1. 1 1 Slide © 2008 Thomson South-Western. All Rights Reserved Slides by JOHN LOUCKS St. Edward’s University

2. 2 2 Slide © 2008 Thomson South-Western. All Rights Reserved Chapter 1 Introduction n Body of Knowledge n Problem Solving and Decision Making n Quantitative Analysis and Decision Making n Quantitative Analysis n Models of Cost, Revenue, and Profit n Management Science Techniques

3. 3 3 Slide © 2008 Thomson South-Western. All Rights Reserved Body of Knowledge n The body of knowledge involving quantitative approaches to decision making is referred to as Management Science Management Science Operations Research Operations Research Decision Science Decision Science n It had its early roots in World War II and is flourishing in business and industry due, in part, to: numerous methodological developments (e.g. simplex method for solving linear programming problems) numerous methodological developments (e.g. simplex method for solving linear programming problems) a virtual explosion in computing power a virtual explosion in computing power

4. Origins of Management Science Frederick Taylor (1856-1915) Inventor of Scientific Management in 1894. Frederick Winslow Taylor was the American industrial engineer who originated scientific management in business. In 1878, he began working at the Midvale Steel Company. He became foreman of the steel plant and applied himself to studies in the measurement of industrial productivity. Taylor developed detailed systems intended to gain maximum efficiency from both workers and machines in the factory. These systems relied on time and motion studies, which help determine the best methods for performing a task in the least amount of time. His management methods were published in The Principles of Scientific Management (1911) and became known later as Taylorism.

5. Origins of Operations Research (World War II) The modern field of operations research emerged during WWII. Scientists in the UK (Patrick Blackett) and in the US (George Dantzig) looked for ways to make better decisions in such areas as logistics and training schedules. After the war it began to be applied to similar problems in industry. Blackett’s Guinea stamp: See more Physics-related stamps at http://th.physik.uni-frankfurt.de/~jr/physstamps.html Dantzig’s TSP portrait (TSP Art: art constructed by solving instances of the Traveling Salesman Problem): http://www.oberlin.edu/math/faculty/bosch/tspart-page.html CREDITS

6. Origins of Operations Research (World War II) During World War II, Britain introduced the convoy system to reduce shipping losses. It was unclear whether it was better for convoys to be small or large: Convoys travel at the speed of the slowest member, so small convoys can travel faster. Small convoys would be harder for German U-boats to detect. Large convoys could deploy more warships against an attacker. The practice of having warships escorting merchant ship convoys started in ancient Rome with Julius Cesar’s war with Pompey in 48 BC (Eric Hotz's Collection, Canada)

7. Origins of Operations Research (World War II) Blackett's analysis showed that: Large convoys were more efficient The probability of detection by U-boat was statistically unrelated to the size of the convoy Slow convoys were at greater risk (though considered overall, large convoys were still to be preferred)

8. And now for a little Quiz… What moves at the speed of the slowest member? A. A ship convoy B. A herd of buffalos C. Messages in your brain cells (neurons) D. All of the above To see a free-roaming herd of buffalos, go 30 minutes west of Denver and take exit 254 on I-70

9. 9 9 Slide © 2008 Thomson South-Western. All Rights Reserved n 7 Steps of Problem Solving (First 5 steps are the process of decision making) 1. Identify and define the problem. 2. Determine the set of alternative solutions. 3. Determine the criteria for evaluating alternatives. 4. Evaluate the alternatives. 5. Choose an alternative (make a decision). --------------------------------------------------------------------- --------------------------------------------------------------------- 6. Implement the selected alternative. 7. Evaluate the results. Problem Solving and Decision Making

10. 10 Slide © 2008 Thomson South-Western. All Rights Reserved Quantitative Analysis and Decision Making DefinetheProblemDefinetheProblemIdentifytheAlternativesIdentifytheAlternativesDeterminetheCriteriaDeterminetheCriteriaIdentifytheAlternativesIdentifytheAlternativesChooseanAlternativeChooseanAlternative Structuring the Problem Analyzing the Problem n Decision-Making Process

11. 11 Slide © 2008 Thomson South-Western. All Rights Reserved Analysis Phase of Decision-Making Process Analysis Phase of Decision-Making Process n Qualitative Analysis based largely on the manager’s judgment and experiencebased largely on the manager’s judgment and experience includes the manager’s intuitive “feel” for the problemincludes the manager’s intuitive “feel” for the problem is more of an art than a scienceis more of an art than a science Quantitative Analysis and Decision Making

12. 12 Slide © 2008 Thomson South-Western. All Rights Reserved Analysis Phase of Decision-Making Process Analysis Phase of Decision-Making Process n Quantitative Analysis analyst will concentrate on the quantitative facts or data associated with the problemanalyst will concentrate on the quantitative facts or data associated with the problem analyst will develop mathematical expressions that describe the objectives, constraints, and other relationships that exist in the problemanalyst will develop mathematical expressions that describe the objectives, constraints, and other relationships that exist in the problem analyst will use one or more quantitative methods to make a recommendationanalyst will use one or more quantitative methods to make a recommendation Quantitative Analysis and Decision Making

13. 13 Slide © 2008 Thomson South-Western. All Rights Reserved Quantitative Analysis and Decision Making n Potential Reasons for a Quantitative Analysis Approach to Decision Making The problem is complex. The problem is complex. The problem is very important. The problem is very important. The problem is new. The problem is new. The problem is repetitive. The problem is repetitive.

14. 14 Slide © 2008 Thomson South-Western. All Rights Reserved Quantitative Analysis n Quantitative Analysis Process Model Development Model Development Data Preparation Data Preparation Model Solution Model Solution Report Generation Report Generation

15. 15 Slide © 2008 Thomson South-Western. All Rights Reserved Model Development n Models are representations of real objects or situations n Three forms of models are: Iconic models - physical replicas (scalar representations) of real objects Iconic models - physical replicas (scalar representations) of real objects Analog models - physical in form, but do not physically resemble the object being modeled Analog models - physical in form, but do not physically resemble the object being modeled Mathematical models - represent real world problems through a system of mathematical formulas and expressions based on key assumptions, estimates, or statistical analyses Mathematical models - represent real world problems through a system of mathematical formulas and expressions based on key assumptions, estimates, or statistical analyses

16. 16 Slide © 2008 Thomson South-Western. All Rights Reserved Advantages of Models n Generally, experimenting with models (compared to experimenting with the real situation): requires less time requires less time is less expensive is less expensive involves less risk involves less risk n The more closely the model represents the real situation, the accurate the conclusions and predictions will be.

17. 17 Slide © 2008 Thomson South-Western. All Rights Reserved Mathematical Models n Objective Function – a mathematical expression that describes the problem’s objective, such as maximizing profit or minimizing cost n Constraints – a set of restrictions or limitations, such as production capacities n Uncontrollable Inputs – environmental factors that are not under the control of the decision maker n Decision Variables – controllable inputs; decision alternatives specified by the decision maker, such as the number of units of Product X to produce

18. 18 Slide © 2008 Thomson South-Western. All Rights Reserved Mathematical Models n Deterministic Model – if all uncontrollable inputs to the model are known and cannot vary n Stochastic (or Probabilistic) Model – if any uncontrollable are uncertain and subject to variation n Stochastic models are often more difficult to analyze.

19. 19 Slide © 2008 Thomson South-Western. All Rights Reserved Mathematical Models n Cost/benefit considerations must be made in selecting an appropriate mathematical model. n Frequently a less complicated (and perhaps less precise) model is more appropriate than a more complex and accurate one due to cost and ease of solution considerations.

20. 20 Slide © 2008 Thomson South-Western. All Rights Reserved Transforming Model Inputs into Output Uncontrollable Inputs (Environmental Factors) Uncontrollable Inputs (Environmental Factors) ControllableInputs(DecisionVariables)ControllableInputs(DecisionVariables) Output(Projected Results) Results)Output(Projected MathematicalModelMathematicalModel

21. 21 Slide © 2008 Thomson South-Western. All Rights Reserved Data Preparation n Data preparation is not a trivial step, due to the time required and the possibility of data collection errors. n A model with 50 decision variables and 25 constraints could have over 1300 data elements! n Often, a fairly large data base is needed. n Information systems specialists might be needed.

22. 22 Slide © 2008 Thomson South-Western. All Rights Reserved Model Solution n The analyst attempts to identify the alternative (the set of decision variable values) that provides the “best” output for the model. n The “best” output is the optimal solution. n If the alternative does not satisfy all of the model constraints, it is rejected as being infeasible, regardless of the objective function value. n If the alternative satisfies all of the model constraints, it is feasible and a candidate for the “best” solution.

23. 23 Slide © 2008 Thomson South-Western. All Rights Reserved Model Solution n One solution approach is trial-and-error. Might not provide the best solution Might not provide the best solution Inefficient (numerous calculations required) Inefficient (numerous calculations required) n Special solution procedures have been developed for specific mathematical models. Some small models/problems can be solved by hand calculations Some small models/problems can be solved by hand calculations Most practical applications require using a computer Most practical applications require using a computer

24. 24 Slide © 2008 Thomson South-Western. All Rights Reserved Model Solution n A variety of software packages are available for solving mathematical models. Microsoft Excel Microsoft Excel The Management Scientist The Management Scientist LINGO LINGO

25. 25 Slide © 2008 Thomson South-Western. All Rights Reserved Model Testing and Validation n Often, goodness/accuracy of a model cannot be assessed until solutions are generated. n Small test problems having known, or at least expected, solutions can be used for model testing and validation. n If the model generates expected solutions, use the model on the full-scale problem. n If inaccuracies or potential shortcomings inherent in the model are identified, take corrective action such as: Collection of more-accurate input data Collection of more-accurate input data Modification of the model Modification of the model

26. 26 Slide © 2008 Thomson South-Western. All Rights Reserved Report Generation n A managerial report, based on the results of the model, should be prepared. n The report should be easily understood by the decision maker. n The report should include: the recommended decision the recommended decision other pertinent information about the results (for example, how sensitive the model solution is to the assumptions and data used in the model) other pertinent information about the results (for example, how sensitive the model solution is to the assumptions and data used in the model)

27. 27 Slide © 2008 Thomson South-Western. All Rights Reserved Implementation and Follow-Up n Successful implementation of model results is of critical importance. n Secure as much user involvement as possible throughout the modeling process. n Continue to monitor the contribution of the model. n It might be necessary to refine or expand the model.

28. 28 Slide © 2008 Thomson South-Western. All Rights Reserved Example: Iron Works, Inc. Iron Works, Inc. manufactures two products made from steel and just received this month's allocation of b pounds of steel. It takes a 1 pounds of steel to make a unit of product 1 and a 2 pounds of steel to make a unit of product 2. Let x 1 and x 2 denote this month's production level of product 1 and product 2, respectively. Denote by p 1 and p 2 the unit profits for products 1 and 2, respectively. Iron Works has a contract calling for at least m units of product 1 this month. The firm's facilities are such that at most u units of product 2 may be produced monthly.

29. 29 Slide © 2008 Thomson South-Western. All Rights Reserved Example: Iron Works, Inc. n Mathematical Model The total monthly profit = The total monthly profit = (profit per unit of product 1) x (monthly production of product 1) x (monthly production of product 1) + (profit per unit of product 2) + (profit per unit of product 2) x (monthly production of product 2) x (monthly production of product 2) = p 1 x 1 + p 2 x 2 = p 1 x 1 + p 2 x 2 We want to maximize total monthly profit: Max p 1 x 1 + p 2 x 2

30. 30 Slide © 2008 Thomson South-Western. All Rights Reserved Example: Iron Works, Inc. n Mathematical Model (continued) The total amount of steel used during monthly production equals: The total amount of steel used during monthly production equals: (steel required per unit of product 1) (steel required per unit of product 1) x (monthly production of product 1) x (monthly production of product 1) + (steel required per unit of product 2) + (steel required per unit of product 2) x (monthly production of product 2) x (monthly production of product 2) = a 1 x 1 + a 2 x 2 = a 1 x 1 + a 2 x 2 This quantity must be less than or equal to the allocated b pounds of steel: This quantity must be less than or equal to the allocated b pounds of steel: a 1 x 1 + a 2 x 2 < b a 1 x 1 + a 2 x 2 < b

31. 31 Slide © 2008 Thomson South-Western. All Rights Reserved Example: Iron Works, Inc. n Mathematical Model (continued) The monthly production level of product 1 must be greater than or equal to m : The monthly production level of product 1 must be greater than or equal to m : x 1 > m x 1 > m The monthly production level of product 2 must be less than or equal to u : The monthly production level of product 2 must be less than or equal to u : x 2 < u x 2 < u However, the production level for product 2 cannot be negative: However, the production level for product 2 cannot be negative: x 2 > 0 x 2 > 0

32. 32 Slide © 2008 Thomson South-Western. All Rights Reserved Example: Iron Works, Inc. n Mathematical Model Summary Max p 1 x 1 + p 2 x 2 Max p 1 x 1 + p 2 x 2 s.t. a 1 x 1 + a 2 x 2 < b s.t. a 1 x 1 + a 2 x 2 < b x 1 > m x 1 > m x 2 < u x 2 < u x 2 > 0 x 2 > 0 ObjectiveFunction “Subject to” Constraints

33. 33 Slide © 2008 Thomson South-Western. All Rights Reserved Example: Iron Works, Inc. n Question: Suppose b = 2000, a 1 = 2, a 2 = 3, m = 60, u = 720, p 1 = 100, p 2 = 200. Rewrite the model with these specific values for the uncontrollable inputs.

34. 34 Slide © 2008 Thomson South-Western. All Rights Reserved Example: Iron Works, Inc. n Answer: Substituting, the model is: Max 100 x 1 + 200 x 2 Max 100 x 1 + 200 x 2 s.t. 2 x 1 + 3 x 2 < 2000 s.t. 2 x 1 + 3 x 2 < 2000 x 1 > 60 x 1 > 60 x 2 < 720 x 2 < 720 x 2 > 0 x 2 > 0

35. 35 Slide © 2008 Thomson South-Western. All Rights Reserved Example: Iron Works, Inc. n Question: The optimal solution to the current model is x 1 = 60 and x 2 = 626 2/3. If the product were engines, explain why this is not a true optimal solution for the "real-life" problem. n Answer: One cannot produce and sell 2/3 of an engine. Thus the problem is further restricted by the fact that both x 1 and x 2 must be integers. (They could remain fractions if it is assumed these fractions are work in progress to be completed the next month.)

36. 36 Slide © 2008 Thomson South-Western. All Rights Reserved Example: Iron Works, Inc. Uncontrollable Inputs $100 profit per unit Prod. 1 $200 profit per unit Prod. 2 2 lbs. steel per unit Prod. 1 3 lbs. Steel per unit Prod. 2 2000 lbs. steel allocated 60 units minimum Prod. 1 720 units maximum Prod. 2 0 units minimum Prod. 2 $100 profit per unit Prod. 1 $200 profit per unit Prod. 2 2 lbs. steel per unit Prod. 1 3 lbs. Steel per unit Prod. 2 2000 lbs. steel allocated 60 units minimum Prod. 1 720 units maximum Prod. 2 0 units minimum Prod. 2 60 units Prod. 1 60 units Prod. 1 626.67 units Prod. 2 60 units Prod. 1 60 units Prod. 1 626.67 units Prod. 2 Controllable Inputs Profit = $131,333.33 Steel Used = 2000 Profit = $131,333.33 Steel Used = 2000 OutputOutput Mathematical Model Max 100(60) + 200(626.67) s.t. 2(60) + 3(626.67) < 2000 60 > 60 60 > 60 626.67 < 720 626.67 < 720 626.67 > 0 626.67 > 0 Max 100(60) + 200(626.67) s.t. 2(60) + 3(626.67) < 2000 60 > 60 60 > 60 626.67 < 720 626.67 < 720 626.67 > 0 626.67 > 0

37. 37 Slide © 2008 Thomson South-Western. All Rights Reserved Management Science Techniques n Linear Programming n Integer Linear Programming n PERT/CPM n Inventory Models n Waiting Line Models n Simulation n Decision Analysis n Goal Programming n Analytic Hierarchy Process n Forecasting n Markov-Process Models n Dynamic Programming

38. 38 Slide © 2008 Thomson South-Western. All Rights Reserved The Management Scientist Software n 12 Modules

39. 39 Slide © 2008 Thomson South-Western. All Rights Reserved Using Excel for Breakeven Analysis n A spreadsheet software package such as Microsoft Excel can be used to perform a quantitative analysis of Ponderosa Development Corporation. n We will enter the problem data in the top portion of the spreadsheet. n The bottom of the spreadsheet will be used for model development.

40. 40 Slide © 2008 Thomson South-Western. All Rights Reserved Example: Ponderosa Development Corp. Ponderosa Development Corporation (PDC) is a small real estate developer that builds only one style house. The selling price of the house is $115,000. Land for each house costs $55,000 and lumber, supplies, and other materials run another $28,000 per house. Total labor costs are approximately $20,000 per house.

41. 41 Slide © 2008 Thomson South-Western. All Rights Reserved Example: Ponderosa Development Corp. Ponderosa leases office space for $2,000 per month. The cost of supplies, utilities, and leased equipment runs another $3,000 per month. The one salesperson of PDC is paid a commission of $2,000 on the sale of each house. PDC has seven permanent office employees whose monthly salaries are given on the next slide.

42. 42 Slide © 2008 Thomson South-Western. All Rights Reserved Example: Ponderosa Development Corp. Employee Monthly Salary President $10,000 President $10,000 VP, Development 6,000 VP, Development 6,000 VP, Marketing 4,500 VP, Marketing 4,500 Project Manager 5,500 Controller 4,000 Office Manager 3,000 Receptionist 2,000

43. 43 Slide © 2008 Thomson South-Western. All Rights Reserved Example: Ponderosa Development Corp. n Formula Spreadsheet

44. 44 Slide © 2008 Thomson South-Western. All Rights Reserved Example: Ponderosa Development Corp. n Question What is the monthly profit if 12 houses are built and sold per month?

45. 45 Slide © 2008 Thomson South-Western. All Rights Reserved Example: Ponderosa Development Corp. n Spreadsheet Solution

46. 46 Slide © 2008 Thomson South-Western. All Rights Reserved Example: Ponderosa Development Corp. n Question: What is the breakeven point for monthly sales of the houses? n Spreadsheet Solution: One way to determine the break-even point using a spreadsheet is to use the Goal Seek tool. One way to determine the break-even point using a spreadsheet is to use the Goal Seek tool. Microsoft Excel ‘s Goal Seek tool allows the user to determine the value for an input cell that will cause the output cell to equal some specified value. Microsoft Excel ‘s Goal Seek tool allows the user to determine the value for an input cell that will cause the output cell to equal some specified value. In our case, the goal is to set Total Profit to zero by seeking an appropriate value for Sales Volume. In our case, the goal is to set Total Profit to zero by seeking an appropriate value for Sales Volume.

47. 47 Slide © 2008 Thomson South-Western. All Rights Reserved Example: Ponderosa Development Corp. n Spreadsheet Solution: Goal Seek Approach Using Excel ’s Goal Seek Tool Step 1: Select the Tools menu Step 2: Choose the Goal Seek option Step 3: When the Goal Seek dialog box appears: Enter B9 in the Set cell box Enter B9 in the Set cell box Enter 0 in the To value box Enter 0 in the To value box Enter B6 in the By changing cell box Enter B6 in the By changing cell box Click OK Click OK

48. 48 Slide © 2008 Thomson South-Western. All Rights Reserved Example: Ponderosa Development Corp. n Spreadsheet Solution: Goal Seek Approach Completed Goal Seek Dialog Box Completed Goal Seek Dialog Box

49. 49 Slide © 2008 Thomson South-Western. All Rights Reserved Example: Ponderosa Development Corp. n Spreadsheet Solution: Goal Seek Approach

50. 50 Slide © 2008 Thomson South-Western. All Rights Reserved End of Chapter 1