The CFO'S Perspective

When to Use a ‘Decision Tree’ for Business Planning

when to use a decision tree for business planningFor those not familiar with the term, a decision tree is a flow chart that works through all possible response options in a scenario to analyze resulting outcomes. Basically, it is a visual version of an “if this then that” statement across all possible alternatives.

The “branches” off each decision alternative that result use data analysis to forecast the most likely outcome of each decision. When one decision leads to another decision that must be made, that branch splits to continue extrapolating the effects of each subsequent decision. The result is a tree-like diagram (hence the name) that is easy to understand and interpret.

Decision trees can be more conceptual in nature or have numbers to back up decision scenarios, as is the case of pricing changes affecting revenue figures. For decision trees with complicated calculations, a software program can assign values and probabilities to streamline decision-making. A decision tree is a critical part of strategic planning because it allows decisionmakers to analyze the effects of a significant change throughout different areas of the business.

Aiding in Complex Decisions

Executive leadership can use a decision tree to assist with making complicated business decisions such as:

  • Downsizing
  • Outsourcing critical functions
  • Expanding into new markets
  • Changing pricing models
  • Relocating
  • Selling the business
  • Changing product offerings
  • Expanding research and development efforts

For instance, a decision tree can aid in succession planning by allowing business owners to evaluate possible options like passing the business onto an heir, selling to a co-owner, selling to a third-party, or selling an ownership stake back to the company.

A sample decision tree from the Harvard Business Review illustrates how a business may decide whether to move forward with a new development project:

sample decision tree

Responding to Changes

Decision trees are also commonly used by companies looking to respond to market trends or business disruptions such as:

  • A natural disaster
  • Regulatory changes
  • A market downturn
  • The emergence of a new technology
  • Supply chain delays
  • Materials shortages
  • Increased industry competition
  • Shifting consumer needs

As a result, decision trees have probably been more widely used over the last year than ever before as businesses attempted to create response scenarios to pandemic-related disruptions throughout 2020. In fact, Jeff Dunn discusses how organizations can use a decision tree for their pandemic response planning when he advises,

“Brainstorm, discuss with business leaders and advisors, play out all the reasonably likely scenarios then build financial models for each. Figure out what works and what does not. Put a plan in place to execute swiftly when the external factors shift and/or variables become known. Know what you are going to do and when you are going to do it based on changing conditions. It is a strange world for many businesses who know what to do but cannot right now because of legal restrictions. They need to get creative about the actions they can take – and plan for future actions as rules change and hopefully relax soon.”

Planning for Worst-Case Scenarios

Additionally, companies looking to be prepared for a worst-case scenario, like those previously mentioned, may also use a decision tree as part of a proactive crisis management strategy. In this case, leadership will identify possible triggers for a significant business disruption and work through the impacts of each to create a well-articulated response plan that anticipates business barriers:

“During a worst-case scenario, leadership must decide whether the organization will make the necessary adjustments needed to continue with business as usual or change how the company will operate. And while the conversation will undoubtedly include operational and capacity considerations, it is primarily a discussion about financial capabilities.”

Since these types of decision trees can become quite involved, triggers are typically ranked in order of likelihood so that business leadership can focus their time on the most probable threats.

Ready to improve your strategic planning? Download a decision tree PowerPoint template to get started.

As cash flow is a key element in decision making you can access our Cash Flow Calculator with our compliments.

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Topics: Data Analysis, Planning, Analysis, Leadership, Growth, Forecasting, Risk Management, Change Management, Strategy

Topics: Data Analysis Planning Analysis Leadership Growth Forecasting Risk Management Change Management Strategy