What is a decision tree? Is it just that flowchart that some managers use or is it a tool that can actually help you make good business decisions? This is the article where you find out what it is, how to make a decision tree, and how it will suit your business for the quarters to come when you have to make an important strategical decision.
Defining the Decision Tree
If you are an entrepreneur or the manager of your own business, then you will come across a moment in your path when you will have to make important decisions. When those moments arrive, you will need to assess all your options very carefully. A tool that you can use to do that is the decision tree.
In simple terms, it’s a diagram or a flowchart which will allow you to explore all the possible alternatives as well as their outcomes.
Every branch which you add to this tree is one such option you have. The smaller branches that extend from these ones are the results or outcomes that may happen when you make one decision or another.
Add to each branch of the tree the cost of every choice as well as the probability it has of happening the way you intend, plan or foresee it. If and when you have these numbers or the data at hand, you can then use it to calculate what is the best and most profitable choice you have.
Now let’s see how to make a decision tree and how it works via some real examples.
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Examples of Decisions Trees
Here is an example that can show you how a decision tree works.
Let’s say that you own a restaurant that you have been building over that past few years. You have also been planning on selling it in the next two years so that you can make a profit. Evidently, you are now trying to figure out if this is the best decision. Build a decision tree with a few branches/options that will look like this.
Branch or Option Number 1 – Open a Secondary Location
This will cost you an estimate of $200,000. Should it fail, you will lose this money. However, if it is a success, you stand to make yet another $50,000 prior to selling the business. Therefore, you increase the total amount of money you can earn. However, you must take into account the fact that new businesses are always risky. Therefore, add a bubble to this branch which says that this probability of success stands at 50 percent.
Branch or Option Number 2 – Go for a Catering Business
The price of this endeavor is $30,000. Once more, evidently, if you fail, you lose all this money. However, if it is successful, you stand to make an additional $15,000. The chances of success here are 80 percent. Still, add another bubble there which says that, even though you have more chances of being successful on this one, there is less gain out of it. The decision is entirely yours now. It depends on what type of person you are, not on how to make a decision tree knowledge.
Branch or Option Number 3 – Focus on the Restaurant You Already Have and Improve It
This means that you have to invest more money into the existing venue. There is no price tag on this one. You can invest as much or as little as you wish. There is also no losing percentage. You already know your restaurant is a success. Improvements can only drive in more customers and business. Therefore, how much money you stand to make before you sell depends entirely on how much you invest in it in the first place.
Only one question remains here after you have learned how to make a decision tree. Which decision is the best? This is where your skills as a business person come in. Use your risk management knowledge or employ a financial adviser if you need extra help. Good luck!