The goals of the firm, as set by the top management and approved by the board of directors, have to be implemented by decisions.
Decisions are taken at various levels of administration (or hierarchy). We will distinguish two levels of decision-making decisions at the level of top management and decisions at lower levels of administration.
1. The decision-making process at the level of top management:
Given the goals of the firm and the resources available, the allocation of these resources to the various departments is decided by the top management and is implemented by the budget. Each department is allocated a certain proportion of the budget, the share of the budget depending mainly on the bargaining power and skill of the head of each department.
The bargaining power is to a large extent determined by the past performance of the particular department, how well it has attained its targets as set by the top management, how well the department’s work was internally coordinated, how efficiently the past budget of this department was used up. The bargaining skill, while affected by past achievement, is basically an inherent attribute of the various managers and executives, of education and experience.
The heads of sections present demands to the top management and by bargaining they attempt to secure as large as possible a share of the firm’s total budget. Their ability in deciding which projects (demands), and at what time to present them to the top management, is crucial. This process determines the internal allocation of most of the resources. Of course the top management always retains some funds for allocation at its own discretion at any point of time to the best of its judgement and ability.
The top management examines and decides on the propositions (projects) presented to it by the managers. The top management, given the limits of time, information and its computational abilities, behaves in a ‘limited’ rational way. It examines any one project on its own merits, by comparing it perhaps with one or two other alternatives aiming at the solution of the same target-problem. No comparison of all possible alternatives is ever attempted.
The top management does not seek information on all possible alternatives since this information is not costless. Whenever a problem is detected a few alternatives are roughly screened and examined. No detailed cost-benefit studies are normally undertaken. Two crude criteria are set for the evaluation of any particular proposal.
The first is budgetary (financial) criterions are there funds available for the realization of the proposed project? The second is an ‘improvement criterion’ does the project being proposed improve the existing situation beyond doubt? If these two criteria are satisfied the top management may approve the project without further considering whether there exist other alternative solutions superior to the one proposed.
In the above decision process, information is required to facilitate the decision-makers. Information activity is problematic in the behavioural theories. That is, a search is made whenever a problem is identified. Information flow is not costless, as the traditional theory of the firm assumed. Furthermore a search is not made on marginalistic rules, as the neoclassical theory postulated.
Economists have eventually recognised that information is not costless, but they have treated the information search as another resource-absorbing activity, which is undertaken and carried out up to the point at which the marginal cost of the information flow is equated to the marginal benefit which would accrue to the firm from the acquisition of the information.
Cyert and March, following Simon, postulate that search is not undertaken on such marginalistic rules, but is directed to the particular area in which some problem appears. Decision-making in general reflects heavily a response of the management to local problems of pressing needs. For example, if sales are dropping, search will be concentrated on the sales department to find out the causes of the shrinking market share and find methods for sales promotion.
If frequent breakdowns in the production flow occur, search will be directed to the production side of the firm and information will be obtained as to the causes of the breakdowns in order to find the ‘best’ possible remedial action. Search is undertaken when and where a problem arises.
Information determines demands of the groups, which, in turn, determine the setting of goals by the top management. Information also affects expectations and hence demands and goals. Thus the role of the flow of information is very important in internal resource allocation. As the search for information is conducted and the results flow from the several sections of the firm, the information is affected by what is known as ‘position bias’.
This bias originates from the desire of the various managers for security and power in the organisation. Production managers tend to give high estimates of costs, so as to be ‘on the safe side’: if costs ex post are lower than the ex ante estimate the position of the production manager is ‘favourable’ as compared with the situation in which realized costs exceed estimated costs.
Sales managers tend to give conservative estimates of expected sales for similar reasons and considerations. In general, staff in the production section tend to acquire an ‘upward bias’ for costs, but presumably a ‘downward bias’ for output, while staff related to the sales section tend to give a ‘downward bias’ for sales, but an ‘upward bias’ for sales costs, which is reflected in their conservative forecasts.
This ‘position bias’ affects information, expectations, demands and ultimately the goals of the firm. Furthermore, the flow of information from one section or member to another is far from perfect. Information may be withheld or distorted as it passes through different sections of the organisation.
In summary; the decisions at the level of top management are not taken on a complete and exhaustive examination of all possible (not even of all known) alternatives, nor are they based on detailed cost-benefit studies, or application of marginalistic rules. Rather the top management undertakes a quick screening of the most promising alternatives and then directs more search for further information on the ‘best’ of these solutions.
Four points are stressed by the behavioural theories regarding the search activity: search is problem oriented, it is not costless, it may be biased due to ‘position bias’, and its flow within the organisation is not always smooth. The final decision on any particular project is based normally on two simple evaluation criteria, a ‘financial and an ‘improvement’ criterion.
2. Decisions at lower levels of management (administration):
The decision process at lower levels of administration involves various degrees of freedom of action. Once the budget-shares are allocated, each manager has normally considerable discretion in spending the funds allocated to his department. The routine sales strategy may be decided by the sales manager and his subordinates; the organisation of labour ‘on the floor’ is decided by the production manager, and so on.
However, all the routine, day-to-day decisions are simplified by delegation of authority within each section and by simple rules which form the ‘blue-print’ of the organisation. For example, to facilitate the calculations involved in costing and pricing the ‘blue-print’ may include a directive-rule to the relevant department, that the price will be set at the level defined by the average direct cost plus a certain gross profit margin (for example, 10 per cent on the direct cost).
This is the rule of ‘average cost pricing,’ which helps employees in their computations, but does not allow them any initiative in deciding the final level of price. Final price decisions are the concern of the top management, which takes into account various factors.
These decisions are subsequently ‘translated’ into simple rules-of-thumb which, when applied at the lower level of administration, result in a price ‘range’ which is consistent with the decision of the top management. Similarly the ‘blue-print’ may include the rule-of-thumb that costs should be increased by, say, 5 per cent if over two or three successive periods the target profit has been attained or overshot (in order to cover probably increased slack payments).
The administrative staff, at lower levels of the hierarchy ‘learn’ by experience, and are helped by such ‘blue-print’ rules in making their decisions. The execution of the budget in each period provides invaluable experience. The staff ‘learn’ by the mistakes and successes of the past. The whole firm is an adoptively rational system. Measures which failed in the past are unlikely to be adopted again, while measures which worked successfully are likely to be adopted again. The top management has the budget and the balance sheet of each section and uses these as controlling devices for the lower levels, on top of various other ‘policing’ techniques (for example, employment of supervisors).