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25.09.

2012

Introduction to Management
Science
Introduction to Modeling

Management Science
Management science
Is a scientific approach to decision making. Makes
extensive use of mathematical/statistical models

This body of knowledge involving


quantitative approaches to decision making is
also referred to as
Quantitative analysis
Operations research
Decision modeling

It had its early roots in World War II and is


flourishing in business and industry with the
aid of computers

Quantitative Analysis
Potential Reasons for a Quantitative Analysis
Approach to Decision Making
The problem is complex for informal methods.
The problem is very important.
The problem is new.
Alternatively, the problem is repetitive.

25.09.2012

Decision Models
Decision models :
Generally mathematical representations.
Provide analytical framework for evaluating
modern business problems.
Provide techniques applicable in many areas Accounting, Economics, and Finance
Logistics, Management, and Marketing
Production, Operations, and Transportation

Decision Models
Decision models subject to
Limitations
Assumptions
Simplifications

Models are not the real problems, but


abstractions of it.

Real
World

Management
Situation

Analysis

Managerial
Judgment

Results
Interpretation

Symbolic
World

Abstraction

Model

Decisions
Intuition

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Some basic definitions


A variable
A measurable quantity that is subject to change

A decision variable
A controllable variable (e.g. inventory items to
order)

A parameter
A measurable quantity that is known and
inherent to the problem (e.g. Selling price of a
product)

The Black Box View of a Model

Decisions
(Controllable)
Parameters
(Uncontrollable)

Model

Performance
Measure(s)
Consequence
Variable(s)

Decision models
Relate decision variables (controllable inputs)
with fixed or variable parameters (uncontrollable
inputs).
Frequently seek to maximize or minimize some
performance measures (objective function)
subject to constraints.
The values of the decision variables that provide
the mathematically-best output are referred to as
the optimal solution for the model.

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Advantages of Decision Models


No emotion/no bias
Consistent
A systematic approach
Easy to express/easy to deal with
Easy to experiment on

Generally, experimenting with models


(compared to experimenting with the real
situation)
requires less time
is less expensive
involves less risk

Disadvantages of Decision Models


Constructing models could be hard
Models could be really hard to solve if not
impossible
Can lose the real problem (too much
abstraction/assumptions)
Quantitative analysis in expense of qualitative
analysis

Cost/benefit considerations must be made


in selecting an appropriate model.
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.

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Types of Decision Models


Decision
Models

Deterministic
Models

Probabilistic
Models

Deterministic models assume


Complete certainty.
All information needed is available with fixed and
known values.

Most commonly used deterministic modeling


technique is Linear Programming

Probabilistic models are also called


stochastic models.
Probabilistic models
assume some of data is not known with
certainty.
take into account information will be known
after decision is made.

25.09.2012

Steps in Decision Modeling


1. Formulation.

2. Solution.

3. Interpretation.

Steps in Decision Modeling


Defining the problem
Develop clear and concise problem statement
Do not solve the wrong problem

Developing a model
Select and develop a decision model
Select appropriate problem variables
Develop relevant mathematical relation for
consideration and evaluation

Steps in Decision
Modeling
Acquiring input data
Collect accurate data for use in model.
Possible data sources are:
Official company reports.
Accounting, operating, and financial information.
Views, and opinions from knowledgeable
individuals.

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Steps in Decision
Modeling
Developing a solution
Solution of set of mathematical expressions
Alternative trial and error iterations
Complete enumeration of all possibilities
Utilization of an algorithm/heuristic
Series of steps repeated until satisfactory solution
is attained

Steps in Decision
Modeling
Testing a solution
Prior to implementation of model solution,
testing solution.
Testing of solution is accomplished by
examining and evaluating:
Data utilized in model by acquiring new data
The model itself

Steps in Decision
Modeling
Interpretation and What-if Analysis
(Analyzing the results and sensitivity
analysis)
Vary data input values and examine differences
in various optimal solutions
Make changes in model parameters and
examine differences in various optimal
solutions

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Steps in Decision
Modeling

Implementing the results

Optimal solution must be interpreted carefully


Do not forget the assumptions
Model is not the real problem
Optimal solution is there to give insight
Solution implementation usually requires making
changes within the organization
Recommendations often require changes in data,
data handling, resource mixes, systems,
procedures, policies, and personnel

Possible Problems
in Decision Modeling
Defining the problem
Conflicting viewpoints
Impact on other departments
Real life is too ambiguous a jungle
Problems that change quickly

Developing a model
Beginning assumptions
Fitting textbook models
Understanding/accepting a model

Possible Problems
in Decision Modeling
Acquiring data
Availability
Accesibility
Relevance
Quality
Missing data

Developing a solution
Complex mathematics
Giving only-one answer (insight is important)
Failing to remember there are assumptions

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Possible Problems
in Decision Modeling
Testing the solution/analyzing
results/implementing results
Problems about realization/implementation
Time dimension (no immediate effects)
Resistance for change

An Example to Spreadsheet Use:


Break-even Analysis
Break-even point
Point of equality
Unit is the # of something
-=+
Revenues = Expenses
Profit = 0

Example: Yesilayirlar
Yeilayrlar Development Corporation
(YDC) is a small real estate developer that
builds only one style house. The selling price
of the house is 115,000TL.
Land for each house costs 55,000TL and
lumber, supplies, and other materials run
another 30,000TL per house. Total labor
costs are approximately 20,000TL per house
The salaries of the employees and the office
rents sum up to 40,000TL per month.

25.09.2012

Example: Yesilayirlar
Revenue per house = r(x) = 115000x
Costs
Fixed cost = F = 40000
Variable costs per house
= v(x) = (55000 + 30000 + 20000)x = 105000x
Total costs = c(x) = F + v(x) = 40000 + 105000x

Break-even point
r(x) = c(x)
115000x = 40000 + 105000x
Solving, x = 4 houses

Example: Yesilayirlar
What is monthly profit if 12 houses are sold?
p(x) = 115000x 105000x 40000
p(x) = 10000x 40000
p(12) = 10000(12) 40000 = 80000TL

What is monthly profit if 2 houses are sold?


p(2) = 10000(2) 40000 = -20000TL

Graph of Break-Even Analysis

Thousands of TLs

1200
Total Revenue =
115000x

1000
800
600

Total Cost =
40000 + 105000x

400
200
0

Break-Even Point = 4 Houses

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5
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Number of Houses Sold (x)

10

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