decision tree

Definition:
A methodology for exploring the existence and relative merits of alternative courses of action available to the decision-maker in solving a problem. As explained in Michael J. Baker, Marketing Management and Strategy (London: Macmillan, 1985), one of the clearest explanations of the use of the decision tree is to be found in John F. Magee's 'Decision Trees for Decision Making' (in Harvard Business Review, July-August 1964, pp. 126-38). Magee starts with a simple example to illustrate the salient characteristics of the decision-tree approach by posing the problem of what to do on an overcast Saturday afternoon when 75 people are coming round for cocktails. This he describes as follows: You and your wife feel it is time you returned some hospitality by holding a party. You have a pleasant garden and your house is not too large; so if the weather permits, you would like to set up refreshments in the garden and have the party there. It would be more pleasant, and your guests would be more comfortable. On the other hand, if you set up the party for the garden and after all the guests are assembled it begins to rain, the refreshments will be ruined, your guests will be damp and you will heartily wish you had decided to have the party in the house. . . . What should you do? This particular decision can be represented in the form of a ‘payoff' table: Rain No Rain Outdoors Disaster Real comfort Indoors Mild discomfort, Mild discomfort, but happy but regrets In turn the information in the pay-off table can be represented pictorially by means of a decision tree. As Magee comments: The tree is made up of a series of nodes and branches. At the first node on the left, the host has the choice of having the party inside or outside. Each branch represents an alternative course of action or decision. At the end of each branch or alternative course is another mode representing a chance effect - whether or not it will rain. Each subsequent alternative course to the right represents an alternative outcome of this chance event. Associated with each complete alternative course through the tree is a pay-off, shown at the end of the rightmost or terminal branch of the course. From this description, it is clear that a decision tree will always combine action choices with different possible events or outcomes which are subject to some degree or other to chance (distinguished by different symbols for emphasis). In the case of the relatively simple decision discussed so far, one probably needs neither a pay-off table nor a decision tree to help one come to a decision. But given more complex decisions where several alternatives are available, it is easy to understand how the content of a pay-off table could confuse rather than illuminate while a decision tree would help disaggregate the problem in a clear and meaningful way. Magee presents such a tree when he analyses the familiar MARKETING problem of whether or not to invest in PRODUCT DEVELOPMENT.

Cross-References:
[product development] [marketing]

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