- A decision tree is a tool that can help businesses project possible outcomes to make educated and well-thought-out choices.
- Use decision trees with other decision-making methods to sort through possible outcomes.
- Creating a decision tree is a straightforward process, unlike some other decision-making techniques.
- This article is for business leaders who need help making difficult decisions in a timely manner.
In business, many decisions will arise that can't be taken lightly. In these instances, it's critical for business leaders to examine all their options carefully. One business decision-making tool is a decision tree.
According to OmniSci, a decision tree "is a graphic representation of various alternative solutions that are available to solve a given problem, in order to determine the most effective courses of action."
Each "branch" of the tree represents one of a decision's potential outcomes. The branches can be extended when one alternative outcome leads to another decision you'll need to make. Incorporated in each branch are the costs associated with each choice and the likelihood of its occurrence.
OmniSci highlights several benefits of this technique: Decision trees are easy to understand and interpret, can be used alongside various other decision-making methods, and help businesses thoroughly prepare for all possible outcomes throughout the decision-making process.
Since many calculations are involved in creating decision trees, many businesses use dedicated decision tree software to help them with the process. Decision tree software helps businesses draw their trees, assign values and probabilities to each branch, and analyze each option. Decision tree software – both free and paid – is available from various vendors, including IBM, TreeAge, SmartDraw, Palisade, Angoss and Edraw.
Drawing a decision tree
The Mind Tools website says that decision trees are useful because they help business leaders form a balanced picture of the risks and rewards associated with every possible course of action.
When drawing a decision tree, start with a square box – representing the decision you must make – either at the top or left-hand side of a page. You'll draw out each option from that box, either down if starting at the top of the page or to the right if starting on the left-hand side. On each line, write the option.
According to Mind Tools, decision-making leaders should consider the results at the end of each line. If an option's result is uncertain, draw a circle. If the result means you must make another decision, draw a small box.
"Starting from the new decision squares on your diagram, draw outlines representing the options that you could select," Mind Tools advises. "From the circles, draw lines representing possible outcomes."
Continue this process until you've drawn as many possible outcomes and decisions as you believe can come from the original decision.
Once you've drawn the tree, analyze it to determine what each branch and outcome means. Assign values to the possible outcomes and estimate the probability of each outcome. With those numbers, you can then calculate which option is best.
The benefits of using a decision tree
Using a decision tree to explore various potential outcomes can provide many advantages:
- It's easy to understand and interpret the information. A decision tree's format makes it easy for people to read – even those who may not be well versed in statistical analysis.
- It's simple to prepare. As long as you have the information available, creating a decision tree is a straightforward process compared to other decision-making techniques.
- It requires less data cleaning. According to the Corporate Finance Institute, because less data cleaning is required after you've created the variables for the decision tree, "cases of missing values and outliers have less significance on the decision tree's data."
Examples of how businesses use decision trees
Decision trees help businesses work through choices to determine the best outcomes for their organizations. According to CFO Selections, businesses use decision trees to lay out all possible outcomes and solutions, which can help them make informed choices on things such as these:
- Downsizing or expanding
- Succession planning
- Changing pricing models or the product offerings
- Expanding research and development
- Deciding whether to sell the business
- Relocating
- Outsourcing
Decision tree examples
To better understand how decision trees work, it's a good idea to look at some examples. One example that MasterClassManagement.com provides its students is a company trying to decide whether to invest in an online employee training program.
The first box holds the principal decision to be made: whether or not to spend money on a training program for new employees. From that box, the two options are "yes" and "no," so one branch is drawn from the first box with a "yes" and another with a "no." Since the outcome from each is still unknown, circles are drawn at the end of each branch.
From the "yes" branch, there are two options for different training programs: "System 1" and "System 2." From the circle at the end of the "yes" branch, two more branches are drawn: one for System 1 and the other for System 2. From there, branches are drawn out for how the system will be paid for, either upfront in full or through monthly installments.
On the "no" side of the tree, branches are drawn to represent using the existing training method or hiring live training experts. Since the existing plan is already in place, no other branches are drawn out from that branch. From the "hiring live trainers branch," two more branches are drawn to represent "field technicians" and "sales engineers."
Once the tree is complete, each branch's costs and probabilities are assigned to calculate and evaluate each option.
To further illustrate how decision trees work, you can find these other examples online:
Decision tree templates
Businesses interested in working through the decision tree technique on their own, without the help of dedicated software, can find these free templates online:
Sean Peek contributed to the writing and research in this article.