Spreadsheet Modeling &

Decision Analysis
A Practical Introduction to
Management Science
4th edition

Cliff T. Ragsdale
 Chapter 1

Introduction to Modeling
& Problem Solving

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 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
today’s managers.

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 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

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 Home Runs in Management Science
• Merril Lynch
– 5 million customers
– 16,000 financial advisors
– Developed a model to design product features
and pricing options to better reflect customer
value
– Benefits:
• $80 million increase in annual revenue
• $22 billion increase in net assiets

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 Home Runs in Management Science
• Jan de Wit Co.
– Brazil’s largest lily farmer
– Annually plants 3.5 million bulbs and produces
420,000 pots & 220,000 bundles of lilies in 50
varieties.
– Developed model to determine what to plant,
when to plant it, and how to sell it.
– Benefits:
• 26% increase in revenue
• 32% increase in contribution margin

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Home Runs in Management Science
• NBC
– Must determine program schedules
– Schedules must meet advertisers
demographic and cost requirements
– Developed optimization model to determine
optimal timing and pricing of commercials
– Benefits:
• $50 million increase in annual revenue

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Home Runs in Management Science
• Samsung Electronics
– Leading DRAM manufacturer
– Semiconductor facilities cost $2-$3 billion
– High equipment utilization is key
– Developed comprehensive planning and
scheduling system to control WIP
– Benefits:
• Cut cycle times in half
• $1 billion increase in annual revenue

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 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.

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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 we’ll be studying)

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 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

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 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.
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Example of a Mathematical Model

Profit = Revenue - Expenses

or
Profit = f(Revenue, Expenses)
or
Y = f(X1, X2)

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 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

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 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).
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 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’s CPM, 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

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 The Problem Solving Process

Identify Formulate &

Problem Implement Analyze Test Implement
Model Model Results Solution

unsatisfactory
results

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The Psychology of Decision Making
• Models can be used for structurable
aspects of decision problems.
• Other aspects cannot be structured
easily and require intuition and
judgment.
• Caution: Human judgment and intuition
is not always rational!

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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 ?

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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 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

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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

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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%)

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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.
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End of Chapter 1

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