Friday, February 5, 2016
Breaking the Limits of Bounded Rationality
Bounded Rationality, developed by Nobel Prize winning economist Herbert Simon, states that human beings have limitations on their abilities to make decisions within given circumstances. We are limited by our cognitive abilities, the information they have and the amount of time we need to make a decision. When under pressure to act people inaccurately make decisions that lead to poor outcomes.
The study of bounded rationality is important for anyone who needs to make important decisions. Whether one is in the military or an executive, understanding the bounds of our rationality makes a big difference in determine our best course of action in difficult situations. As decision-making increases so does our ability to create optimal outcomes through better choices.
All decisions are goal-directed and seek to maximize opportunities while reducing risk. From an economic perspective, all actors make decisions that put themselves in the most advantageous position. Only when they don't have the right information, ability to understand, or time to make a decision does the less than optimal outcomes occur. Knowing these constraints can also help people make sound decisions that lead to increasingly opportune results.
Information, Intelligence and Time
People are bound because they are not "all knowing" and live in an environment that doesn't provide them with all the answers they need at the time they need them. People are forced to make choices with imperfect information that leads to less than perfect outcomes. The data available to them can be subjective, partial, and in many cases inaccurate.
They are also limited in their knowledge and mental faculties. Intelligent people may be able to make better decisions but they are also limited by their ability to understand their environment and process information quickly. As people become more educated they often increasingly make optimal decisions but are still subject to the constraints of human capacity.
We can't spend our lives making a single decision. As new challenges present themselves we settle on a decision and move forward. Life is a series of decisions that we must meet, accept, decide, and implement on so that we can get onto the business of survival. It makes no difference if you are deciding over employment, relationships, coffee or tea, or life choices because the time mechanics work in much the same way.
Objective rationality occurs when people make decisions that others would understand while subjective rationality happens when you cannot be convinced you made a wrong decision. We can see objective perceptions when it is a reasonable conclusion under the circumstances while someone who is subjective believes they are right under nearly all circumstances.
To avoid subjective reality we must be willing to explore options and alternatives. According to Simon, “The task of decision involves three steps: (1) the listing of all the alternative strategies; (2) the determination of all the consequences that follow upon each of these strategies; (3) the comparative evaluation of these sets of consequences” (1997, p. 67)
People wittingly or unwittingly use decision processes that lead to outcomes. Their objective rationality in a situation is based on knowing 1.) alternative behaviors, 2.) consequences for maximization, and 3.) their values. Thus people will look at all of the potential behaviors, determine the potential consequences of each and make decisions based on their personal values.
Impact on Organizations
Organizations are collectives of people who make tens of thousands of small decisions that lead to organizational success. When information is limited employees may not have the data necessary to make appropriate decisions. It is also possible that lack of organizational identity and time constraints can make day-to-day employee decisions difficult.
It is important to ensure that employees are aware of their roles, have the information to do their jobs well, and are empowered to solve problems as they arise. Employees will be guided by their bounded understandings to decide important issues over the scope of their responsibilities.
Improving decisions requires looking at the flow of information within organizations, the skill development/selection of employees, and the overall incentives within the organization. When factors that lead to better decisions are created employees will be pushed to make better decisions that help optimize work outcomes. They will foster group expectations that can reinforce positive decisions.
A Better Way of Making Decisions
Before making a major decision we should consider the potential outcomes and this takes time. To do this well requires that we do some research and get as much information as possible. For example, if you are going to buy a car a person will research the different types of cars available, assess personal needs, and understand the financial options. Useful information from consumer reports and customer feedback may aid in the selection process.
The same can be said of executives who must explore multiple choices before finalizing a strategic path. The investment costs between two alternative strategies or product lines can be substantial. The quality and quantity of information will determine its usefulness in decision making. Researching each of the alternatives and then assessing the company's capabilities can lead to optimal outcomes.
When faced with a major decision consider the following process to improve decision making:
1. Recognize the problem.
2. Formalize an understanding of the problem.
3. Research the problem.
4. Determine the root cause of the problem.
5. Explore alternate paths and outcomes that overcomes the problem.
6. Compare and contrast possible choices for optimization.
7. Chose the path that has the greatest flexibility and likelihood of success.
8. Maintain the ability to step back or adjust course if unknown issues arise.
9. Reassess the strategy occasionally.