© 2002 South-Western/Thomson Slide 1-1 Chapter 1 - Decision Making and Quantitative Modeling ©...

© 2002 South-Western/Thomson Slide 1-1

Chapter 1 -Chapter 1 -Decision Making andDecision Making andQuantitative ModelingQuantitative Modeling

© 2002 South-Western/Thomson Learning™Slides prepared by Jeff Heyl, Lincoln University


1.11.1 Quantitative Business Quantitative Business ModelingModeling

• Definition of a ModelDefinition of a Model

• Benefits and Drawbacks of Benefits and Drawbacks of ModelingModeling

• Types of ModelsTypes of Models

• Effective ModelersEffective Modelers


1.21.2 The Modeling ProcessThe Modeling Process

• A Five-Step Modeling ProcessA Five-Step Modeling Process• Step 1:Step 1: Opportunity/Opportunity/

Problem RecognitionProblem Recognition• Step 2:Step 2: Model FormulationModel Formulation• Step 3:Step 3: Data CollectionData Collection• Step 4:Step 4: Analysis of the ModelAnalysis of the Model• Step 5:Step 5: Implementation and Implementation and

Project ManagementProject Management


1.31.3 Detailed Modeling ExampleDetailed Modeling Example

• Step 1:Step 1: Opportunity/Opportunity/Problem RecognitionProblem Recognition

• Step 2:Step 2: Model FormulationModel Formulation• Step 3:Step 3: Data CollectionData Collection• Step 4:Step 4: Analysis of the ModelAnalysis of the Model• Step 5:Step 5: Implementation and Implementation and

Project ManagementProject Management


1.41.4 Software for ModelingSoftware for Modeling1.51.5 The Structure of this TextThe Structure of this TextQuestionsQuestionsExperiential ExercisesExperiential Exercises

Modeling ExercisesModeling ExercisesCase - Henry Ford HospitalCase - Henry Ford Hospital

I.I. Learning Curve ExerciseLearning Curve ExerciseII.II. Scoring Model ExerciseScoring Model Exercise


Influence Diagram Influence Diagram for Car Purchasefor Car Purchase

Invoice Invoice priceprice

Dealer Dealer profitprofit

Cost to Cost to insureinsure

Car priceCar price

ComfortComfort

AccelerationAcceleration

WarrantyWarranty

Select carSelect car

Fuel Fuel economyeconomy

Maximize Maximize satisfactionsatisfaction

Exhibit 1.1Exhibit 1.1


Data Collected for Car Data Collected for Car Purchase DecisionPurchase Decision

LegLeg SpeedSpeedInsuranceInsurance RoomRoom WarrantyWarranty 0 to 600 to 60

CarCar RatingRating MPGMPG (Inches)(Inches) (Months)(Months) CostCost (Seconds)(Seconds)

BMW Z3 1.9LBMW Z3 1.9L Better thanBetter than 2020 41.841.8 4848 $27,625$27,625 7.17.1 averageaverage

CorvetteCorvette AverageAverage 1818 42.742.7 3636 34,50234,502 5.05.0

PorschePorsche AverageAverage 1919 41.641.6 4848 37,16037,160 7.57.5 BoxsterBoxster

Mustang GTMustang GT Much worseMuch worse 1717 41.941.9 3636 23,60423,604 n.a.n.a. convertibleconvertible than average than average

FirebirdFirebird Worse thanWorse than 1919 43.043.0 3636 23,79123,791 8.78.7 convertibleconvertible average average

Mercedes SLKMercedes SLK AverageAverage 2121 42.742.7 4848 35,89535,895 7.57.5

Volvo C70Volvo C70 AverageAverage 2020 41.341.3 4848 36,56436,564 6.56.5

n.a. = not availablen.a. = not available Exhibit 1.2Exhibit 1.2


Method for Scoring Cars Method for Scoring Cars on Each Criteriaon Each Criteria

CriterionCriterion 1 Point1 Point 2 Points2 Points 3 Points3 Points

CostCost > $36,000> $36,000 $28,000 – $36,000$28,000 – $36,000 < $28,000< $28,000

WarrantyWarranty 3636 months months 4848 months months

Insurance ratingInsurance rating Worse than Worse than AverageAverage Better thanBetter than averageaverage average average

Zero to 60 MPHZero to 60 MPH > 8> 8 seconds seconds 77 to to 88 seconds seconds < 7< 7 seconds seconds

Leg roomLeg room < 42< 42 inches inches 42 – 42.9942 – 42.99 inches inches ≥ 43≥ 43 inches inches

MPGMPG < 20< 20 MPG MPG 20 – 20.9920 – 20.99 MPG MPG ≥ 21≥ 21 MPG MPG



Method for Scoring Cars Method for Scoring Cars on Each Criteriaon Each Criteria

Criterion 1 Point 2 Points 3 Points

Cost > $36,000 $28,000 – $36,000 < $28,000

Warranty 36 months 48 months

Insurance rating Worse than Average Better than average average

Zero to 60 MPH > 8 seconds 7 to 8 seconds < 7 seconds

Leg room < 42 inches 42 – 42.99 inches ≥ 43 inches

MPG < 20 MPG 20 – 20.99 MPG ≥ 21 MPG


BMW Z3BMW Z3Total ScoreTotal Score == (3 x 15) + (2 x 10) + (3 x 15) + (2 x 10) +

(1 x 15) + (3 x 25) +(1 x 15) + (3 x 25) +( 2 x 15)( 2 x 15)

== 245245


Quantitative Quantitative Business ModelingBusiness Modeling

Definition, qualities, and perceptions Definition, qualities, and perceptions of modelsof models

A simplified representation or A simplified representation or abstraction of realityabstraction of reality

Important qualities – Important qualities – Validity, Usability, Value Validity, Usability, Value

Positivists or relativistsPositivists or relativists


Benefits of ModelingBenefits of Modeling

Models enable the compression of timeModels enable the compression of time Manipulation of a model is easier than Manipulation of a model is easier than

manipulating the real systemmanipulating the real system The costs of mistakes is much smallerThe costs of mistakes is much smaller Allows the consideration of riskAllows the consideration of risk Lower cost than experimenting with Lower cost than experimenting with

the real systemthe real system


Benefits of ModelingBenefits of Modeling

Models enhance and reinforce learningModels enhance and reinforce learning Using the QBM process forces the use Using the QBM process forces the use

of rigorous thinkingof rigorous thinking The use of mathematical models The use of mathematical models

enables quick identification and enables quick identification and analysis of a very large number of analysis of a very large number of possible solutionspossible solutions

Provides a better understanding of the Provides a better understanding of the real situationreal situation


Drawbacks of ModelingDrawbacks of Modeling

It is time consumingIt is time consuming Managers might be reluctant to Managers might be reluctant to

accept resultsaccept results Obtaining necessary data might be Obtaining necessary data might be

difficult, time consuming, expensive, difficult, time consuming, expensive, or not even feasibleor not even feasible

It may be difficult to assess It may be difficult to assess uncertaintiesuncertainties


Drawbacks of ModelingDrawbacks of Modeling An oversimplified model might lead to An oversimplified model might lead to

erroneous recommendationserroneous recommendations QBM can be expensive to undertake QBM can be expensive to undertake

relative to the size of the problemrelative to the size of the problem Studies and may be abandoned or Studies and may be abandoned or

results ignored resulting in results ignored resulting in unproductive expenseunproductive expense

The common perception that if done The common perception that if done on a computer, it must be correcton a computer, it must be correct


Types of ModelsTypes of Models

Physical – least abstract, usually Physical – least abstract, usually based on a different scalebased on a different scale

Analog – do not look like the real Analog – do not look like the real situation, but behave like itsituation, but behave like it Hourglass, organizational charts, Hourglass, organizational charts,

maps, stock market charts, graphsmaps, stock market charts, graphs


Y = SUMPRODUCT(B$4:G$4,B7:G7) [copy to cells H8:H12]

Car purchase decision

Criteria: Ins. Rating MPG Leg Room

Weights: 15 10 15

Options Ins. Rating MPG

BMW Z3 1.9L 3

A B C D

1

2

3

4

5

6

7

Knobs

x1 = Number oforders per year

x2 = Quantity of safety stock

Cost ($1,000)

Dial

Types of ModelsTypes of Models

Mathematical – most abstract, yet Mathematical – most abstract, yet easily manipulated for easily manipulated for experimentation and predictionexperimentation and prediction Independent variables – those Independent variables – those

we can controlwe can control Uncontrollable parameters – Uncontrollable parameters –

governed by nature or outsidersgoverned by nature or outsiders Dependent variables – Dependent variables –

our measures of interestour measures of interest


Uses of ModelsUses of Models

Prescriptive – used to find the Prescriptive – used to find the optimal solution within the optimal solution within the assumptions of the modelassumptions of the model EnumerationEnumeration Complete, exhaustive enumerationComplete, exhaustive enumeration AlgorithmAlgorithm


Uses of ModelsUses of Models

Descriptive – characterize things as Descriptive – characterize things as they arethey are Used to investigate outcomes or Used to investigate outcomes or

consequencesconsequences Solutions not necessarily optimalSolutions not necessarily optimal Useful in predicting the behavior of Useful in predicting the behavior of

systems under various conditionssystems under various conditions


Effective ModelersEffective Modelers

Internal skills: creativity, sensitivity Internal skills: creativity, sensitivity to the client, and persistenceto the client, and persistence

Interpersonal skills: communication Interpersonal skills: communication and teamworkand teamwork

Expertise in quantitative business Expertise in quantitative business modelingmodeling


A Five-Step Modeling ProcessA Five-Step Modeling Process

Real-life opportunity or problem

Step 1: Opportunity/ Step 1: Opportunity/ problem problem

recognitionrecognition

Step 2: Model Step 2: Model formulationformulation

Step 3: Data Step 3: Data collectioncollection

Step 4: Analysis Step 4: Analysis of the modelof the modelStep 5: Implementation Step 5: Implementation

and project and project managementmanagement

ValidationValidationSolution testing, verification

Solution testing, verification



The General Structure of a ModelThe General Structure of a Model

Uncontrollable Uncontrollable factors factors

(parameters)(parameters)

Mathematical relationships

Independent Independent (decision) (decision) variablesvariables

Dependent Dependent variablesvariables



Example of the Components ModelsExample of the Components Models


DecisionDecision DependentDependent UncontrollableUncontrollableAreaArea VariablesVariables VariablesVariables VariablesVariables

Financial Financial Investment amountsInvestment amounts Total profitTotal profit Inflation rateInflation rate investment investment Period of investmentPeriod of investment Rate of returnRate of return Prime ratePrime rate

Timing of investmentTiming of investment Earnings/shareEarnings/share CompetitionCompetitionLiquidityLiquidity

MarketingMarketing Advertising budgetAdvertising budget Market shareMarket share Disposable incomeDisposable incomeNumber of modelsNumber of models Customer Customer Competitor’s actionsCompetitor’s actionsZonal sales repsZonal sales reps satisfaction satisfaction

ManufacturingManufacturing Production amountsProduction amounts Total costTotal cost Machine capacityMachine capacityInventory levelsInventory levels Quality levelQuality level TechnologyTechnologyIncentive planIncentive plan SpoilageSpoilage Materials pricesMaterials prices

AccountingAccounting Audit scheduleAudit schedule Data processingData processing Legal requirementsLegal requirementsUse of computersUse of computers cost cost Tax ratesTax ratesDepreciation scheduleDepreciation schedule Error rateError rate Computer technologyComputer technology

ServicesServices Number of serversNumber of servers Customer Customer Demand for serviceDemand for service satisfactionsatisfaction


A Manufacturing Systems ModelA Manufacturing Systems Model

MachinesMachinesMethodsMethodsToolsToolsLaborLaborEnergyEnergy

Dependent variables:

QuantityQualityProfit

Decision variables:

What to produceWhenWho will workWhere to stock

Uncontrollable variables:

Price of materialSpeed of machineWagesLegal requirements

Environment

Raw Raw materialsmaterials

Finished Finished productsproducts

InputsInputs ProcessesProcesses OutputsOutputs



A Simplified Model of a A Simplified Model of a Manufacturing SituationManufacturing Situation

Uncontrollable variables:5, 2, and 50

(market prices, marketing limitation)

Decision variables:

x1, x2

(What quantities of products 1 and 2

should be produced?)

Dependent variable:

R = 5x1 + 2x2

(total revenue)

Mathematical relationship:Mathematical relationship:

Maximize Maximize revenuerevenue

ObjectiveObjective

ConstraintConstraintSubject to:Subject to:

xx11 + x+ x22 50 50



Problem ClassificationProblem Classification

Allocation situationsAllocation situations There are a number of activities to be There are a number of activities to be

performedperformed There are multiple ways to perform these There are multiple ways to perform these

activitiesactivities Resources or facilities are limitedResources or facilities are limited

Decision situationsDecision situations Waiting-line situationsWaiting-line situations Predicting the behavior of a systemPredicting the behavior of a system


Decision-Making CategoriesDecision-Making Categories

Ignorance Uncertainty Risk Certainty

Increasing knowledge



Analysis of the Model – Analysis of the Model – Selecting an AlternativeSelecting an Alternative

Generate AlternativesGenerate Alternatives Predict the Outcome of Each Predict the Outcome of Each

AlternativeAlternative Relate Outcomes to GoalsRelate Outcomes to Goals Compare the AlternativesCompare the Alternatives Select an AlternativeSelect an Alternative


Audio Equipment Assembly LineAudio Equipment Assembly Line

Adopt Adopt video-video-based based

technologytechnology

Learning Learning raterate

Process technology

Cross-Cross-trainingtraining Task tenureTask tenure

Product design

Worker Worker forgettingforgetting

Worker Worker productivityproductivity

Increase capacity of line



Apartment Rental Apartment Rental ProblemProblem

CostCost

ViewView

ParkingParking

SizeSize

Apartment selection

New apartment

ShoppingShopping

EntertainmentEntertainment



ShoppingShopping EntertainmentEntertainmentLocationLocation CostCost SizeSize ViewView ParkingParking ConvenienceConvenience ConvenienceConvenience

AA

BB

CC

DD

EE



ShoppingShopping EntertainmentEntertainmentLocationLocation CostCost SizeSize ViewView ParkingParking ConvenienceConvenience ConvenienceConvenience

AA $1,450$1,450 650650 ExcellentExcellent Attended Attended Average Average GoodGood lotlot

BB 900900 850850 AverageAverage Self-park Self-park Excellent Excellent GoodGood lotlot

CC 725725 725725 PoorPoor On-streetOn-street Good Good ExcellentExcellent

DD 875875 905905 Average Average Own Own GoodGood GoodGood garagegarage

EE 1,1301,130 795795 GoodGood Attended Attended PoorPoor GoodGood garagegarage



Criterion Criterion [[weightweight]] 11 point point 22 points points 33 points points 4 4 pointspoints

Cost Cost [15][15] > $1,200> $1,200 $1,000 - $1,200$1,000 - $1,200 $800 - $1,000$800 - $1,000 < $800< $800

Size Size ((sq ftsq ft)) [10][10] < 700< 700 700 - 800700 - 800 800 - 1,000800 - 1,000 > 1,000> 1,000

View View [10][10] PoorPoor AverageAverage GoodGood ExcellentExcellent

Parking Parking [20][20] On-streetOn-street AttendedAttended OwnOwn AttendedAttended or self-or self- lot lot garage garage garage garage park lotpark lot

Shopping Shopping [10][10] PoorPoor AverageAverage GoodGood ExcellentExcellent convenienceconvenience

Entertainment Entertainment [15][15] PoorPoor AverageAverage GoodGood ExcellentExcellent convenienceconvenience

© 2002 South-Western/Thomson Slide 1-1 Chapter 1 - Decision Making and Quantitative Modeling ©...

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