Spreadsheet Modeling & Decision Analysis: A Practical Introduction To Management Science

Spreadsheet Modeling
& Decision Analysis

A Practical Introduction to
Management Science
5th edition
Cliff T. Ragsdale
Chapter 1
Introduction to Modeling
& Problem Solving
Introduction
We face numerous decisions in life &
business.
We can use computers to analyze the
potential outcomes of decision
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
Decision science
Home Runs
in Management Science
Motorola
Procurement of goods and services account
for 50% of its costs
Developed an Internet-based auction system
for negotiations with suppliers
The system optimized multi-product, multivendor contract awards
Benefits:
$600 million in savings
Home Runs
Waste Management
Leading waste collection company in North
America
26,000 vehicles service 20 million residential & 2
million commercial customers
Developed vehicle routing optimization system
Benefits:
Eliminated 1,000 routes
Annual savings of $44 million
Home Runs
Hong Kong International Terminals
Busiest container terminal in the world
122 yard cranes serve 125 ships per week
Thousands of trucks move containers in & out of storage
yard
Used DSS to optimize operational decisions involving
trucks, cranes & storage locations
Benefits:
35% reduction in container handling costs
50% increase in throughput
30% improvement in vessel turnaround time
Home Runs in
Management Science
John Deere Company
2500 dealers sell lawn equipment & tractors with support
of 5 warehouses
Each dealer stocks 100 products, creating 250,000
product-stocking locations
Demand is highly seasonal and erratic
Developed inventory system to optimize stocking levels
over a 26-week horizon
Benefits:
$1 billion in reduced inventory
Improved customer-service levels
What is a Computer Model?

A set of mathematical relationships and
logical assumptions implemented in a
computer as an abstract representation of
a real-world object of phenomenon.
Spreadsheets provide the most
convenient way for business people to
build computer models.
The Modeling Approach

to Decision Making
Everyone uses models to make
decisions.
Types of models:
Mental (arranging furniture)

Visual (blueprints, road maps)
Physical/Scale (aerodynamics, buildings)
Mathematical (what well be studying)
Characteristics of Models
Models are usually simplified versions of
the things they represent
A valid model accurately represents the
relevant characteristics of the object or
decision being studied
Benefits of Modeling
Economy - It is often less costly to
analyze 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.
Models give us insight & understanding
that improves decision making.
Example of a Mathematical Model

Profit = Revenue - Expenses
or
Profit = f(Revenue, Expenses)
or
Y = f(X1, X2)
A Generic Mathematical Model

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 the relationship between the Xi
&Y
Mathematical Models & Spreadsheets

Most spreadsheet models are very similar
to our generic mathematical model:
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).
Categories of Mathematical Models

Model
Category
Form of f(.)
Independent
Variables
Prescriptive
known,
known or under
well-defineddecision makersCPM, EOQ, NLP,
control
GP, MOLP
OR/MS
Techniques
LP, Networks, IP,
Predictive
unknown,
known or under
Regression Analysis,
ill-defined decision makersTime Series Analysis,
control
Discriminant Analysis
Descriptive
well-defined
Models
known,
uncertain
unknown or
Queueing,
Simulation, PERT,
Inventory
The Problem Solving Process
Identify
Problem
Formulate &
Implement
Model
Analyze
Model
unsatisfactory
results
Test
Results
Implement
Solution
The Psychology of Decision Making

Models can be used for structurable
aspects of decision problems.
Other aspects cannot be structured
easily, requiring intuition and judgment.
Caution: Human judgment and intuition
is not always rational!
Anchoring Effects
Arise when trivial factors influence initial
thinking about a problem.
Decision-makers usually under-adjust
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 choose between:
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 been given $2000
and must choose between:
A. Give back $500 immediately
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
$1,000
Good Decisions vs. Good Outcomes

Good decisions do not always lead to good
outcomes...
A structured, modeling approach to

decision making helps us make good
decisions, but cant guarantee good
outcomes.
End of Chapter 1

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Spreadsheet Modeling

& Decision Analysis

What is Management Science?

What is a Computer Model?

The Modeling Approach

Mental (arranging furniture)

Example of a Mathematical Model

A Generic Mathematical Model

Mathematical Models & Spreadsheets

Categories of Mathematical Models

The Problem Solving Process

The Psychology of Decision Making

Framing Effects (Example)

A Decision Tree for Both Examples

Good Decisions vs. Good Outcomes

A structured, modeling approach to

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