Chapter

p
1
Introduction to Modeling
& Problem Solving

Introduction

We face numerous decisions in life &

business.
We can use computers to analyze
l
the
h
potential outcomes of decision
p
alternatives.
Spreadsheets are the tool of choice for
todays managers.

What is Management Science?

A field of study that uses computers,

statistics, and mathematics to solve
business problems.
Also known as:

Operations research
h
Decision science

Success story in management science

Merril Lynch
y

5 million customers
16 000 financial advisors
16,000
Developed a model to design product
feat es and pricing
features
p icing options to better
bette
reflect customer value
Benefits:

$80 million increase in annual revenue

$22 billion increase in net assiets

Success story in management science

Jan de Wit Co.

Brazils largest lily farmer

Annuallyy p
plants 3.5 million bulbs and
produces 420,000 pots & 220,000 bundles
of lilies in 50 varieties.
Developed model to determine what to
plant, when to plant it, and how to sell it.
Benefits:

26% increase in revenue

32% increase in contribution margin

Success story in management science

NBC

Must determine program schedules

Schedules must meet advertisers
demographic and cost requirements
Developed optimization model to
determine optimal timing and pricing of
commercials
Benefits:

$50 million increase in annual revenue

Success story in management science

Samsung Electronics

Leading DRAM manufacturer

Semiconductor facilities cost $2
$2-$3
$3 billion
High equipment utilization is key
Developed comprehensive planning and
g system to control WIP
scheduling
Benefits:

Cut cycle times in half

$1 billion increase in annual revenue

What is a Computer
Comp te Model?

A set of mathematical relationships and

logical assumptions implemented in a
computer as an abstract representation
of a real-world object of phenomenon.
S
Spreadsheets
d h t provide
id the
th mostt
convenient way for business people to
build computer models.

206361

Programming
P
i &
Database

Modeling
M
d li &
Analysis

Modeling approach to decision making

Everyone
y
uses models to make
decisions.
Types of models:

Mental (arranging furniture)

Visual (blueprints, road maps)
Physical/Scale
y
/
((aerodynamics,
y
, buildings)
g )
Mathematical (what well be studying)

Ch
Characteristics
t i ti off Models
M d l

Models are usually simplified versions

of the things they represent
A valid
lid model
d l accurately
t l represents
t the
th
relevant characteristics of the object or
decision being studied

Benefits
f off Modeling
d l

Economyy - it is often less costlyy to analyze

y decision
problems using models.
Timeliness - models often deliver needed
information more quickly than their real-world
counterparts.
Feasibility - models can be used to do things that
would be impossible.
impossible
Models give us insight & understanding that
i
improves
decision
d i i making.
ki

Example of a mathematical model

Profit = Revenue - Expenses

or
f(Revenue,, Expenses)
p
)
Profit = f(
or
Y = f(X
(X1, X2)

A Generic
G
i mathematical
th
ti l model
d l
Y = f(X1, X2, , Xn)
Where:

Y = dependent variable
(aka bottom-line performance measure)
Xi = independent variables (inputs having an impact on Y)
f(.) = function defining
g the relationship
p between the Xi & Y

M th
Mathematical
ti l Models
M d l & Spreadsheets
S
d h t
Most spreadsheet models are very similar
to our generic mathematical
h
l model:
d l
Y = f(X1, X2, , Xn)
Most spreadsheets have input cells
(representing Xi) to which mathematical
functions ( f(.)) are applied to compute a
bottom line performance measure (or Y)
bottom-line
Y).

Categories of Mathematical Models

Model
Category
Prescriptive

Form of f(.)

Independent
Variables

OR/MS
Techniques

known,
well-defined

known or under
decision maker
makerss
control

LP, Networks, IP,

CPM EOQ,
CPM,
EOQ NLP,
NLP
GP, MOLP

Predictive

unknown,
ill-defined

known or under
decision makers
control

Regression Analysis,
Time Series Analysis,
Discriminant Analysis

Descriptive

known,
known
well-defined

unknown or
uncertain

Simulation, PERT,
Simulation
PERT
Queueing,
Inventory Models

The
h Problem
bl
Solving
S l
Process

Identify
Problem

Formulate &
Implement
Model

Analyze
Model

unsatisfactory
results

Test
Results

Implement
Solution

Psychology of decision making

Models can be used for structurable

aspects of decision problems.
Other aspects cannot be structured
easily and require intuition and
j d
judgment.
t
Caution
Caut
o : Human
u a judgment
judg e t and
a d intuition
tu t o
is not always rational!

Anchoring Effects

Arise when trivial factors influence initial

thinking about a problem.
Decision-makers
k
usually
ll under-adjust
d
d
from their initial anchor.
Example:

What is 1x2x3x4x5x6x7x8 ?
What is 8x7x6x5x4x3x2x1 ?

Framing Effects

Refers to how decision-makers view a

problem from a win-loss perspective.
The way a problem is framed often
influences choices in irrational ways
Suppose youve been given $1000 and
must
ust choose
c oose bet
between:
ee

A. Receive $500 more immediately

B. Flip a coin and receive $1000 more if heads
occurs or $0 more if tails occurs

Framing Effects (Example)

Now suppose youve

you ve been given $2000
and must choose between:

A. Give back $500 immediately

A
B. Flip a coin and give back $0 if heads occurs
or give back $1000 if tails occurs

A Decision Tree for Both Examples

Payoffs
$1,500

Alternative A
Initial state
Heads (50%)
Alternative B
(Flip coin)

Tails ((50%))

$2,000
$
,000
$1,000

G dD
Good
Decisions
i i
vs. Good
G d Outcomes
O t
Good decisions do not always lead to good
outcomes...
t

A structured,
t t d modeling
d li approach
h to
t decision
d i i
making helps us make good decisions, but cant
guarantee good outcomes.

Introduction
d i to Excel:
l Graphs
G h

What is Excel?

Calculation spread sheet (

Algebra, Boolean, Matrix, Stat, Finance,
g etc.
Data mgmt

Run chart (QC)

This graph shows how a variable has

change
h
over time
i
Use to analyze
y trend,, pattern
p
or outline
of the data
By adding the control limits,
limits the control
chart is established
Excel features: simple math operations
& line graph

Pareto chart (diagram)

This chart is based on a natural tendency

for the majority of the problem to be due
t a minority
to
i it causes (80
(80:20
20 rule)
l )
Excel features: Bar graph and Sort
function

Histogram

This chart shows the statistical

frequency distribution of a variable of
interest.

Scatter diagram()

x

(Independent Variable)
Va iable)

y

(Dependent Variable)
Scatter diagram Excel

Insert Chart XY (Scatter)

When to use scatter diagram?

(Brain storming)

Scatter Diagram

)
(2 )

Example

BENDRIX1.XLS
To use scatterplots to examine the relationships between
overhead, machine hours, and productions runs at
Bendrix.
d
The manager of the factory wants to get a better
understanding
d t di off overhead
h d costs.
t
These overhead costs include supervision, indirect labor,
supplies payroll taxes,
supplies,
taxes overtime premiums
premiums,depreciation,
depreciation
and a number of miscellaneous items such as insurance,
utilities,, and
u
a d janitorial
ja o a and
a d maintenance
a
a
expenses.
p

Correlations (r)

Correlations are numerical summary

measures that
h indicate
i di
the
h strength
h off
relationships between pairs of variables
A correlation between a pair of variables is
g number that summarizes the
a single
information of a scatter plot
However it can only measure the strength
However,
of a linear relationship.
So Ho about
SoHow
abo t nonlinear
nonlinea relationship
elationship

Formula for Correlation

rxy

(x

xy

x)(yi y) /(n 1)
sxsy

1
(x i x)(yi y)
n i 1

C
Covariance
i
can also
l be
b used
d to
t representt correlation

l ti off X & Y

Summary

Scatter Diagram Graphing Relationships

Linear vs Nonlinear relationship (Visualization)

Outliners
Unequal variance
N relationship
No
l ti
hi !!!