Project Example with Decision Tree

Let's see how a specific project example might work with the decision tree methodology learned so far. Here is the scenario:

■ You are the project manager making a make or buy decision on a particular item on the work breakdown structure (WBS). Alternative "A" is "make the item" and alternative "B" is "buy the item."

■ There are risks in both alternatives. The primary risk is that if the outcome of either "A" or "B" is late, the delay will cost the project $10,000 per day.

■ If you decide to make the item, alternative "A", then there is a fixed materials and labor charge of $125,000. If you decide to buy the item, alternative "B", there is a fixed purchase cost of $200,000. Putting risks aside, "A" seems to be the more attractive by a wide margin.

■ Although manufacturing costs are fixed, your team estimates there is a 60% chance the "make" activity will be 20 days late. Your judgment is that you simply do not have a lot of control over in-house resources that do not report to you. However, your team's estimate is that there is only a 20% chance the "buy" activity will be late 20 days, and the purchase price is fixed.

What is your decision? Figure 4-6 shows the decision tree for this project scenario. The decision node is the decision you are seeking: "make or buy." The tree branches lead back through each of the two alternatives. Inputs to the decision-making process are both quantitative and qualitative or judgmental. You know the manufacturing cost, the alternative procurement cost, and the cost of a day's delay in the project. You make judgments about the performance expectations of your in-house manufacturing department and about the performance of an alternative vendor. Perhaps there is a project history you can access of former "similar-to" projects that provide the data for the judgments.

As the mathematics show, there is only a $5,000 difference between these two alternatives when all the risk adjustments are factored into the calculation. In fact, the decision favors a "buy" based on the decision policy element to take the alternative of most advantage to the project, just the opposite from the initial conclusion made before risk was taken into account

How about the downside considerations? If you make the item and the 20-day delay materializes, you are out $325,000. If you buy the item and the 20-day delay happens, you are out $400,000. Since you budget for expected value, either $245,000 or $240,000, the most pessimistic figures provide the information about how much unbudgeted downside risk you are managing:

Downside risk (buy) = $240,000 - ($200,000 + $200,000) = -$160,000

Downside risk (make) = $245,000 - ($125,000 + $200,000) = -$80,000

You, or your project sponsor, must also decide if the unbudgeted risk is affordable if all risk mitigations fail and the 20-day delay occurs.

Project Management Made Easy

Project Management Made Easy

What you need to know about… Project Management Made Easy! Project management consists of more than just a large building project and can encompass small projects as well. No matter what the size of your project, you need to have some sort of project management. How you manage your project has everything to do with its outcome.

Get My Free Ebook

Post a comment