Embedded Files
This is a breakdown of an insightful article on decision trees from Harvard Business Review and how companies effectively use them to make smart decisions.
Let’s dive into an example to see how this works!
This is a breakdown of an insightful article on decision trees from Harvard Business Review and how companies effectively use them to make smart decisions.
Let’s dive into an example to see how this works!
The Problem:
The Problem:
Imagine a company, Stygian Chemical, is deciding on a new product with a 10-year lifespan. They're unsure if demand will be high or low.
Imagine a company, Stygian Chemical, is deciding on a new product with a 10-year lifespan. They're unsure if demand will be high or low.
Here's the dilemma:
Here's the dilemma:
- Build a small plant: This is safe but limits future growth if demand is high.
- Build a small plant: This is safe but limits future growth if demand is high.
- Build a large plant: This is risky if demand is low, leaving them with excess capacity.
- Build a large plant: This is risky if demand is low, leaving them with excess capacity.
A decision tree helps visualize this situation. It includes:
A decision tree helps visualize this situation. It includes:
- Decision Points: Forks in the road, like "Build small plant" or "Build large plant."
- Decision Points: Forks in the road, like "Build small plant" or "Build large plant."
- Chance Events: Uncertainties, like "High demand" or "Low demand."
- Chance Events: Uncertainties, like "High demand" or "Low demand."
- Outcomes: The final results, like profit or loss.
- Outcomes: The final results, like profit or loss.
Building the Tree:
Building the Tree:
1. Identify choices: Small plant or large plant.
1. Identify choices: Small plant or large plant.
2. Identify uncertainties: High or low demand.
2. Identify uncertainties: High or low demand.
3. Estimate values: Assign probabilities to each outcome (e.g., 70% chance of high demand).
3. Estimate values: Assign probabilities to each outcome (e.g., 70% chance of high demand).
4. Analyze alternatives: Consider potential profits and losses for each path.
4. Analyze alternatives: Consider potential profits and losses for each path.
The Benefit:
The Benefit:
By mapping all these possibilities, the decision tree helps Stygian see:
By mapping all these possibilities, the decision tree helps Stygian see:
- Expected value: The average profit considering all potential outcomes.
- Expected value: The average profit considering all potential outcomes.
- Risk-reward trade-off: The balance between potential gains and potential losses.
- Risk-reward trade-off: The balance between potential gains and potential losses.
The article acknowledges that decisions aren't just about money. Factors like:
The article acknowledges that decisions aren't just about money. Factors like:
- Job security for employees.
- Job security for employees.
- Career advancement for managers.
- Career advancement for managers.
- Company survival in a competitive market.
- Company survival in a competitive market.
These can influence how different people approach the decision.
These can influence how different people approach the decision.
The Takeaway:
The Takeaway:
A decision tree is a powerful tool for complex business choices.
A decision tree is a powerful tool for complex business choices.
It helps consider various possibilities and their impact, leading to more informed investment decisions.
It helps consider various possibilities and their impact, leading to more informed investment decisions.
However, it's important to remember that it's a framework, not a magic formula.
However, it's important to remember that it's a framework, not a magic formula.
Other factors beyond pure financial gain should also be considered.
Other factors beyond pure financial gain should also be considered.
Get in touch at jain.van@northeastern.edu
Get in touch at jain.van@northeastern.edu
Page updated
Google Sites
Report abuse