Decision Making, Planning, and Control: The Five-Step Decision-Making Process

Learning Objective 4 Explain the five-step decision-making process and its role in management accounting

• identify the problem and uncertainties; obtain information; make predictions about the future; make decisions by choosing among alternatives; implement the decision, evaluate performance, and learn 
• planning and control of operations and activities

We illustrate a five-step decision-making process using the example of the Daily News, a newspaper in Boulder, Colorado. Subsequent chapters of this text describe how managers use this five-step decision-making process to make many different types of decisions.

The Daily News differentiates itself from its competitors by using (1) highly respected journalists who write well-researched news articles; (2) color to enhance attractiveness to readers and advertisers; and (3) a Web site that delivers up-to-the-minute news, interviews, and analyses. The newspaper has the following resources to deliver on this strategy: an automated, computer-integrated, state-of-the-art printing facility; a Web-based information technology infrastructure; and a distribution network that is one of the best in the newspaper industry.

To keep up with steadily increasing production costs, Naomi Crawford, manager of the Daily News, needs to increase the company’s revenues in 2020. As she ponders what she should do in early 2020, Naomi works through the five-step decision-making process.

1. IDENTIFY THE PROBLEM AND UNCERTAINTIES. Naomi has two main choices:
   1. increase the selling price of the newspaper or
   2. increase the rate per page charged to advertisers.

1. These decisions would take effect in March 2020. The key uncertainty is the effect any increase in prices or advertising rates will have on demand. A decrease in demand could offset the price or rate increases and lead to lower rather than higher revenues.

2. OBTAIN INFORMATION. Gathering information before making a decision helps managers gain a better understanding of uncertainties. Naomi asks her marketing manager to talk to some representative readers to gauge their reaction to an increase in the newspaper’s selling price. She asks her advertising sales manager to talk to current and potential advertisers to assess demand for advertising. She also reviews the effect that past increases in the price of the newspaper had on readership. Ramon Sandoval, management accountant at the Daily News, presents information about the effect of past increases or decreases in advertising rates on advertising revenues. He also collects and analyzes information on advertising rates competing newspapers and other media outlets charge.
3. MAKE PREDICTIONS ABOUT THE FUTURE. Based on this information, Naomi makes predictions about the future. She concludes that increasing prices would upset readers and decrease readership. She has a different view about advertising rates. She expects a marketwide increase in advertising rates and believes that increasing rates will have little effect on the number of advertising pages sold.

1. Making predictions requires judgment. Naomi looks for biases in her thinking. Has she correctly judged reader sentiment or is the negative publicity of a price increase overly influencing her decision making? How sure is she that competitors will increase their advertising rates? Is her thinking in this respect biased by how competitors have responded in the past? Have circumstances changed? How confident is she that her sales representatives can convince advertisers to pay higher rates? She retests her assumptions and reviews her thinking. She feels comfortable with her predictions and judgments.

4. MAKE DECISIONS BY CHOOSING AMONG ALTERNATIVES. A company’s strategy serves as a vital guidepost for individuals making decisions in different parts of the organization. Consistent strategies provide a common purpose for these disparate decisions. Only if these decisions can be aligned with its strategy will an organization achieve its goals. Without this alignment, the company’s decisions will be uncoordinated, pull the organization in different directions, and produce inconsistent results.

1. Consistent with a product differentiation strategy, Naomi decides to increase advertising rates by 4% to $5,200 per page in March 2020 but not increase the selling price of the newspaper. She is confident that the Daily News’s distinctive style and Web presence will increase readership, creating value for advertisers. She communicates the new advertising rate schedule to the sales department. Ramon estimates advertising revenues of 
2. $$\$\text{4,160,000}\hspace{0.17em}(\$\text{5,200}\hspace{0.17em}\text{per\hspace{0.17em}page}\times 800\hspace{0.17em}\text{pages\hspace{0.17em}predicted\hspace{0.17em}to be sold\hspace{0.17em}in\hspace{0.17em}March}\hspace{0.17em}2020).$$

Steps 1 through 4 are collectively referred to as planning. Planning consists of selecting an organization’s goals and strategies, predicting results under alternative ways of achieving goals, deciding how to attain the desired goals, and communicating the goals and how to achieve them to the entire organization. Management accountants serve as business partners in planning activities because they understand the key success factors and what creates value.

The most important planning tool when implementing strategy is a budget. A budget is the quantitative expression of a proposed plan of action by management and is an aid to coordinating what needs to be done to execute that plan. For March 2020, the budgeted advertising revenue of the Daily News equals $4,160,000. The full budget for March 2020 includes budgeted circulation revenue and the production, distribution, and customer-service costs to achieve the company’s sales goals; the anticipated cash flows; and the potential financing needs. Because multiple departments help prepare the budget, personnel throughout the organization have to coordinate and communicate with one another as well as with the company’s suppliers and customers.

5. IMPLEMENT THE DECISION, EVALUATE PERFORMANCE, AND LEARN. Managers at the Daily News take action to implement and achieve the March 2020 budget. Management accountants collect information on how the company’s actual performance compares to planned or budgeted performance (also referred to as scorekeeping). The information on actual results is different from the predecision planning information Naomi and her staff collected in Step 2 to better understand uncertainties, to make predictions, and to make a decision. Comparing actual performance to budgeted performance is the control or postdecision role of information. Control comprises taking actions that implement the planning decisions, evaluating past performance, and providing feedback and learning to help future decision making.

1. Measuring actual performance informs managers how well they and their subunits are doing. Linking rewards to performance helps motivate managers. These rewards are both intrinsic (recognition for a job well done) and extrinsic (salary, bonuses, and promotions linked to performance). We discuss this in more detail in a later chapter (Chapter 23). A budget serves as much as a control tool as a planning tool. Why? Because a budget is a benchmark against which actual performance can be compared.

Consider performance evaluation at the Daily News. During March 2020, the newspaper sold advertising, issued invoices, and received payments. The accounting system recorded these invoices and receipts. Exhibit 1-4 shows the Daily News’s advertising revenues for March 2020. This performance report indicates that 760 pages of advertising (40 pages fewer than the budgeted 800 pages) were sold. The average rate per page was $5,080, compared with the budgeted $5,200 rate, yielding actual advertising revenues of $3,860,800. The actual advertising revenues were $299,200 less than the budgeted $4,160,000. Observe how managers use both financial and nonfinancial information, such as pages of advertising, to evaluate performance.

The performance report in Exhibit 1-4 spurs investigation and learning, which involves examining past performance (the control function) and systematically exploring alternative ways to make better-informed decisions and plans in the future. Learning can lead to changes in goals, strategies, the ways decision alternatives are identified, and the range of information collected when making predictions and sometimes can lead to changes in managers.

The performance report in Exhibit 1-4 would prompt the management accountant to raise several questions directing the attention of managers to problems and opportunities. Is the strategy of differentiating the Daily News from other newspapers attracting more readers? Did the marketing and sales department make sufficient efforts to convince advertisers that, even at the higher rate of $5,200 per page, advertising in the Daily News was a good buy? Why was the actual average rate per page ($5,080) less than the budgeted rate ($5,200)? Did some sales representatives offer discounted rates? Did economic conditions cause the decline in advertising revenues? Are revenues falling because editorial and production standards have declined? Are more readers getting their news online?

Answers to these questions could prompt the newspaper’s publisher to take subsequent actions, including, for example, adding sales personnel, making changes in editorial policy, expanding its presence online and on mobile devices, getting readers to pay for online content, and selling digital advertising. Good implementation requires the marketing, editorial, and production departments to work together and coordinate their actions.

The management accountant could go further by identifying the specific advertisers that cut back or stopped advertising after the rate increase went into effect. Managers could then decide when and how sales representatives should follow up with these advertisers.

Planning and control activities must be flexible enough so that managers can seize opportunities unforeseen at the time the plan was formulated. In no case should control mean that managers cling to a plan when unfolding events (such as a sensational news story) indicate that actions not encompassed by that plan (such as spending more money to cover the story) would offer better results for the company (from higher newspaper sales).

The left side of Exhibit 1-5 provides an overview of the decision-making processes at the Daily News. The right side of the exhibit highlights how the management accounting system aids in decision making.

Planning and control activities get more challenging for innovation and sustainability. Consider the problem of how the Daily News must innovate as more of its readers migrate to the Web to get their news and apply the five-step process. In Step 1, the uncertainties are much greater. Will there be demand for a newspaper? Will customers look to the Daily News to get their information or to other sources? In Step 2, obtaining information is more difficult because there is little history that managers can comfortably rely on. Instead, managers will have to make connections across disparate data, run experiments, engage with diverse experts, and speculate to understand how the world might evolve. In Step 3, making predictions about the future will require developing different scenarios and models. In Step 4, managers must make decisions recognizing that conditions might change in unanticipated ways requiring them to be flexible and adaptable. In Step 5, the learning component is critical. How have the uncertainties evolved and what do managers need to do to respond to these changing circumstances?

Planning and control for sustainability is equally challenging. What should the Daily News do about energy consumption in its printing presses, recycling of newsprint, and pollution prevention? Among the uncertainties managers face is whether customers will reward the Daily News for these actions by being more loyal and whether investors will react favorably to managers spending resources on sustainability. Information to gauge customer and investor sentiment is not easy to obtain. Predicting how sustainability efforts might pay off in the long run is far from certain. Even as managers make decisions, the sustainability landscape will doubtlessly change with respect to environmental regulations and societal expectations, requiring managers to learn and adapt.

Do these challenges of implementing planning and control systems for innovation and sustainability mean that these systems should not be used for these initiatives? No. Many companies value these systems to manage innovation and sustainability. But, in keeping with the challenges described earlier, companies such as Johnson & Johnson use these systems in a different way—to obtain information around key strategic uncertainties, to implement plans while being mindful that circumstances might change, and to evaluate performance in order to learn.