What Is a Decision Tree?

What is a decision tree?

A decision tree is a flowchart graph or diagram that explores all potential decisions and their possible outcomes.

Each “branch” of the tree represents one of the decision’s potential outcomes. The branches can be extended when one alternative outcome leads to another decision you’ll need to make. Incorporated into each branch are the costs associated with each choice and the likelihood of its occurrence.

Because decision trees require numerous calculations, many businesses use dedicated decision tree software to help them with the process. Decision tree software helps businesses draw their trees, assign values and probabilities to each branch, and analyze each option. There are both free and paid versions of decision tree software available from vendors such as IBM, TreeAge, SmartDraw, Palisade, Angoss and Edraw.

How to draw a decision tree

Decision trees help business owners and leaders understand the risks and rewards associated with each decision. These include all possible outcomes, both positive and negative. Here’s how to create a decision tree.

1. Start with a square box — representing the decision you must make — on the top or left side of a page.
2. From that box, draw out each option — either down, if you’re starting at the top of the page, or to the right, if you’re starting on the left side. On each line, write the option.
3. Draw a circle around any uncertain option, and draw a box around any option that requires a further decision, with lines going to additional outcomes.
4. Continue this process until you’ve drawn as many possible outcomes and decisions as you believe can come from the original decision.

Once you’ve drawn the tree, analyze it to determine what each branch and outcome means. Assign values to the possible outcomes, and estimate the probability of each one. With those numbers, you can calculate which option is best.

The benefits of using a decision tree

Using a decision tree to explore and compare potential outcomes can provide many advantages.

• A decision tree makes it easy to understand and interpret information. A decision tree is easy for people to read, even for those who may not be well versed in statistical analysis.
• A decision tree is simple to prepare. As long as you have the information, creating a decision tree is more straightforward than other decision-making techniques.
• A decision tree reduces data cleaning. According to the Corporate Finance Institute, because less data cleaning is required after you’ve created the variables for the decision tree, “cases of missing values and outliers have less significance on the decision tree’s data.”

Examples of how businesses use decision trees

Decision trees can help companies make informed choices about a wide range of business areas, including the following: 

• Pricing products or services
• Promoting employees
• Offering training to employees
• Selling the business
• Hiring contract workers

Decision tree examples

To better understand how decision trees work, consider some examples. For instance, say you’re deciding between hiring a full-time employee and working with a contractor. For this decision tree, separate your two options into different boxes. Then, branch those out into various outcomes, including some benefits or downfalls you might experience from making that particular choice.  

Alternatively, create two separate decision trees — “Should I hire a full-time worker?” and “Should I hire a contract worker?” — and then dive deeper into each choice. Then, break down the question into two boxes: “Yes” and “No.” From there, explore the outcomes by asking further questions, like “Is this necessary for our company’s workload?” Then, add “Yes” and “No” boxes. Continue this until you’ve exhausted all options and solutions and have determined all possible outcomes. 

Using a decision tree in the workplace

Using a decision tree is a great way to make more informed decisions for your business. No matter how many options you’re weighing, breaking them down into different branches and boxes will allow you to understand any potential outcome that might benefit or harm your company. 

If you have a business idea or question regarding your business operations, consider turning to a decision tree as your solution. You can use a decision tree template or simply create your own decision tree using the above tips and examples.

Chad Brooks and Sean Peek contributed to this article.