SIMULATION

Many of the problems in decision sciences are solved by standard mathematical tools. But application of
these mathematical models is based on certain assumptions. In real business scenario at times it
becomes quite difficult to satisfy these assumptions. Under these circumstances managers use the
technique of simulation. It is a very popular technique.

Simulation means imitation. In simulation, a given system is copied and artificial environment is created to
examine the behaviour of the system under specified conditions. It is a descriptive and not an optimizing
technique. It does not generate solutions but enables managers to test their alternative solutions on a
model that is an imitation of the original situation. Where optimization models cannot be easily applied
because of non-fulfillment of assumptions, cost or other practical difficulties; simulation models offer a
convenient, inexpensive and quick way to evaluate alternative systems.

The technique of simulation has very extensive areas of application. It is used to train managers to handle
real life business challenges and solve very complex business problems. Through simulation, business
engineers are taught to evaluate aerodynamic properties of aeroplanes by placing their models in wind
tunnels where air is blown to examine its impact on the model. “Decision simulators” have been
developed and are in use in the corporate world through which managers test various alternative
decisions and their impact on corporate profitability. Another field where simulation is widely applied is
designing. Alternative system designs are developed and evaluated to measure system performance.
Some of the well-known areas of simulation application are waiting lines, production designing, capacity
planning, manpower and machine scheduling, location, layout and typically complex problems of
inventory and maintenance.

Process of simulation
The process of simulation involves the following steps:

1. Definition of the problem: For simulating a problem it must be well defined, its purpose and
objectives should be clearly specified. The objectives, controllable and uncontrollable variables
should also be defined. For example a wholesaler in apples wishes to maximize his revenues by
a simulation model. His objective is maximization of revenue, controllable variable is quantity of
apples procured and uncontrollable variable is market demand for apples. In the absence of
clarity of objective, the cost and efforts put in developing a simulation model will be wasted.
2. Construction of a simulation model: A simulation model imitates a real situation. It can be a
physical model or a mathematical model or a mixture of both. We shall discuss only mathematical
models. Data collection is an important step of a mathematical model and its evaluation. Type of
data and their volume depends upon the nature and scope of the problem. The simulation model
must be developed in a manner so that evaluation of various alternatives can be carried out.
3. Experimentation with the model constructed: After the development of the simulation model it is
run. The starting value of the variables is an important determinant of the model as it may bias
the results. Afterwards the number of runs is decided. If the model is deterministic, with all its
parameter known and constant, then only a single run would be enough. But if the simulation is
stochastic in nature, with the parameters subject to random variation, then it should be run a large
number of times to obtain a better idea of the model performance with real system performance.
4. Evaluating results of the simulation: A simulation can be evaluated in a number of ways. Some
experts view it as statistical inference system. Others compare it with past performance of similar
system. But the true evaluation is its performance in real system after the implementation of the
model results. This validation is usually done by analysts’ familiar with real life system.

Advantages and disadvantages of simulation

The most commonly known advantages of simulation are as follows:

1. These days many computer software packages are available. Their application has made
simulation very easy and simple.
 2. It is capable of analyzing large and complex real-world situations that cannot be done through
other quantitative models.
3. Simulation answers what if questions. Managers would like to know in advance what options are
available and which one is better.
4. Simulation does not disrupt the real system because simulation experiments are undertaken with
the model and not on the system.
5. “Time compression” is possible with simulation. Years of experience, say in the field of
advertising, in the real system can be compressed into minutes or seconds.
6. Many quantitative techniques are based on certain probability distributions such as Poisson or
normal. In the absence of these distributions these techniques cannot be used. But simulation is
quite flexible and can use any probability distribution that the user defines.
7. Simulation models are also used for training purposes under a wide range of situations.

The main disadvantages of simulation are:

1. Development of a simulation model for a complex situation may be very expensive, needs
considerable patience and efforts and time consuming. A complicated model may take months or
years to build.
2. Simulation is based on trial and error approach hence unable to provide optimal solutions as one
can obtain from linear programming. Moreover, it produces different solutions in repeated runs.
3. Since simulation is based on random numbers it may be less accurate than mathematical model.
If direct mathematical model is available for solving a particular problem, it is better to use that.
4. Simulation models are not standardized. For every situation the model is unique. Therefore,
different individuals may develop different models for the same situation.

AREAS OF SIMULATION APPLICATION

Simulation owes its popularity to its application in a large number of business areas where other
mathematical models fail. The detail of areas of its application is quite exhaustive but we name a few of
them. They are production planning, engineering, financial analysis, research and development,
information systems, materials, and personnel. Some of the most common applications of simulation are
explained here.

Waiting Lines Models

Simple waiting line problems can be solved by the known mathematical models of waiting lines. For
complex waiting line systems, it is not possible to apply the known formulas, and simulation is often the
only popular technique used to solve them. For example, for the coffee home in Delhi’s Connaught Place
with multiple waiting lines and multiple servers, simulation may be the only model available to determine
the appropriate number of servers required to meet customer demand.

Inventory Management
Organizations face vast challenges in procurement and management of large number of items.
Questions of order size, safety stock, storage and in process inventory need to be answered. Since the
available inventory models assume constant demand but in practice it varies from time to time; under
such a situation the established inventory models are unable to solve inventory problems but simulation is
capable of solving such problems. Further, when companies wish to use JIT inventory model, simulation
can guide them about its benefits without disrupting the current inventory practices.

Production and Manufacturing

There are large number of areas of production process and conversion of inputs where simulation is
frequently applied. The most common areas are scheduling, sequencing, bottlenecks and assembly line
balancing, layout and location, machine breakdown and maintenance of machines. Some of these areas
involve multiple variables that have different probabilities of occurrence. Instead of mathematical models,
simulation is a better technique in such situations.

Capital Investment and Budgeting

Companies procure investment from a large number of sources such as shares, bonds, banks and other
agencies that carry different costs and observe different constraints. Similarly, capital budgeting problems
involve inward and outward cash flows relating to many sources. Simulation is a very appropriate
technique used by finance managers to deal with problems of investment and capital budgeting.

Logistics
As logistics problems involve a large number of random variables, such as distance, suitable mode of
transportation under different circumstances and their costs, delivery schedule; simulation can be used to
tackle these complex problems and suggest suitable solution under different situations. It is also used to
handle complex problems of the combination of different modes of transportation such as road and rail or
shipping and road.

Public Services
Public services include water supply, fire fighting operations, medical facilities, public transport system
and law and order machinery. The size of these services is enormous and their operations are complex.
Because of their complexity and involvement of a large number of random variables no other technique is
found suitable except simulation.

Management of Environment
Civil society and governments have shown a great concern towards environment in the recent years.
Some of the plants needing environmental clearance in India are power plants, huge steel plants, mining
projects, nuclear power plants, waste disposal systems. Often permission is not granted for many
industries and plants without evaluating their impact on environment. Simulation models have been
developed to determine the impact of such a variety of large projects on environment.

MONTE CARLO SIMULATION

Simulation can be of many types, but we shall focus on the probabilistic simulation using the Monte Carlo
method. Monte Carlo technique is based on the selection of random numbers which range from 00 – 99,
and these random numbers are used for trial run. It is a mathematical process of simulation.

Steps in Monte Carlo Simulation

To understand the various steps of Monte Carlo simulation model, let us take an example. A motor-cycle
dealer wishes to simulate demand for motor-cycles for 10 days. He has the following data:
Daily demand of frequency Probability Cumulative Interval of
Motor-cycles of demand of demand probability random-numbers
x P(x)
0 1 0.05 0.05 00 - 04
1 5 0.25 0.30 05 - 29
2 8 0.40 0.70 30 - 69
3 2 0.10 0.80 70 - 79
4 2 0.10 0.90 80 - 89
5 1 0.05 0.95 90 - 94
6 1 0.05 1.00 95 - 99
Total 20 1.00
Ten random numbers are: 09, 52, 71, 38, 69, 80, 92, 44, 67, 47.

1. Decide random variables. If the firm wishes to develop a simulation model for the sale of motor-
cycles, daily demand of the number of motor cycles (in the range of 0 to 6) may be considered a
random variable and denoted by x. Price may be considered another random variable denoted
by y.
2. Build a probability distribution for each random variable decided in step 1. On the basis of actual
sales of last 20 days’ demand frequency is noted and from this frequency distribution, a
probability distribution [P(x)] of demand can be developed.
3. Generate random numbers. Random numbers are such numbers each of which has equal
chance of selection at random. Instead of generating random numbers personally, managers
select them from the table of random numbers that are conveniently available in computer
software/books. Random numbers represent random variables.
 4. Establish an interval of random numbers for each variable. For creating this interval cumulative
probability distribution is computed. If the cumulative probability for zero demand is 0.05, its range
of random number will be 00 – 04; for cumulative probability of 0.30, its range of random number
will be 05 – 29 and so on.
5. Simulate a series of trials. There is no specific recommended number of runs as they vary in
different situations. The benefit of running a series of trials is that one can achieve a reasonably
stable result. The run of the above example is shown below:

Days Random Interval of Simulated

Numbers Random Numbers Demand
1 09 05 – 29 1
2 52 30 – 69 2
3 71 70 – 79 3
4 38 30 – 69 2
5 69 30 – 69 2
6 80 80 – 89 4
7 92 90 – 94 5
8 44 30 – 69 2
9 67 30 – 69 2
10 47 30 – 69 2

25
=2. 5
Average of daily demand = 10
If the manager so wishes he can undertake another trial run by selecting a new set of ten random
numbers, either using the old probability distribution or building a new probability distribution on
the basis of the first run.

EXERCISES

Q. 1 Explain the Monte Carlo Technique of simulation and how random variables are used in a Monte
Carlo process.

Q. 2 Why is simulation called a technique of last resort?

Q. 3 What are the advantages and disadvantages of simulation?

Q. 4 What are the main areas of application of simulation technique?

Q. 1 Frontier bakery keeps stock of a popular brand of cake. Daily demand based on past experience is
as given below:
Daily 0 15 25 35 45 50
demand
Probability 0.01 0.15 0.20 0.50 0.12 0.02
Consider the following sequence of random numbers: 48, 78, 09, 51, 56, 77, 15, 14, 68, 09. Using the
sequence, simulate the demand for next 10 days.
Find out the stock situation at the end of each day if the owner of the bakery decides to make 35 cakes
every day. Also estimate the daily average demand for the cakes on the basis of simulated data.

Solution:
Random number coding: demand distribution
Daily Probability Cumulative Random number
deman Probability Intervals
d
0 0.01 0.01 00-00
15 0.15 0.16 01-15
25 0.20 0.36 16-35
35 0.50 0.86 36-85
45 0.12 0.98 86-97
50 0.02 1.00 98-99
The given random number 48 corresponds to 36-85 matching the demand for 35 cakes.
Calculation of demand corresponding to random numbers
Random Daily Stock at the
numbers demand End of every
Day if 35 cakes
Are orderd
48 35 0
78 35 0
09 15 20
51 35 20
56 35 20
77 35 20
15 15 40
14 15 60
68 35 60
09 15 80
Total 270
demand
Thus, average daily demand is 270/10=27 cakes.