Management invariably encounters situations in which uncomfortable decisions must be made. In some cases, the difficulty may be that, although certain alternative choices are clear, the consequences of these choices are not readily apparent. One possible tool for a manager in such a situation is decision tree analysis.
A decision tree is a graphical diagram consisting of nodes and branches. The nodes are of two types. The first is a rectangle that represents the decision to be made. The branches emanating from decision nodes are the alternative choices with which the manager is faced. One and only one alternative can be implemented. The second type of node is a circle. Circles represent chance nodes. That is, the alternatives emanating from chance nodes have some element of uncertainty as to whether or not they will occur. The primary benefit of a decision tree is that it provides a visual representation of the choices facing the manager.
The first task of the manager is to identify the decision that needs to be made based upon a given situation. Next, the manager must think of all the possible alternative actions that could be implemented which would “solve” the problem. These alternatives are connected to the decision node as straight lines emanating from the node. The next step is to identify all the possible consequences that could occur as a result of an alternative being implemented. This process is accomplished for each and every alternative action identified in the previous step. Since these consequences have some element of uncertainty as to whether or not they will occur, the manager needs some way in which to evaluate the likelihood that they will (may) occur. The end goal is to obtain probabilities as to the likelihood of each consequence occurring. The best process to obtain these probabilities is to use past experience of similar outcomes. But, often there is no past experience of similar outcomes available to the manager. In these cases, the best tool is to utilize the collective wisdom of experts as to how likely it is that the particular consequence will occur in the future. Using an appropriate consensus building technique, estimates from a panel of experts can be combined or averaged to create a probability of the likelihood of the occurrence of each and every consequence. The only requirement is that the sum of the probabilities of the set of consequences emanating from a chance node must equal one.
The next step is to evaluate the end result of each possible alternative in concert with the consequences identified for each alternative. This step results in a monetary figure that would be obtained if this course of action were implemented. This step is accomplished for each possible alternative. Finally, the entire tree is evaluated by employing a technique known as mathematical expectation in order to select the most beneficial alternative.
Product Planning at Gerber
Gerber Products, Inc., the well-known baby products company, recently used decision tree analysis in deciding whether to continue using the plastic known as poly-vinyl chloride or, more commonly, PVC. The situation involved a number of organizations including the environmental group Greenpeace, the U.S. Consumer Products Safety Commission, the toy and plastics industries, and the general public.
PVC is a composite plastic material used in numerous household, commercial, and medical products including food storage containers, toys, and medical tubing. To make PVC soft and pliable, a chemical plasticizer known as “phthalates” is added to soften the plastic. In the latter half of 1998, Greenpeace announced that it had conducted scientific testing on phthalates and found them to be carcinogenic in lab rats. Further, Greenpeace claimed that the chemical leeches from the plastic over time and voiced particular concern with, “products that were aimed at small children and used to suck on or chew on.” Although phthalates have been used in plastic for over 30 years, and there are no known cases of phthalates causing health problems, Greenpeace’s press release was strategically timed to coincide with the Christmas toy season, thereby guaranteeing maximum media coverage. As expected, it was immediately picked up by the television networks and, in fact, the ABC show 20/20 did an entire segment on the possible health risks of phthalates.
The problem grew worse for Gerber when the media focused specifically on products made for oral use by children. Gerber, the largest producer of nipples, pacifiers, and feeding products in the U.S., produced some 75 different products containing phthalates and was under considerable pressure to respond publicly to the investigation.
Gerber management had to evaluate all of the current information, weigh the consequences of each action, and proceed on the most prudent course to insure as limited an interruption in business as possible. Gerber knew that a vast body of scientific evidence indicates that phthalates are completely safe. However, once the Greenpeace announcement was publicized, the Consumer Product Safety Commission was spurred to issue a press release expressing new doubts. As the focus gradually fell on items children put in their mouths, and large toy manufacturers like Mattel and Disney began to distance themselves from phthalates, the spotlight of the CPSC fell squarely on Gerber. A month before Christmas, the CPSC informed Gerber they would issue a press release advising parents of the potential dangers of phthalates, and Gerber would be named as one of the companies involved. This is the point at which Gerber implemented a decision tree.
Gerber basically faced two choices, neither of which was particularly beneficial. The firm could be reactive, wait for the announcement, and gauge consumer response before deciding on a course of action, or it could be proactive and aggressively pursue resolution of the problem regardless of the public’s response to the report. The CSPC report suggested the agency would either issue a recall of all products containing phthalates (shown on the decision tree as the unfavorable response), or they would issue a report merely expressing concern in which case the public response would be minimal (shown on the decision tree as favorable).
Gerber projected eight possible outcomes on its decision tree. If the firm reacted proactively by discontinuing use of all phthalates, and the CSPC report simply issued a warning, Gerber predicted an 80 percent chance that the public would react favorably to Gerber’s responsiveness causing sales to increase over competitors who reacted more slowly. A potential nationwide revenue increase of $l million was entered into the decision tree. Given a proactive response and a favorable CSPC report, Gerber also recorded a 20 percent chance that sales would decline by $1 million due to the sensationalistic nature of the press coverage.
If the CSPC report is negative and a recall is issued, Gerber predicted 25 percent likelihood that it could preserve current sales through a proactive response. On the other hand, the firm placed a 75 percent probability that a recall would hurt sales by $1.25 million.
Four more alternatives were predicted in the event that Gerber waited for the CSPC report before taking action. With a favorable report and a delayed response, there was thought to be a 25 percent chance that sales would remain flat, along with a 75 percent chance that sales would decline by $2 million.
The worst case scenario is if Gerber remains passive and the CSPC report calls for a recall. In that case, Gerber optimistically predicted a 20 percent probability that it could still increase sales by taking advantage of companies who were less prepared for the report and actually gain approximately $.5 million. However, it was considered an 80 percent probability that significant volume would be lost.
Using a decision tree like the one shown at the end of this article, Gerber concluded that its best option was to be proactive and initiate its own solutions without waiting for the CPSC report. Then, Gerber hoped for a favorable report that would provide a strategic advantage over competitors who opted for a different path.
Some Branches May be Missing From the Tree
As this example shows, decision trees enable managers to use available data to conceptualize and articulate possible scenarios of future events even though important pieces of information may still be missing.
Unfortunately, some important branches of the tree, such as ethical considerations, may be missing since they are not easily converted into financial terms. But the ability to predict economic outcomes in this way can still play a vital role in management decision-making.
Subsequent to these actions by Gerber, phthalates were approved for use in toys and other products by the U.S. Consumer Product Safety Commission, the U.S. Food & Drug Administration, and the American Council on Science and Health. An ACSH panel of scientists and physicians headed by former U.S. Surgeon General Dr. C. Everett Loop took the extra step of underscoring the benefits associated with the use of the phthalate DEHP in medical applications because of its demonstrated reliability.