How do you use a decision tree framework to analyze complex and uncertain scenarios?

1 Define the objective

The first step is to define the objective of your analysis. What are you trying to achieve or decide? What are the main criteria or metrics that you will use to measure your success? For example, if you are analyzing a new product launch, your objective might be to maximize the expected profit or market share. You should also clarify the scope and timeline of your analysis. For example, are you looking at a one-year or a five-year horizon? Are you considering only the domestic market or the global market?

2 Identify the alternatives

The second step is to identify the alternatives that you can choose from. These are the different actions or strategies that you can implement to achieve your objective. You should list all the feasible and relevant alternatives, and eliminate any that are clearly inferior or irrelevant. For example, if you are analyzing a new product launch, your alternatives might include launching the product with different features, prices, or marketing channels.

3 Estimate the probabilities and outcomes

The third step is to estimate the probabilities and outcomes of each alternative. This is where you use data, research, assumptions, and logic to quantify the uncertainty and the impact of each alternative. You should assign a probability to each possible scenario or event that can affect your objective, and estimate the outcome or payoff of each scenario or event. For example, if you are analyzing a new product launch, you might assign probabilities to different levels of customer demand, competitor response, or market conditions, and estimate the profit or market share of each combination.

4 Draw and evaluate the decision tree

The fourth step is to draw and evaluate the decision tree. A decision tree is a diagram that shows the alternatives, probabilities, outcomes, and expected values of your analysis. You can use software or online tools to draw a decision tree, or you can do it manually with a paper and a pencil. To draw a decision tree, you should start with a square node that represents your decision, and branch out with lines that represent your alternatives. Then, for each alternative, you should add circle nodes that represent the uncertain scenarios or events, and branch out with lines that represent the probabilities. Finally, for each scenario or event, you should add triangle nodes that represent the outcomes or payoffs. To evaluate a decision tree, you should calculate the expected value of each alternative by multiplying the probabilities and outcomes along each branch, and adding them up. The expected value is the average or weighted outcome that you can expect from each alternative. You should choose the alternative that has the highest expected value, or that best aligns with your objective and criteria.