Bounded Rationality and Heuristics - Essay Example

Managerial Economics Module Assignment Table of Contents Portfolio Task One: Bounded Rationality and Heuristics 3 1 Introduction 31.2 Effectiveness of Bounded Rationality 3 1.3 Evaluation of the use of Heuristics in decision-making process 5 1.4 Conclusion 6 Reference List 8 2.Portfolio Task Two: Roadside Catering Market 9 2.1 Introduction 9 2.2 Justification for the identification of the Market Structure 9 2.3 Evaluation of the strategies used by the Roadside Catering Market 13 2.4 Conclusion 15 Reference List 16 1. Portfolio Task One: Bounded Rationality and Heuristics 1.1 Introduction Rationality denotes a particular behaviour within an individual that is particularly needed for achieving a goal despite the presence of conditions and binding constraints (Hatchuel, 2001). However, the theories of rationality may be normative or it can be descriptive depending on the concept related to the rationality. These theories state the behaviour of the people under the given conditions and in order to achieve the objectives within the organization. Herbert Simon who was considered as the self proclaimed philosopher of bounded rationality tried to develop a theory of bounded rationality. Rationality is considered as an important aspect of the behavioural theory (Simon, 2001). There is a distance between the behaviour and rationality and they are connected by the concept of decision making. A decision making process is common in an organization where the managers have to take various decisions in order to achieve the mission of the organization (Ethiraj and Levinthal, 2004). The aim for this paper is to evaluate the effectiveness of bounded rationality and the critical analysis of how the heuristics creates biasness towards decision making. The research would offer a scope to have a detailed analysis of bounded rationality as explained by Herbert Simon. 1.2 Effectiveness of Bounded Rationality According Herbert Simon (1961), rationality in behavioural characteristics of a person considers a relation of efficacy between the presumed end and the means to reach them (Kahneman, 2003). According to the researcher, the human beings lack in their rational behaviour due to the different aspects that is the rationality requires knowledge as well as understanding of the situation. However, the decision makers cannot be always called as rational because since they are likely to take decisions based on the available data and are unable to incorporate new information within their decision making process. According to the researcher, the organization must have a clear organizational goal so that the employees can work hard in order to achieve the goal (Simon, 2001). The organizations would have benefits for developing the organizational goals that helps in the organizational decision making process. It is said when the organizational members experience bounded rationality, managing the situations becomes much more difficult and the organizations are supposed to use both formal and informal control mechanisms in order to make the employees perform rationally (Simon, 2001). A theory of rational behaviour involves both the rationality of the individual as well as the rationality of the organization. One of the main differences between the two theories is that the theory of the organizational rationality must deal with a goal conflict but there is no such conflict in case of the individuals (Korobkin, 2003). According to the researcher, the organizations are expected to develop clear organizational goals for the employees such that they can work in order to achieve these goals (Gigerenzer, 2004). These goals must depend on the decision making process of the organization and also need to consider what is acceptable for the benefit of the organization. A researcher says that the organizations would find it to be beneficial to develop as well as communicate their organizational goals (Ethiraj and Levinthal, 2004). This might help the employees to plan their process as well as the managers can formalise the structure of the organization according to the goal to be achieved. However, when the members of the organization suffers from bounded rationality, managing as well as organizing becomes difficult and the organizations are expected to provide the control mechanisms to make the managers and the employees of the organization perform efficiently within the organization (Ethiraj and Levinthal, 2004). Bounded rationality considers the way in which the managers make decisions within an organization. It further considers the limitations of the decision maker in terms of information as well as the cognitive capacity of the manager to make decisions. This phenomenon challenges the perspectives of the traditional rationalist and says that the rationality reflected by actual human beings and the company is always partial or it is bounded by the inefficiencies of human beings. It indicates that the decision making takes place in the presence of uncertainty as well as incomplete information. Most people are considered to be partly rational, whereas, they are mostly irrational in the remaining part of their decision making process (Mullainathan, 2002). They face restrictions in the process of solving complex problems mainly due to the incomplete information available to them or due to their incapability in making rational decisions. 1.3 Evaluation of the use of Heuristics in decision-making process Heuristics are considered as efficient cognitive processes that does not consider the full and relevant information. According to a researcher, since heuristic decision making does not depend on relevant information, there are errors in the decision making process compared to the rational decisions that are generally made based on the analysis carried out using statistical models (Ethiraj and Levinthal, 2004). Heuristics involves in the reduction of efforts and using less information and also it examines fewer alternatives. It ignores the part of relevant information with an aim of making decision more quickly and without using any complex procedure (Dequech, 2001). The classical explanation suggests that the people save time by participating in the heuristic decision making process instead of going through complex processes of following statistical models and carrying out a detailed analysis. However, there is an uncertainty involved in the process. The choice of heuristic decision making process made by the people depends on the theme on which the decision is to be made because it is not worthwhile to spend time in every decision making (Jones, 2003). So according to the researcher, depending on the Heuristic decision making process can be considered as rational in case where the cost of efforts put in are higher than the gain from accuracy of the work (Simon, 2000). These are considered as cognitive shortcuts or the rules of thumb using which the people make their own decisions without considering the relevant information. The main reason for such heuristic practices is the lack of cognitive information in order to carry out the decision making process efficiently (Ethiraj and Levinthal, 2004). Although these are practiced everyday, yet ignoring the part of relevant information results in systematic biases and in turn leads to sub-optimal decisions. For example, the use of heuristic decision making process may affect the court judges and there may be biases in the decisions made by them. 1.4 Conclusion Rationality is an important concept that affects the decision making process of the individual as well as the organization. The concept of organizational rationality depends on the goals of the organization. The organization must clearly set their goals and communicate them with the managers as well as the employees so that the employees can work hard in order to achieve the goals of the organization. However, the managers within the organization must be rational in making their decisions related to the organization. According to the researcher, the bounded rationality is a concept that deals with the way in which the managers take their decisions. Often there are cases when the managers take their decisions without considering the full and relevant information. There lies an uncertainty in their decision making process. There is a tendency of the managers to reduce the time and efforts required for the decision making and hence they adopt a heuristic process of making decisions. Heuristic process often leads to a bias as it does not consider the entire information needed to carry out the evaluation. Thus, the heuristic process differs from rationality. However, there are some cases where the individuals as well as the organization prefer to make heuristic decisions in order to save time and cost. Reference List Dequech, D., 2001. Bounded rationality, institutions, and uncertainty. Journal of economic issues, pp. 911-929. Ethiraj, S. K. and Levinthal, D., 2004. Bounded rationality and the search for organizational architecture: An evolutionary perspective on the design of organizations and their evolvability. Administrative Science Quarterly, 49(3), pp. 404-437. Gigerenzer, G., 2004. Fast and frugal heuristics: The tools of bounded rationality. Blackwell handbook of judgment and decision making, pp. 62-88. Hatchuel, A., 2001. Towards design theory and expandable rationality: the unfinished program of Herbert Simon. Journal of management and governance, 5(3), 260-273. Jones, B. D., 2003. Bounded rationality and political science: Lessons from public administration and public policy. Journal of Public Administration Research and Theory, 13(4), pp. 395-412. Kahneman, D., 2003. Maps of bounded rationality: Psychology for behavioral economics. American economic review, pp. 1449-1475. Korobkin, R., 2003. Bounded rationality, standard form contracts, and unconscionability. The University of Chicago Law Review, pp. 1203-1295. Mullainathan, S., 2002. A memory-based model of bounded rationality.Quarterly Journal of Economics, pp. 735-774. Simon, H. A., 2000. Bounded rationality in social science: Today and tomorrow. Mind and Society, 1(1), pp. 25-39. Simon, H., 2001. On simulating Simon: his monomania, and its sources in bounded rationality. Studies in History and Philosophy of Science Part A, 32(3), pp. 501-505. 2. Portfolio Task Two: Roadside Catering Market 2.1 Introduction According to the Mintel report October 2014 the roadside catering business has been prevalent mostly in the UK (Shanahan, 2003). Many of the fast food providers have set up their catering business as the customers get more attracted to the fast food that are available roadside. There is an uncertainty related to the quality of the food that is sold by the roadside eateries. Mostly, the food served in the roadside outlets is unhealthy as well as of poor quality that is likely to cause health issue for the customers (Ekinci, Prokopaki and Cobanoglu, 2003). However, high operating costs as well as decline in the numbers of outlets indicates that the roadside catering market has experienced low sales growth in the recent years. This can mainly be due to the low quality food products that are served, which leads to a decline in customer loyalty for the food items. Hence, the aim of this research would be to carry out a detailed analysis on the roadside catering market in order to understand the overall performance of the catering business. The researcher would offer a scope to study about the market and gain knowledge regarding its annual sales and profit. 2.2 Justification for the identification of the Market Structure Since roadside catering business has become the most important mode of earning for most of the fast food outlets, there is a need to consider the market structure related to such business. The market structure for the road side catering business mainly comprises of a perfectly competitive market where there is large number of buyers as well as sellers and there is no restriction imposed on the new entrants in the market (Johns and Lynch, 2007). The market structure is considered as perfectly competitive because there are many competitors practicing the roadside catering business like Mc Donald’s, Dominos, Burger King that have successfully set up their business (Johns and Lynch, 2007). Also, there is large number of the customers willing to purchase the fast food produced by these outlets. Further, the catering business has become so familiar that there is a possibility that large numbers of firms would wish to enter this market in order to serve the many customers. Figure 1: Annual Sales of Mc Donalds (Source: Wilson, Murray and Black, 2000) The figure shows that there is a rise in Fast food Business of Mc Donald’s from 2008 to 2013 which indicates a growth in the roadside catering market. There are large number of producers and the consumers for this roadside catering market and hence the demand curve can be considered as perfectly elastic (Wilson, Murray and Black, 2000). This refers to the fact that as the demand for fast food increases, the number of store participating in the catering business will also rise and hence there is a possibility of huge competition within the rivals. The roadside catering business in the UK involves the food and drink that is usually purchased outside the home and is consumed on the premises (Johns and Lynch, 2007). It involves the fast food as well as the take away outlets where the customers purchases the food items but may not consume on the premises. However, the roadside catering market excludes the catering service provided by the local authorities and also the public-sector agencies. According to the researcher, the market experienced no growth for the last few years (Rimmington, Carlton Smith and Hawkins, 2006). There was decline in annual sales in the public houses as well as hotels but there was an increase in the sales figures in case of the restaurants and contract catering. The decline in the sales figures of the catering business was mainly due to the outbreak of the foot and mouth epidemic, travel problems as well as decline in the consumer spending capacity in the economy (Johns and Lynch, 2007). Due to the health issue, the consumers have reduced their overall spending on the fast food sector and as a result, there is a low demand for fast food. As the demand curve for the market is perfectly elastic, the fall in demand for fast food leads to a fall in production which in turn affects the roadside catering market. Despite the decline in sales, there is a significant growth experienced by a number of businesses that had successfully registered themselves for value added taxes that is to be paid by the customers. Although the industry concentration is increasing, the number of employees has stabilized at around 1.7 million with majority of the employees working in the bars and pubs (Olsen, Warde and Martens, 2000). These employees even comprise of part-time workers. Many of the roadside catering companies have been rationalising their portfolio and they are trying to focus on the core brands and high profit has been earned by key players of other market sectors. However, the market for bars and pubs declined in recent years due to the fall in number of pubs and there was no recent increase in the excise duties that is imposed on beer and there was a huge competition in the international market that brought down the beer prices. The alcoholic beverages comprise of the largest share in the market for bars (Johns and Lynch, 2007). The non-alcoholic food and drinks assumes a high growth in trade. Nonetheless, the market for bars and pubs is getting segmented with food items contributing to the 50% sales of the pubs (Crespi, 2006). The ownership pattern of the pubs has been changing in the recent years and the owners of the pub are considered to be the major players who have replaced the traditional owners. The hotel market in the UK has also continued to experience a loss, as the numbers of roadside hotels are declining. This is mainly due to the unhygienic food that is served in this kind of business that often causes health issues to the customers and the company gradually loses its sales (Burton, 2004). The segmentation of the hotels and their rebranding has taken place in many of the hotel groups. However, the major hotel groups are planning to expand their business in the international markets through acquisition of new lands for construction of hotels. The annual sales in the take away and the fast food market have increased by around 3.2% in the recent years (Burton, 2004). The sales have increased due to change in food habits of the customers who prefer to have lighter food compared to a heavy breakfast. Moreover, the customers often have a busy schedule and they prefer to either have a light breakfast before getting engaged in their activities or they opt to pack their lunch from these take away outlets (Burton, 2004). Hence, it is studied by the researcher that the companies that are engaged in their fast food business have earned a huge profit in the recent years. Nonetheless, there are limitations of getting engaged in this business because the managers of the roadside catering companies have to be careful about the quality of food served or else it would lose its brand loyalty. The researcher has pointed out that the sandwich sector has increased by around 4.1% with the increase in sales of the companies producing sandwiches and burgers (Cox, Chicksand and Yang, 2007). 2.3 Evaluation of the strategies used by the Roadside Catering Market The roadside fast food centres tend to enjoy their monopoly power by setting up their outlets on the highways (Crespi, 2006). They tend to attract the customers travelling at night when the customers would have no other option but to visit the roadside outlets. Figure 2: Market Share captured by fast food industry (Source: Seaman and Eves, 2006) The biggest fast food producing sectors like Mc Donald’s, KFC and Burger King have set up their business all over the world and they use advertising strategies to attract customers. They collect feedback from the customers regarding their products and launch new food items as per the desires of the customers (Seaman and Eves, 2006). According to the researcher, Mc Donald’s has captured about 91% of the market share in the international roadside catering business and KFC has captured around 78% of the share in the fast food market (Seaman and Eves, 2006). Thus, it shows that the fast food brand spends a lot of their profit in advertising of the products. The roadside outlets often provide food to the customers at cheap rates that influence the customers to purchase from these shops. The roadside eateries tend to capture a large market share by serving its customers at cheap rates compared to all other shops, but in doing so; the companies often fail to maintain quality in their products (Crespi, 2006). However, the fast food market has shown a declining trend in the recent years due to the fall in consumption level of the customers and also due to the customers suffering from health issues. Advertising plays a key role in attracting the customers and many companies use this mode. The companies use social media advertising as well as distribution of pamphlets to inform customers about their newly launched products. Companies offer discounts on their newly launched products to encourage more customers to buy their new products at affordable rates (Seaman and Eves, 2006). The strategies used by the companies to attract huge customer base prove to be effective as many customers gain information regarding the launch of new products through social media and they visit the outlets only if they wish to purchase the new product. The managers are also taking care in handling the business in order to ensure the good quality food is served to the customers such that there are no customer complaints (Seaman and Eves, 2006). Further, the managers plan their work according to the feedback submitted by the customers in order to meet their desires. They aim at raising the customer base for their catering business by delivering good quality food products and gain a brand loyalty. Thus, they plan to use better technology to ensure that quality food is served to the customers and that makes the customers visit their outlets regularly. According to the researcher, an increase in brand loyalty may enhance their business in the international markets (Seaman and Eves, 2006). 2.4 Conclusion The research suggests that the roadside catering market is perfectly competitive because there is large number of buyers as well as the sellers within the market. Since the demand for fast food is rising, many companies are producing fast food and there is a healthy competition in the international markets. The demand curve for such market tends to be perfectly elastic because the production rises according to the rise in demand. However, the roadside catering business has experienced some challenges due to the low quality food supplied in the roadside outlets. There is a recent decline in the demand for fast food as the people have been suffering from the health issues. There were various strategies applied by the companies to grab the attention of the customers for their newly launched products. They use social media advertising as well as distribute pamphlets among the customers to attract them towards their new products. The strategies have been highly effective in influencing the customers because they are seen to carry out a research on the new product launched by their preferred brand and then they decide to visit the stores. However, the roadside catering market is expected to grow in the next few years due to the gradual rise in customer base of this market. Reference List Burton, D., Knights, D., Leyshon, A., Alferoff, C. and Signoretta, P., 2004. Making a market: the UK retail financial services industry and the rise of the complex sub-prime credit market. Competition and Change, 8(1), pp. 3-25. Cox, A., Chicksand, D. and Yang, T., 2007. The proactive alignment of sourcing with marketing and branding strategies: a food service case. Supply Chain Management: An International Journal, 12(5), pp. 321-333. Crespi, G., Criscuolo, C., Haskel, J. and Hawkes, D., 2006. Measuring and understanding productivity in UK market services. Oxford Review of Economic Policy, 22(4), pp. 560-572. Ekinci, Y., Prokopaki, P. and Cobanoglu, C., 2003. Service quality in Cretan accommodations: marketing strategies for the UK holiday market. International Journal of Hospitality Management, 22(1), pp. 47-66. Johns, N. and Lynch, P., 2007. The self-catering accommodation market: A review of electronic and other sources. International Journal of Hospitality Management, 26(2), pp. 293-309. Olsen, W. K., Warde, A. and Martens, L., 2000. Social differentiation and the market for eating out in the UK. International Journal of Hospitality Management, 19(2), pp. 173-190. Rimmington, M., Carlton Smith, J. and Hawkins, R., 2006. Corporate social responsibility and sustainable food procurement. British Food Journal, 108(10), pp. 824-837. Seaman, P. and Eves, A., 2006. The management of food safety—the role of food hygiene training in the UK service sector. International Journal of Hospitality Management, 25(2), pp. 278-296. Shanahan, K. J., 2003. The degree of congruency between roadside billboard advertisements and sought attributes of motels by US drive tourists. Journal of Vacation Marketing, 9(4), pp. 381-395. Wilson, M. D., Murray, A. E. and Black, M. A., 2000. Contract catering: the skills required for the next millennium. International Journal of Contemporary Hospitality Management, 12(1), pp. 75-79. Read More