of Decision Trees in Business.
of Decision Trees in Business.
trees refer to a graph that utilizes branching methods to illustrate every
plausible outcome from a decision. They can be hand drawn or created using a
graphics program or some specialized software. Informally they are essential
where a group has to make a decision. Program wise they can be used to assign
values such as money or time to possible outcomes so that decisions can be
automated. Decisions tree software's are used to mine data to simplify the
complex strategic challenges and also evaluate the cost effectiveness of
business decisions and research.
The management of a company that I will
call Ohio manufacturing industries limited must decide whether to build a large
plant or a small to manufacture a new product that there are about to launch it
the market. The product is expected to last in the market for five years. The
decision here depends on the market size for the market. (Prinsloo, H. F,
2016). It's plausible that the market will demand the product in high demand
possibly for the first three or two years then demand will fall if the first
customers find it unsatisfactorily. Or maybe an initial high market demand
might indicate continued demand for the product. If demand is good and the firm
does not grow into new markets within the first three years, competitive
products would probably flood the market. If the product intends to build a
bigger plant, it must match with whatever the market demand will be. If a small
plant is constructed, management will have the option of growing and expanding
the plant in three years the event that demand will be high during the initial
stages of tapping into the market. (Prinsloo, H. F, 2016). While in the
scenario the demand is low than expected the company will maintain operations
with the small plant and make good profits on the low volume manufactured.
Management of the company isn't sure what to
do. The company expanded rapidly during the 1980s it maintained its pace with
other chemical industry players. The new market if turns out to be expansive it
thus offers the present management an opportunity to grow into a new period of
growth. The operations manager; the project engineer is pushing for
construction of a large plant to exploit this major product the operations
department has developed. The CEO, a key stakeholder, is uncertain of a large
unneeded plant capacity. He, therefore, proposes building a smaller plant but
agrees with the latter expansion plans once the waters in the market have
tested. The CEO also acknowledges that unless the company moves swiftly to fill
the demand which opens, competitors will exploit the market with their
Ohio Manufacturing Ltd, the problem is oversimplified and illustrates the
issues and business uncertainties that management must resolve to arrive at a
well thought of the decision. These decisions are growing in complexity every
day as companies are continuously faced with expansion and shrinking of their
market share. In such a dilemma a decision tree can be useful to the management
and assist them to arrive at a decision.
Suppose you are trying to decide whether to
approve a budget development plan for an improved product. You want to make the
approval because the product will give a competitive edge but if you don't
develop the product, your competitors will and will undermine your market
share. An example of a decision tree.
Decision point 1.
Your present decision is to authorize the
project with the hope that it succeeds according to your market study. Here the
project can either fail or succeed. (Janda, K., & Moreira, D, 2016).The
competitor may introduce their rival commodity and competition arise, or the
competitor may choose not introduce a rival product as they don't think it
viable and no competition arises.
decision is to produce commercially or shelve the product. If produced
commercially the market share could increase and either you maintain your
market share, or you share with the competitor who introduces a similar product
thus competition. (Tattan, K. V, 2016).
If shelved you would land your product slightly late in the market thus
loss of some level of market share to the competitor or there may be no change
in the market as the competitor may not introduce their product.
These outcomes from these decisions are
based on the present information. Of course, you don't analyze all the facts
and events that may happen. (Janda, K., & Moreira, D, 2016). In this
decision tree, you look at only those events and decisions that are important
to you and may have consequences you want to look at.
Let's now return to the indecisiveness of
Ohio Manufacturing Ltd; the company must decide whether to go for a small or
large plant. The decision must be made now if the company is expanding and
maintain its market share. (Janda, K., & Moreira, D, 2016). If the company
chooses to construct a small plant and finds the market to be receptive and
demand high, it can later expand the plant to a large scale plant after three
But, let's look at it on a bare outline of
alternatives. In making decisions, executives must factor in costs, returns and
probabilities which most appear probable. (Janda, K., & Moreira, D, 2016)
Based on the data available to management now and making the assumption that no
change in the company's situation they decide as follows;
estimates show a 60% chance of the market and a 40% chance of demand
large plant with a high volume production would yield $1000, 000 annually
regarding cash flow.
large plant with low volume yields only $100,000 when you factor in
inefficiencies and fixed costs.
small plant with low production would be economical and would produce $400,000
annual cash flow.
the small plant is expanded but demand did not match estimated $50,000 annual cash
flow could be netted.
further estimated that a large plant would cost $3 million to a small plant
into operation while a small plant would cost $1.3 million and expanding the
small plant would cost $2.2.
When the above data is incorporated, we are
beginning to see the value of decision trees in laying out what's known to
management in a way that enables a more systematic analysis hence leads to
better decisions. (Janda, K., & Moreira, D. (2016).In summary the
requirements for making a decision tree, the management must;
the alternatives and decisions available.
the type of alternative outcomes and points of uncertainty at each point.
the values needed to determine the analysis, especially the likelihood of
different actions and events and gains and cost of the actions and events.
the alternative value to determine a course.
the course of action.
A decision tree does not give the management
an answer to a problem, but rather it helps management to determine which
course of action will yield the expected gain by looking at the information and
alternatives about the decision. Just like any other company managers at Ohio
Manufacturing Ltd have varied opinions and viewpoints on which direction the company
should take. The many percipients in the decision-making process; those
supplying capital, data, ideas, decisions, and data will have different values
while looking at risk. Unless these differences are solved and dealt with those
making the decision will be biased. (Tattan, K. V, 2016). For example, company stakeholders may treat a
particular investment as a series of probabilities some of which will work out
some not. A major investment poses risks to a middle-level manager to his
career and job no matter the decision made. Another may have a lot to gain from
the success but not much to lose in the event of failure of the project.
In conclusion, the relation between future
events and present planning; long-term planning does not deal with future
decisions. It deals with the prediction of future decisions. This unique
feature of the decision tree as it allows the management to combine both
analytical techniques and present value methods with a clear description of the
future decisions events and alternatives. Using the decision tree decision
makers can consider various courses of action with ease and clarity. However
the decision tree does not offer final answers to managements trying to make
decisions in the face of uncertainty, but nevertheless, it's a valuable concept
for demonstrating the structure of investment decisions.