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ECONOMICS 3200B Lecture 11 December 3, 2013

ECONOMICS 3200B Lecture 11 December 3, 2013. Motivation. Decision-making: mistakes and intuition How to select senior officers to dismiss Excessive risk. Strategic Decisions. Going from “Here” to “There” What does “Here” look like? Where is “There” and what does it look like?

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ECONOMICS 3200B Lecture 11 December 3, 2013

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  1. ECONOMICS 3200BLecture 11 December 3, 2013

  2. Motivation • Decision-making: mistakes and intuition • How to select senior officers to dismiss • Excessive risk

  3. Strategic Decisions • Going from “Here” to “There” • What does “Here” look like? • Where is “There” and what does it look like? • Role of incentives in choosing “There” • Multiple paths • Time frame – is “There” the ultimate destination

  4. Key Decisions • How much to invest (what happens if company does not invest?): • Marketing • Product development • Training • Supplier relations • Production capacity and capabilities • How to spend the money? • Time frame

  5. Forward Looking • Essence of decision-making: forward looking – based on guesses/assumptions, analysis • Known-knowns • Known-unknowns • Unknown-knowns • Unknown-unknowns Mistakes inevitable!

  6. Intuition Clouseau: Listen to me, Hercule, and you will learn something. Now then, the facts in this case are: the body of the chauffeur was found in the bedroom of the second maid. Fact! Cause of death: Four bullets in the chest. Fact! The bullets were fired at close range from a .25 caliber Beretta automatic. Fact! Maria Gambrelli was discovered with the murder weapon in her hand. Fact! The murder weapon was registered in the name of the deceased, Miguel Ostos, and was kept, mind you, in the glove compartment of the Ballon Rolls-Royce. Fact! Now then, members of the household staff have testified that Miguel Ostos beat Maria Gambrelli frequently. And now, finally comes the sworn statement of Monsieur and Madame Ballon, as well as all the members of the staff, each of them with perfect alibis. Now then, Hercule, What is the inescapable conclusion? Hercule LaJoy: Maria Gambrelli killed the chauffeur. Clouseau: What? You idiot! It's impossible. She's protecting someone. Hercule LaJoy: How do you know that? Clouseau: Instinct! Hercule LaJoy: But that facts...

  7. Mistakes • Lesson: Must be tolerant of mistakes • Questions: • How many mistakes to tolerate (Board, CEO, other members of senior management team) • How to recognize a mistake? • What to do?

  8. Digression: Investment Decisions • Basis for any investment decision: critical component of strategic decisions in moving from “Here” to “There” • Traditional academic investment criterion: make investment if PV of incremental cash flows ≥ cost of investment (I) • Where do incremental cash flows come from? • Implications for corporate tax policy

  9. Digression: Investment Decisions • Risks: • Confidence in guesses – distribution of possible outcomes • Confidence in guesses re. probability distributions • Size of bet – probability of bankruptcy • Investment criterion: PV/I > X (X>1) • The larger is X, the greater the margin for error • The less confidence, the greater should be the margin for error • The larger the size of the bet, the greater should be the margin for error

  10. Digression: Investment Decisions • Two problems • For public companies, shareholders may want company to go all-in (bet the company) • Investment decisions are integral part of the strategy – selection of the path from “Here” to “There” and the time frame; hence incremental cash flows must include losses if company fails to make investment and fully execute the strategy

  11. Strategic Decisions • What is the basis for selecting the preferred path and the associated investments?

  12. Selecting the Path • Need to know competitive strengths/weaknesses – what “Here” looks like • Need to know competitors – who are they, now and in the future • Need to know strengths and weaknesses of all competitors – what “Here” looks like • Need to know strategic actions/re-actions of competitors • Need to predict macro-economic environment – locally, globally • Time frame and options

  13. Recognizing Mistakes • How to recognize when the strategic decision is a mistake? • Break grand strategy into projects • Milestones -- dashboards • Financial results • Bottlenecks • Periodically re-visit original guesses/assumptions – frequency?

  14. Contingency Planning • Be prepared to change course, including selecting a new “There” • Important to have developed contingency plans at outset – what are your plans B, C, etc. • Decision rules to decide when to change strategy and direction and what alternative to select

  15. Wrap-up • At the end of the day – combination of sound analysis and intuition (individual and collective) • What data; how much data; what types of analysis, by whom? • Can’t get carried away with spreadsheets and pseudo-scientific analysis • Can’t wait to become fully informed – at what point do you make a decision? • Mistakes inevitable – speed of recovery and success of alternatives critical

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