plants to boost energy and morale.
ETHICAL DECISION MAKING
Ethical Decision Making: this short article explains Ethical Decision
Making in a practical way. Next to what it is (definition), this article also
highlights the framework or models, the roadmap and process. Enjoy reading!
What is ethical decision making?
Definition
Ethical decisions inspire trust and with it fairness, responsibility and care for
others. The ethical decision making process recognizes these conditions and
requires reviewing all available options, eliminating unethical views and
choosing the best ethical alternative.
Good decisions are both effective and ethical. In professional relationships,
good decisions build respect, trust, and are generally consistent with good
citizenship. Effective decisions are effective when they achieve what they were
made for. A choice that produces unintended results is ineffective and therefore
not good.

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The key to making good decisions is to think about the different choices that lie
ahead in order to achieve the objectives. For that reason, it is also very
important to understand the difference between short-term vs. medium to long
term objectives.
Making ethical decisions requires a certain sensitivity to ethical issues and a
method of examining all the considerations associated with a decision. Having a
method or structure for making ethical decisions is therefore essential. After this
process has been performed a few times, the method is trusted and it is easier to
walk through the steps.
Below is a description of ethical decision-making methods.
Framework, model and methods for ethical decision making
If ethics is not based on religion, feelings, law, social practices or science, what
is it based on? Countless philosophers and ethicists have attempted to answer
this critical question. At least five different ethical norms or standards have
been proposed. The most important are explained below.
The Utilitarian Approach
This approach dictates that the action that is the most ethical is the action that
produces the most good and causes the least harm. In other words, the decision
that strikes the greatest balance between good and evil.
In a business environment, it is therefore the decision that yields the most
benefits and causes the least damage to customers, employees, shareholders, the
environment, etc.
The Right Approach
The right approach suggests that the most ethical decision is the one that best
protects and respects the moral rights of all concerned. This approach argues
that people have a dignity based on human nature or their ability to freely
choose what they want to do with their lives.
Based on that dignity, they have the right to be treated equally by others and not
just as a means to an(other) end.

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The Fairness or Justice Approach
All equals should be treated equally. The Greek philosopher Aristotle and others
contributed to that idea. Today, this idea is used to indicate that ethical
decisions treat everyone equally. If not equal, this must be based on a standard
that is explainable.
People are paid more for their hard work when they contribute more to the
organization. That is fair. But many wonder whether the salaries of CEOs, some
100 times higher than others, are fair. Is this standard defensible?
The Common Good Approach
The Greek philosophers also contributed to the idea that living in a community
is a good thing. People’s actions and actions must contribute to this. This
approach suggests that relationships within society are the basis of ethical
reasoning and acting. Respect and compassion for all others, especially the
vulnerable, are prerequisites for maintaining an ethical way of life.
The Virtue Approach
An ancient approach to ethics is the belief that acting ethically must be in
accordance with certain virtues that ensure the development of humanity in
general. Virtues are tendencies and habits that enable man to act with the
highest potential of human character.
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INFO
Ethical decision-making process and roadmap
Below is a summary of the roadmap for the ethical decision-making process.
1. Gather the facts
Don’t jump to conclusions until the facts are on the table. Ask yourself
questions about the issue at hand, such as the 5 whys method. Facts are not
always easy to find, especially in situations where ethics plays an important
part. Some facts are not available or clearly demonstrable. Also indicate which
assumptions are made.

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2. Define the ethical issue
Before solutions or new plans can be considered, the ethical issue is clearly
defined. If there are multiple ethical focal points, only the most important
should be addressed first.
3. Identify the stakeholders
Identify all stakeholders. Who are those primary stakeholders? And who are the
secondary stakeholders? Why are they interested in this issue?
4. Identify the effects and consequences
Think about the possible positive and negative consequences associated with the
decision. What is the magnitude of these consequences? And what is the
probability that these consequences will actually occur? Distinguish between
short-term and long-term consequences.
5. Consider integrity and character
Consider what the community thinks would be a good decision in this context.
How would you like it if the national newspaper wrote about your decision?
What is public opinion? How does your character and personality influence the
decision to be made?
6. Get creative with potential actions
Are there other choices or alternatives that have not yet been considered? Try to
come up with additional solutions or choices if a small number is considered.
7. Decide on the right ethical action
Consider the options based on each option’s consequences, duties, and character
aspects. Which arguments are most suitable to justify the choice?

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