1. A behavioral theory of the firm
Chapter Three
BY CYERT & MARCH

2. Introduction
Chapters 1 & 2 tried to understand decision –making processes. Chapter 3 & 4 tried to understand decision –making nature and dynamics.
The theory is a statement of critical relations among system variable ( ex output-price) . These relationships may be:-
a- Assumptions about the identification and interdependence of variables
b- Assumptions about the functional form of the interdependence
c- Assumptions about the broad structural attributes of the system.
Economic problems can be analyzed using framework of a classic form of an economic theory ( Marshall)

3. Introduction
The prevailing theory about the firm is based on the following assumptions ( The perfectly competitive market )
Firms seek to maximize profits - Free entry & exit at zero cost
Firms operate with perfect knowledge – Homogenous Products
One of the requirement for the usefulness of any theory is the requirement that all important variables in the system be eventually represented within the concept of the theory
The theory outlined in this chapter specifies:-
Alternate framework ( called the basic framework)
Alternate set of key relations
for dealing with the modern “representative firm”(the large multi-product firm operating under uncertainty in an imperfect market) .

4. Basic framework
We can analyze the process of decision making in the terms of the variables ( three features or three concepts) that affect decision making process :-
The goals of organization.
The expectations of the organization.
The choice of the organization.
AND THE VARIABLES THAT AFFECT THESE VARIABLES

5. The goal of organization
Two set of variables affect the goals of an organization :-
1. The first set influences goal dimensions ( i.e. what type of things are viewed as important by some participants) . For-example, with respect to organizational (official) goals they are affected by ( variables) :-
1. Changes as new participants enter or old ones leave the firm.
2. Operative goals for a particular decision. These are the goals of the sub-unit making that decision .
3. The definition of evoked problems facing the firm.
The second set of variables influences the aspiration ( soundness , desiring ) level of any particular goal . These variables are :-
The organizational past performance.
The organizational past goal.
The past performance of other comparable organizations in market.
* The aspiration level is viewed as some weighted function of the above three variables.

6. The organizational expectations
Expectations are seen as the result of drawing inferences (conclusions) from available information. Thus we have to consider variables that affect either:-
The process of drawing inferences
The process by which information is made collected and made available to the organization

7. B The organizational expectations (cont)
Concerning the process of drawing inferences variables , it is not meant with respect to individual’s psychology, but about some simple pattern recognition variables and the effect of hopes on expectations ( e.g. linear extrapolation , forecasting models ).
Concerning processes to collect information, some variables do affect search activity for information in a firm. Such as , intensity , success of search & direction of search ( search direction in return is affected by the nature of the problem stimulating the search and the location in the firm at which the search is focused.)

8. The choice of the organization
Choice takes place in response to the evoked problem definition
Choice takes place in response to the uses of standard operating rules.( A rule is defined as what to do or not to do)
Choice involves identifying acceptable alternative to achieve an evoked goal.
In brief , variables that affect a choice are those that influence the definition of a problem, the standard decision rule and the order of consideration of alternatives.
The standard decision rules in return are affected by the past experience & past record of the organizational .
As far as order in which alternatives are considered depends on whom and what part of the firm is doing this and on past experience of this part in considering alternatives.

9. Major relational concepts (For dealing with modern organizations)
In course of developing the three theories (goals ,expectations & choice) we have 4 major related concepts that represent the heart of the theory of business decision making these concepts are :-
Quasi ( compromise) resolution of conflicts
Uncertainty avoidance in organizations.
Problemestic search in organizations
Organizational learning in organization.

10. Quasi Resolution Of Conflicts
In any firm different members have different conflicting goals. But usually we have a coalition of members. They undergo thru a process of negotiation and compromise . Thus , it is required to have some sort of procedures for resolving conflict. The following procedures could be used :-
List all the goals as independent constraints . In any firm we have a series of independent aspiration ( soundness , desiring ) level constraints imposed on the firm by members of the firm coalition. These constraints include:-
Non-essential demands ( demands that are already satisfied when other constraints are met).
Sporadic demands ( demands that are made only occasionally)
Non- operational demands ( demands with no operational measures)
Essential continuous operative goals . Fore-example, in the Price-output models we assume a profit goal , sales targets, market share, inventory and a production goal . These will pose problems in form of potential conflict and we have to get procedures to solve it.
The conflict is resolved by ( details next slide) :-
Assuming local rationality to get some compromised goals.
Attention should be given to the acceptable level of the decision rules.
Sequential attentions to the goal.

11. 1 .Quasi Resolution Of Conflicts
A- Assuming Rationality.( Decentralization)
Here we assume that the firm factors (reduces) its decision problems into sub problems and assign them to subunits . The importance of such local rationality is to help individual sub-unit to focus & to deal with limited set of problems and goals. The limit is reduced to solving one problem in terms of only one goal. This delegation and specialization in decisions and goals reduces complex situations with conflicting goals to a number of simple problems.
Whether such procedure resolve a conflict or not depends whether the decisions generated are consistent with each other and with the demands of the external environment. This consistency is facilitated by two characteristics of decision ,namely rules and sequential attention to goals. ( next slide )

12. 1 .Quasi Resolution Of Conflicts
B- Attention to decision rules level.
It is required that local decisions satisfying local demands that are made by a series of independent decision centers should result in a joint solution that satisfies all demands. Here it is assumed that a firm can and do operate with much weaker rules of consistency.
C- Sequential attentions to the goal
Consistency of goals or decisions means that, in some way assessing their internal logic and importance at a point in time. That is firms resolve conflicts in goals by attending different goals at different times according to priorities .The resulting time buffer between goals permits the firm to solve one problem at time .( ex. Smooth production and satisfy customers.)

13. Uncertainty avoidance
Much of the modern decision making theory is concerned with problems of making decisions under risk & uncertainty. The solutions involved to dilute these problems are by using procedures for finding certainty equivalents (ex. expected value) or introducing rules for living with uncertainties (ex. The game theory).
This uncertainty avoidance will aid a firm to be risk averse. As for uncertainty it could be with respect to:-
Behavior of the market and suppliers
Attitude of shareholders
Competition .( remember BMD chapter 2)
The future actions of government agencies ( BBC case)

14. 2 . Uncertainty avoidance ( CONT.)
Organizations avoid uncertainty by:
Avoiding long term planning ( where plans depends on predictions of uncertain future events ) . Avoid anticipation for distant future and concentrate on short-run reaction to short –run feedback .
Using a feed back react decision procedures such that the firm solve emerging problems and wait for the next one. ( case by case)
Avoiding the requirement to anticipate future reactions of other parts of their environment by arranging a negotiated environment . In return they impose plans and standard operating procedures ( standard products). In short they depend on predictions of uncertain events and emphasize plans that can be made self-confirming through some control device . I n other words , they tend to find a way to control environment rather than treat the environment as exogenous (introduced from outside the system) and thus to suffer uncertainty (ex. in case of competitors, one mean of control is thru establishing industry–wide range conventional practices such as standardizing , or internally thru budgeting whereby each unit avoid uncertainty in other units in making decisions.)

15. Problemestic search
By problemestic search we mean the search stimulated by a problem ( usually a specific one) and is directed towards finding a solution to that problem. ( ex. Search could be for an alternative to meet a goal.)
In general , a problemestic search can be distinguished from:-
- Random curiosity ( since the search has a goal ).
- The search for understanding which is a search only interested in so far as such understanding contributes to control.

16. 3 . Problemestic search ( CONT.)
In considering an organizational search , three issues should be assumed :-
First , Search is motivated .
Second , Search is simple-minded.
Third , Search is biased .

17. 3 . Problemestic search ( Cont)
1. Motivated search:
A -Whenever a goal is not satisfied or even anticipated to fail, a problem is raised and search is motivated & this will continue as long as the problem is not solved.
B- The problem is solved either by finding another alternative or by adjusting the goal to meet the level of available alternative acceptable.
C- In theory , variations in search activity and productivity reflect the extent to which motivation for search exists.
2 . Simple minded search:
It is assumed that rules for search are simple minded in the sense that they reflect simple concepts of causality until driven to a more complex one. Subject to learning , search is based initially on two rules:-
1- Search in neighborhood of the problem symptom
2- Search in neighborhood of the current alternative.
These two rules mean that the cause will be near its effect and that a new solution will be near an old one. This inhibits the movement of the firm to radically new alternatives . If this does not work then the firm goes for distant search in various vulnerable areas.

18. 3 . Problemestic search
3- Bias in search: Basic kinds of search bias are four :-
Bias reflecting special training or experience of various parts and of the participants in the firm .This bias is implicit in the previous discussion of specialization ( decentralization) in problem solving and in the assumptions of search learning (next slide).
Bias reflecting the interaction of hopes and expectations. Here we have a bias in adjusting expectations to hopes for the sake of decreasing the amount of problem solving time and stimulating the growth of organizational slack during god times and eliminating it during bad times.
Bias reflecting unresolved conflict within organization .Under conditions where internal biases in the firm are all in the same direction or where biases are in one direction are located in parts of the organization with an extremely favorable balance of power.
Biases in the way thru which the environment is viewed and how communication about the environment is processed thru the organization.

19. Organizational learning
Means that organizations exhibit adaptive behavior over time. Here it is assumed that firms change their goals , shift their attention and revise their procedures for search as a function of their experience and learning.
Three different phases of organizational adaptation:-
Adaptations of goals :-
In the form of aspiration level . For each dimension of the firm’s goals there are critical values that could change over time in reaction to experience. Goals at a any particular time are a function of;-
Goals at previous time period
Firm’s experience with respect to goal in previous period.
Experience of comparable organization with respect to goal in previous period.

20. 4 . Organizational learning
Adaptation in attention rules
As firms learn what to strive for in their environment, they also learn to attend , look after or pay attention to some parts of that environment and not to others . Here we note two different kind of adaptations:-
Evaluating performance by using explicit measurable criteria such as indices of performance.
Learn to pay attention to some parts of the organization comparative environment and ignore other parts.
Adaptation in search rules
Search rules change if search is problem – oriented . The order in which various alternative solutions to a problem are considered will change with the firm experience success or failure with an alternative. (Success Breads Success).

21. Quasi resolution of conflict Uncertainty avoidance Problematic search
Organizational
learning
Goals as independent constraints
Local rationality
Acceptable level decision rules
Sequential attention to goals
Feed back-react
decision procedure.
Negotiated environment
Motivated search
Simple-minded search
Bias in search
Adaptation of goals
Adaptation in attention rules
Adaptation in search rules
Observe feedback
From environment. No
Is there
uncertainty ?
Is goal 1
being achieved?
If yes
Negotiate with the
environment
yes
yes No
Search locally.
Is it successful?
Evaluate
search No
Expand search
Evaluate
decision rules
Adapt to feedback with
standard decision rules
Consider in same way
goals 2 &decision 2
Evaluate goals
& rules