Sessions 4C & 4D: Behavioral Operations Management

Prof. Dr. David Wuttke

Technische Universität München
School of Management
Campus Heilbronn
Heilbronn, 2023
Behavioral Dimensions of Decision Making

Prof. Dr. David Wuttke | Operations and Supply Chain Management| TUM Heilbronn | 2023 2
Behavioral Dimensions of Decision Making
Do you agree with these statements?

Firms seek to maximize profits (including expected future profits).

Managers can be incentivized to act in the interest of firms.

Money is the main driver in managerial decision making in our capitalistic world.

Prof. Dr. David Wuttke | Operations and Supply Chain Management| TUM Heilbronn | 2023 3
People, not firms, decide!

Humans or teams of humans make decisions

Utility ≠ Profit

Satisficing not maximizing

Individual preferences

Social norms

Take other decision makers into account (the world is a game!)

Mind biases

Prof. Dr. David Wuttke | Operations and Supply Chain Management| TUM Heilbronn | 2023 4
Taxonomy of strategies and criteria for decision-making

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Taxonomy of strategies and criteria for decision-making
Category Strategy Criterion

Intuitive Arbitrary Based on the most easy or familiar choice

Preference Based on propensity, hobby, tendency, expectation
Common senses Based on axioms and judgment
Empirical Trial and error Based on exhaustive trial
Experiment Based on experiment results
Experience Based on existing knowledge
Consultant Based on professional consultation
Estimation Based on rough evaluation
Heuristic Principles Based on scientific theories
Ethics Based on philosophical judgment and belief
Representative Based on common rules of thumb
Availability Based on limited information or local maximum
Anchoring Based on presumption or bias and their justification
Prof. Dr. David Wuttke | Operations and Supply Chain Management| TUM Heilbronn | 2023 6
Taxonomy of strategies and criteria for decision-making
Category Strategy Criterion

Rational Minimum cost Based on minimizing energy, time, money

Maximum benefit Based on maximizing gain of usability, functionality, reliability, quality,
dependability
Maximum utility Based on cost-benefit ratio
Certainty Based on maximum probability, statistic data
Risks Based on minimum loss or regret
Uncertainty
Pessimist Based on maximin
Optimist Based on max
Regretist Based on minimax of regrets

Prof. Dr. David Wuttke | Operations and Supply Chain Management| TUM Heilbronn | 2023 7
The optimum is not always required.

Heuristics are very, very helpful!

Bounded rationality is good!

Please beat me in chess by starting with the

optimal move!

Prof. Dr. David Wuttke | Operations and Supply Chain Management| TUM Heilbronn | 2023 8
Biases in decision making and influence

Prof. Dr. David Wuttke | Operations and Supply Chain Management| TUM Heilbronn | 2023 9
Robert Cialdini’s six weapons of influence

Commitment and
Reciprocation Social proof
Consistency

Liking Authority Scarcity

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Dan Ariely’s predictable irrationality
Fallacy of
Cost of zero Cost of social Power of a
Relativity demand and
cost norms free cookie
supply

Procrastina-
Influence of High price of Keeping Effect of
tion and self
arousal ownership doors open expectations
control

The context
Power of The cycle of Beer and free
of our
price distrust lunches
character

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Behavioral Operations Management

Prof. Dr. David Wuttke | Operations and Supply Chain Management| TUM Heilbronn | 2023 12
Behavioral Operations Management

Managers

Customers Employees

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 Behavioral Operations Management

Behavioral operations is the study of potentially

non hyper-rational actors in operational contexts.

Source(s): Croson, Schultz, Siemsen, and Yeo (2013), “Behavioral operations: The state of the field”, Journal of Operations Management, 31 (5)

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Behavioral Operations Management

(Social)
Psychology

Applied Operations
mathe- Mana-
matics gement

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 Behavioral Operations Management

Source(s): Croson, Schultz, Siemsen, and Yeo (2013), “Behavioral operations: The state of the field”, Journal of Operations Management, 31 (5)

Prof. Dr. David Wuttke | Operations and Supply Chain Management| TUM Heilbronn | 2023 16
Experiments

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Framing in the cinema Price per ticket: € 9.50.
Students and seniors (above 65
years) get a € 2 discount.

Price per ticket: € 7.50.

Normal aged people pay an
extra fee of € 2.

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Prof. Dr. David Wuttke | Operations and Supply Chain Management| TUM Heilbronn | 2023 20
Coordination game: Effort in quality improvements
If you decide…
You can invest into digital transformation on a level 0 to 5 incurring costs of 1,000€
per level. 0 1 2 3 4 5
Four additional firms in your supply chain also decide on a level between from 0 to
0 0 -1000 -2000 -3000 -4000 -5000
5 incurring the same costs.

If the minimum of
all decisions is…

The cells are your

The overall level of digital transformation is the minimum of all decisions. 1 1000 0 -1000 -2000 -3000

outcomes.
Each firm obtains an extra revenue of 2,000€ times the overall level. 2 2000 1000 0 -1000
Please decide on the level of digital transformation and write down this number.
3 3000 2000 1000

4 4000 3000

5 5000

(I will afterwards pick five random students. Hence you

My decision: _____________ do not know with whom you are in a supply chain.)

Prof. Dr. David Wuttke | Operations and Supply Chain Management| TUM Heilbronn | 2023 21
Coordination game: Implications for Supply Chain
Management
Did you identify what is best for your supply chain?
Did you think that other students in this room are capable of identifying the same optimal strategy?
Did you choose what is best for everyone?
If you could change one rule of this game, which one would it be?

Coordination is a central element of supply chains. While in theory contracts may achieve full
coordination, in reality people often feel it is better to deviate from the optimal solution even if the
optimum is obvious.

If you are in a coordination game, that is, everyone benefits from coordinating, communication is the
best approach.

Prof. Dr. David Wuttke | Operations and Supply Chain Management| TUM Heilbronn | 2023 22
Prof. Dr. David Wuttke | Operations and Supply Chain Management| TUM Heilbronn | 2023 23
Ultimatum game with powerful buyers
Please form groups of two students.
The older student plays the role of the buyer, the younger one is the supplier.
In this game, you share no prior business experience so far. There is a one time opportunity for the
upcoming season that the buyer could order a specific product from the supplier. The product would yield a
total profit of $100,000 which is known to both parties.
• The buyer makes a one time offer to the supplier – take it or leave it – as to how to share this profit. If the supplier
agrees, your both companies would receive what you agreed on. If the supplier rejects, both get $ 0. I.e., there
are no alternatives for either side.
Buyer, please make an offer and write it down:

• Buyer’s offer: __________________

Supplier, do you accept this offer?

• Supplier:  Yes  No
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Prof. Dr. David Wuttke | Operations and Supply Chain Management| TUM Heilbronn | 2023 25
P-Beauty contest
Please pick any real number between and including 0 and 100.
2
Your objective: Try to guess the number which equals of the average of all numbers picked in this very
3
room.
The student of you who is closest wins!

• Your number: __________________

Prof. Dr. David Wuttke | Operations and Supply Chain Management| TUM Heilbronn | 2023 26
P-Beauty contest: Implications for Supply Chain
Management
Did you think about what other students might think? Here are some consequences of thinking about the
other players’ thoughts:
2
• Step 1: no one will pick a number larger than 100. So the average will be at most 100. So I could pick 66 = 3100.
Or anything smaller.
• Step 2: Everyone should think the same. So no one should pick a number larger than 66. Hence, the average
2
must be below 66. So I could pick 44= 66. …
3
• Step 3: Everyone should think the same
• ….
• Step 𝑛𝑛 → ∞: I should pick 0 (!)

Most applications of game theory (and other theories including rationality) rely on the assumption of
full knowledge and complete induction. I know that you know that I know… . However, even if trained
in economics and business, people do not think like that. Hence, when deciding on SCM it is good to
make weaker assumptions on what other actors should/will do.
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Prof. Dr. David Wuttke | Operations and Supply Chain Management| TUM Heilbronn | 2023 28
Public goods: exerting efforts to increase sales
Please build groups of five students. Everyone represents a member of a supply chain, such as retailer or manufacturers. For
this game it does not matter, which specific firm you are.
Everyone of you can exert effort to increase sales. For instance, you could launch some advertisement campaigns or invest in
CSR. You will pick as effort level either 0, 1, 2, 3, 4, or 5.
Only the customer (ME!) observes your effort. I will calculate the profit for everyone as follows:
• Overall effort = sum of all individual efforts
• Profit for each firm = Overall effort TIMES $ 100 DIVIDED BY 5
Effort is costly. Per unit effort you pay $ 50.
In this game, you are a supply chain and you can communicate by talking. However, no matter what you do you will never be
able to see the effort of each individual firm.

How much effort do you want to invest in increasing sales: __________________

For the customer only: What is the sum of all effort levels: __________________

How much profit did your firm make? __________________

Prof. Dr. David Wuttke | Operations and Supply Chain Management| TUM Heilbronn | 2023 29
Public goods: exerting efforts to increase sales
Have you been willing to exert any effort to increase sales in your supply chain?
What did you expect other members of your supply chain would do?
What was your strategy during the negotiation phase upfront?
Individually optimal (i.e., profit maximizing strategy) is to exert no efforts. This is the unique Nash Equilibrium.
Supply Chain optimal solution would be everyone investing fully
If you could observe other members actions and base contracts on their effort, you could design contracts that lead to supply
chain optimal effort levels.

Often you face situations with collaborating firms (suppliers or customers) that have similar objective like your firm
(increase sales) but at the same time conflicting interests (maximizing their share of the profit).

Communication is often ineffective whenever actions cannot be fully observed. One strategy is to make actions
observable.
Even if actions are partially observable, this effect remains.

Prof. Dr. David Wuttke | Operations and Supply Chain Management| TUM Heilbronn | 2023 30
The effectiveness of communication is highly context
dependent

coordination game
public goods game

 Interests are aligned  Interests are not aligned

(Nash Equilibrium = Pareto Optimum) (Nash Equilibrium ≠ Pareto Optimum)
 Strategic uncertainty drives suboptimal  Profit maximizing behavior drives
behavior suboptimal decisions
 Ethics/values/inequity aversion drive
better than Nash Equilibrium decisions
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Fairness Concerns

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What is fair-mindedness? What is inequity aversion?

https://www.youtube.com/watch?v=lKhAd0Tyny0&ab_channel=TVPUniversity

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Behavioral Dimensions of Decision Making
Do you agree with these statements?

Firms seek to maximize profits (including expected future profits).

Managers can be incentivized to act in the interest of firms.

Money is the main driver in managerial decision making in our capitalistic world.

Prof. Dr. David Wuttke | Operations and Supply Chain Management| TUM Heilbronn | 2023 34