Use of Decision Trees in Business.
Decision-making 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 equivalent products.
The 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.
Decision event chains.
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 point 2.
The other 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 years.
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;
· Marketing estimates show a 60% chance of the market and a 40% chance of demand developing.
· A large plant with a high volume production would yield $1000, 000 annually regarding cash flow.
· A large plant with low volume yields only $100,000 when you factor in inefficiencies and fixed costs.
· A small plant with low production would be economical and would produce $400,000 annual cash flow.
· If the small plant is expanded but demand did not match estimated $50,000 annual cash flow could be netted.
· It's 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;
· Identify the alternatives and decisions available.
· Identify the type of alternative outcomes and points of uncertainty at each point.
· Estimate the values needed to determine the analysis, especially the likelihood of different actions and events and gains and cost of the actions and events.
· Analyze the alternative value to determine a course.
Choosing 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.
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