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Decision trees help provide strategic answers for uncertain scenarios

4 min read


Large corporations and government agencies often struggle with how to handle uncertain future scenarios. But, the constantly changing business climate requires executives to plan for a variety of outcomes to remain competitive. Too often, complex decisions are made based on “gut feeling” and lack evidence-based methods that apply quantitative techniques to verify expertise and experience.

As a result, important questions frequently arise when businesses consider the future. For example: What do I do if our competitors figure out a way to apply new research to a key product line? What happens to the physician practices my hospital just acquired if Medicare payments are cut? What difference does it make if a foreign country nationalizes our supplier? What do I do if my adversary discovers a way to deny or deceive my best intelligence collection method?

Executives do not have time to examine every angle. And, their teams are not always equipped to know the best path forward, especially when future scenarios require a change in strategy or operations. As a result, organizations should turn to decision analysis to determine the best course of action.

Decision analysis techniques help companies solve complex problems, as well as evaluate a potential project’s financial value. Big Sky has helped clients in several industries, including the U.S. Department of Defense, apply decision trees and probabilistic problem solving to tough challenges.

Figure 1

Decision trees provide a method to think through the probability of multiple scenarios and determine the potential impact of each. That impact may be financial in nature (as shown in Figure 1), or it might pertain to the risk of a negative event, such as an insider threat or a natural disaster. This process allows decision makers to assign a quantifiable value to the choices presented by future scenarios and pick the best option.

Decision trees are a way of applying solid risk-analysis methods to a variety of business problems. And whether the problems are organizational or related to national security or investments, the flexibility is quite remarkable. By quantifying the uncertainty, decision trees allow decision makers to model a variety of outcomes at multiple levels and react appropriately.

The process works by assigning probabilities to the outcome of a particular scenario based on managers’ experience and judgment. When used as a strategic planning tool, decision trees can help organizations determine how to allocate resources and when to scale up or delay investment.

Figure 2

For example (see Figure 2), a company estimates that next year’s demand for a new product has a 30% chance of being high, a 40% chance of being fair and a 30% chance of being low. The product costs $3 million to bring to market. Based on the costs associated with bringing the product to market, returns are positive in this scenario if the demand is high or fair, but negative if the demand is low.

In this example, the three scenarios result in a 30% chance of $7 million in cash flow, a 40% chance of $2 million and a 30% chance of $6 million. Based on those probabilities, the project’s expected value is $1.1 million in positive cash flow.

By calculating investment costs and comparing them to potential returns based on the likelihood of demand for the product, the company can pick the highest-value alternative. Based on the alternatives in this scenario, the company should introduce their new product next year for a better chance of success.

This example, while valid, is simplistic. In a real decision tree, most organizations would include several layers reflecting probabilities that explore a variety of “what ifs” for each choice. While the example deals with a product launch, the same method can be used to explore the consequences and subconsequences of security investments intended to prevent terrorist attacks and the resulting costs. It can also be applied to natural disasters or other failures.

By assigning a quantifiable value to potential outcomes, decision trees help organizations make good decisions to navigate uncertain future scenarios.

John Dillard, who has more than 15 years of experience as an analyst and consultant for large government agencies and Fortune 500 companies, co-founded management consulting firm Big Sky Associates in 2006 and serves as president and partner-in-charge. Dillard leads consulting projects focused on improving the speed and effectiveness of decision making, as well as core processes and functions. He has received the University of South Carolina’s Moore School of Business 2011 Distinguished Young Alumni Award and the U.S. Army Commander’s Award for Public Service. Dillard received bachelor’s degrees in political science and international studies from American University in Washington, as well as a master’s degree in international business from the University of South Carolina’s Moore School of Business.