Situation 2: You understand your causal model and can predict a range of possible outcomes, along with probabilities for those outcomes. Imagine now that the McDonald’s managers are deciding whether to introduce a new sandwich in the United States. They still have a reliable way to model costs and revenues; they have relevant data about demographics, foot traffic, and so forth. (In other words, they have a causal model.) But there’s significant uncertainty about what the outcome of introducing the sandwich will be: They don’t know what the demand will be, for example, nor do they know what impact the new product will have on sales of complementary products. However, they can predict a range of possible outcomes by using quantitative multiple scenario tools. Some preliminary market research in different regions of the country will most likely give them a range of outcomes, and perhaps even the probability of each. It might be possible to summarize this information in simple outcome trees that show the probability of different demand outcomes and the associated payoffs for McDonald’s. The trees could be used to calculate the expected value, variance, and range of financial outcomes that McDonald’s might face if it introduced the sandwich. Managers could then use standard decision-analysis techniques to make its final determination.
Alternatively, McDonald’s could pilot the new sandwich in a limited number of regions. Such pilots provide useful information about the potential total market demand without incurring the risk of a full-scale rollout. Conducting a pilot is akin to investing in an “option” that provides information and gives you the right but not the obligation to roll out the product more extensively in the future. (This approach is still market research, but usually a more expensive form.) Real options analysis, which quantifies the benefits and costs of the pilot in light of market uncertainty, would be the appropriate decision-making tool in this case.
Tools: Quantitative multiple scenario tools such as Monte Carlo simulations, decision analysis, and real options valuation. (These tools combine statistical methods with the conventional capital-budgeting models favored in Situation 1. Managers can simulate possible outcomes using known probabilities and discounted cash flow models and then use decision analysis tools to calculate expected values, ranges, and so on.)
Situation 3: You understand your causal model but cannot predict outcomes. Let’s now assume that McDonald’s is entering an emerging market for the first time. Executives still understand the model that will drive store profitability. The cost and revenue drivers may well be the same, market to market. However, the company has much less information about outcomes, and predicting them using market