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

and professional settings.
 We can use computers to analyze the
potential outcomes of decision
alternatives.
 Spreadsheets are often the tool of
choice for today’s problem-solvers.
 What is Operations Research?

 A field of study that uses computers,

statistics, and mathematics to solve
problems in a variety of settings.
 Also known as:
– Management Science
– Decision science
 Home Runs
in Operations Research
 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, multi-
vendor contract awards
– Benefits:
$600 million in savings
 Home Runs
in Operations Research
 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
Revenue $14.48 billion
Net Income $1.95 billion
 Home Runs
in Operations Research
 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 OR 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
Operations Research
 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 Problem Solving
 Everyone uses models to make
decisions.
 Types of models:
– Mental (arranging furniture)
– Visual (blueprints, road maps)
– Physical/Scale (aerodynamics, buildings)
– Mathematical (what we’ll 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)
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).
 A Generic Mathematical Model

Y = f(X1, X2, …, Xn)

Where:

Y = dependent (response) variable

(bottom-line performance measure)

Xi = independent (explanatory) variables

(inputs having an impact on Y)

f(.) = function defining the relationship between the Xi & Y

 Categories of Mathematical Models
Model Independent OR/MS
Category Form of f(.) Variables Techniques
Prescriptive known, known or under LP, Networks, IP,
well-defineddecision maker’sCPM, EOQ, NLP,
control GP, MOLP

Predictive unknown, known or under Regression Analysis,

ill-defined decision maker’sTime Series Analysis,
control Discriminant Analysis

Descriptive known, unknown or Simulation, PERT,

well-defined uncertain Queueing, Inventory
Models
 The Problem Solving Process

Identify Formulate &

Problem Implement Analyze Test Implement
Model Model Results Solution

unsatisfactory
results
 The Psychology of Decision Making

 Models can be used for technical

aspects of decision problems.
 Other aspects cannot be modeled
easily, requiring intuition and judgment.
 Caution: Human judgment and intuition
is not always rational!
 Framing Effects
 Refers to how decision-makers view
alternatives in a problem, often from a
win-loss perspective.
 The way a problem is framed often
influences choices in irrational ways…
 Suppose you’ve 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 you’ve 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

Alternative A $1,500

Initial state
Heads (50%)
$2,000
Alternative B
(Flip coin) $1,000
Tails (50%)
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 can’t guarantee good
outcomes.
End of Chapter 1