Probability Used By The Managers - Essay Example

February 2006 Probability for Managers Probability is inherent in all management action, though more often in intuitive form than as a formal and conscious method. The essence of management is to take decisions for the development and deployment of human, material, financial and intangible resources. This is inevitably with the future in view, as there is a lag between decisions and their effects. The gestation period tends to increase as the strategic value of issues addressed comes more sharply in to focus. Large and complex investments typically take months if not years before they yield any revenue. The growing uncertainties under which managers must function, is a feature of the conventional environment (Daum, 2004). The aspect of uncertainty is exacerbated by information overload. Studies confirm that the information available to managers exceeds human capacity to process and to use such information. This makes for very difficult operating systems for managers. A third aspect of management practice is that most processes involve groups and teams. Even where final authority rests with an individual, the varying capabilities of managers to focus and to absorb information, requires that a common platform is created, so that each participant can express his or her views. Dissent is often the result of opposing parties basing their opinions on different scenarios, which they think is probable. Scientific application of probability theories has therefore a watershed role in building common understanding, if not consensus in teams that run firms. Formal probability techniques have been used in research functions of firms for a long time. Market Research, Clinical Trials and all other experiments to study the safety and efficacy performances of new products, use probability methodology. Random number generation and use, sampling, determination of significance and confidence levels all depend on probability science. Managers who are not formally trained in mathematics, or who do not remember their academics, may use outputs stated in qualitative terms for their decisions. This can lead to critical matters being effectively delegated to specialists who understand mathematics. Many examples of such distortion can be found in the high-profile pharmaceutical industry. Products have been released for the market, though research showed the probabilities of side-effects and adverse events. Managers in the concerned firms, regulators and doctors have all been victims of their ignorance of probability science, in taking decisions that were to subsequently cost consumers dearly! This trend will continue as technology takes us in to fields with multiple outcomes. It highlights the need for modern managements to fully understand the conclusions of formal probability methods. Insurance is another traditional field for the use of probability (Matthew & Stewart, 1999, p 2). The industry that provides cover against premiums depends on probability theories in large measure for their sustained probability, as indeed do all bookmakers involved in structured and informal gambling operations of all kinds. Firms with large capital assets often invest in internal positions, using specialists to determine their insurance policies and practices. Product liability is often determined in companies by people without adequate grounding in the mathematics of probability: under provision for related claims is often the result. All products and services that have potential implications for human safety and in terms of environmental impacts need the systematic and continuous application of established and proven probability techniques, for appropriate decision making. Stock valuation and its future course have emerged as industries in their own rights with the development of bourses world wide and the spread of the financial services and merchant banking sectors. Mutual funds also depend almost entirely on future estimates of market capitalization. Forecasts of scrip values started with simple regression and transited to sophisticated methods of accounting for discrete events changing the nature of independent variables. There is a recent move towards the use of stochastic modeling to predict share valuation, especially for firms in nascent businesses, and those that entail severe discontinuities. Methods such as the use of Markov Chains have proved to be very useful for high technology sectors that do not have long historical records for estimation of future value through normal regression. Nanotechnology, biotechnology and new energy sources, are examples of very high growth sectors of the economy that will have to use stochastic methods for future projections. This is an exciting and highly productive field for the application of probability in management. There is a trend towards the use of probability by managers with general qualifications. The methodology has the potential from extending from the domains of specialist researchers, to more widespread use in business. Decision Making is a large field of application of probability. All formal techniques for taking decisions involve the consideration of alternative outcomes. The use of Tree Diagrams is an example of common management techniques, the utility of which is greatly enhanced by the deployment of probability methods (Grinstead, & Snell, not dated, p 34). Decision Trees and related methods focus on assigning probabilities to each node of possibilities, and the complicated inter-relationships of strategic matters offers much scope for the intensive use of probability methodology. Much of this has been at the intuitive level in the past, and the quality of management, and the reliability of decisions can improve as modern management emerge with greater appreciation of probability science. Budgeting is another universal management activity in which probability methods hold much promise. The conventional business environment is too fluid for traditional budgeting to retain its old utility. Managers now have to be nimble, and bring resources to bear on sudden opportunities and threats that present themselves in a set of changing business conditions (Daum, 2004). Probability methods can enable managers to work with multiple and related budgets, responding to environmental changes with greater speed. Rapid and continual changes in budgets can hamper performance appraisal in functions such as sales, and even lead to chaos in firms that use relational databases such as SAP. Probability methods can ensure that order is maintained, so that budgetary changes are genuine responses to new conditions, rather than subjective whims to shield poor individual performance. Probability need not be confined to budgeting exercises in modern companies. Scenario Planning is a new approach that can help managers deal with the uncertainties that affect the quality of their decision making (Daum, 2004). This is especially useful for companies such as those in oil prospecting, which have to take far-reaching decisions based on incomplete facts, with ramifications deep in to the future. Scenario Planning is also useful for lines of business such as that of toxic chemicals, which entail the occurrence of severely adverse events. Such firms can rehearse contingent measures and plan preventive actions as well. Many such actions may involve significant investments and fundamental changes in costs and margins. Probability techniques can help managers in such situations to take rational decisions. The Risk Management approach to business, as opposed to older methods of profit or growth optimization, has become most relevant as markets become more turbulent. The Katrina episode, the Asian Tsunami and the looming bird flu pandemic are prominent examples of severe discontinuities of which no one can be certain. They serve to highlight the need for managers to address risks with severe consequences, though their individual probabilities may be unknown to people at large. Many companies which are thought of as being highly successful, may on deeper analysis, be found to have taken injudicious risks, though no actual adverse event affected reported financial results. There could be greater public pressures on such firms in future to use probability methods to cover their inherent risks better. Since the practice of management inevitably involves human intellect, research in to the working of the brain yields insights in to how managers can perform better. We now have the phenomenon of neurosurgeons advising and teaching practicing and prospective managers (Daum, 2004). Human intelligence is always at play in the business world, and its systematic applications can result in improved performance. This approach has resulted in the concept of a 'Management Cockpit', which is essentially a meeting room with electronic display screens. Managers have access to all the inter-related effects of decisions they may take, and the impact on central strategy. The 'Management Cockpit' approach emphasizes the impact of present and short-term decisions on the long term business prospects for the firm. It therefore relies heavily on probability. People who participate in meetings which use 'Management Cockpits' need to be well versed in the principles of probability in order to use the technique and the electronic resources at meetings fully. It is significant that individual participants in a 'Management Cockpit' need to prepare on their own in advance for meetings. They would not be able to participate without basic understanding of the principles and theories of probability. Companies which have implemented 'Management Cockpits' in their offices, have experienced delays with getting projects off the ground because individual and senior managers are sometimes poorly informed and read in this respect. It has been said that commercial considerations may have stimulated the development of probability theory in 16th century France (Grinstead, & Snell, not dated, page 40). Indeed, the concept has many applications for managers, and the principles of this body of mathematics have remained relevant in the face of changing environmental conditions. Managers may underestimate risks and be overly optimistic about future events. Differences between intuitive and statistical probabilities are major ingredients of management errors and failure (Daum, 2004). There are potential benefits for firms and their stake holders, if probability science were to be used more widely in all planning operations. Though probability belongs to the field of mathematics, it finds applications in diverse fields of human endeavor (Grinstead, & Snell, not dated). Probability was first enunciated by Blaise Pascal and Pierre de Fermat some 400 years ago, but its relevance has not diminished in any way. Works Cited Daum, J. H (2004), 'Interview with Patrick M. Georges: How can executives improve their personal productivity', The new New Economy Analyst Report, retrieved February 2006 from Grinstead, C. M & Snell, J. L, not dated, retrieved February 2006 from Matthew, J & Stewart, D. G (1999), Probability for Risk Management, ACTEX Publications 1600 words 7 pages 3 sources MLA Read More