CHAPTER 1: INTRODUCTION TO MANAGEMENT SCIENCE

BA 424 l MANAGEMENT SCIENCE l PRELIM

MANAGEMENT SCIENCE 1.1 PROBLEM SOLVING AND DECISION MAKING

- also called Operations Research / Decision Science PROBLEM SOLVING

- approach to decision making based on the scientific
method, makes extensive use of quantitative analysis - The process of identifying a difference between the
- significance in Accounting: it is important for a actual and desired state of affairs and then taking
company's profitability, efficiency, and high-quality action to resolve the difference.
decision-making process 1. Identify and define the problem
2. Determine the set of alternative solutions
HISTORY 3. Determine the criterion or criteria that will be
used to evaluate the alternatives
SCIENTIFIC MANAGEMENT REVOLUTION 4. Evaluate the alternatives
5. Choose an alternative
6. Implement the selected alternative
- originated on the early 1900s
7. Evaluate the result to determine whether a
- initiated by Frederic W. Taylor
satisfactory solution has been obtained
- provided the foundation for the use of quantitative
methods in management DECISION MAKING
MODERN MANAGEMENT SCIENCE RESEARCH - is generally associated with the first five steps of
problem-solving
- originated during the World War II - first step is to identify and define the problem
- teams with diverse specialties (mathematicians, - ends with the choosing of an alternative (the act of
engineers, and behavioral scientists) were formed to making the decision)
deal with strategic and tactical problems faced by the Single-criterion decision problems - problems in which
military by utilizing the scientific method the objective is to find the best solution with respect to
one criterion
TWO DEVELOPMENTS THAT OCCURRED DURING
POST-WORLD WAR II PERIOD THAT LED TO THE Multicriteria decision problems - problems that involve
GROWTH AND USE OF MANAGEMENT SCIENCE IN more than one criterion
NONMILITARY APPLICATIONS

1.2 QUANTITATIVE ANALYSIS AND DECISION

1. Continued research resulted in numerous
MAKING
methodological developments - George Dantzig’s
1947 discovery of the simplex method for solving
linear programming problems.
2. Digital computers prompted a virtual explosion in
computing power - personal computers can now be
used to solve problems larger than those solved on
mainframe computers in the 1990s.

MANAGEMENT SCIENCE IN ACTION

REVENUE MANAGEMENT AT AT&T PARK

- one of the most important applications of MS in the

sports and entertainment industry
- Revenue Management: a business technique that
enables to maximize revenue by adjusting demand TWO BASIC FORMS OF DECISION-MAKING
patterns PROCESS
- Application of Management Science: Adopted the
dynamic ticket-pricing system and realized the QUALITATIVE ANALYSIS
importance of the revenue management system in the
company through operations research. This technique - based primarily on the manager’s judgment and
provided a 7% to 8% increase in revenue per seat for experience, intuitive “feel” for the problem and is more
Giants ’ home games during the 2010 season. than art than a science
- may be used for simple problems with experience
 QUANTATIVE ANALYSIS 1. Iconic models
- physical replicas of real objects (e.g., toy airplanes
- used when there is little experience with similar or & toy trucks)
complex problems 2. Analog models
- it is an approach where an analyst will concentrate on - models that are physical in form but do not have
the quantitative facts or data associated with the the same physical appearance as the object being
problem and develop mathematical expressions that modeled (e.g., the speedometer of an automobile
describe the objectives, constraints, and other & thermometer)
relationships that exist in the problem
- a manager who is knowledgeable in quantitative 3. Mathematical models
decision-making procedures is in a much better - includes representations of a problem by a system
position to compare and evaluate the qualitative and of symbols and mathematical relationships or
quantitative recommendations and combine them to expressions and are a critical part of any
arrive at the best decision quantitative approach
- e.g., Total profit (P) can be determined after
multiplying the profit per unit (Php 10) by the
quantity sold (x) → P = 10x

● The purpose or value of any model is that it enables

us to make inferences about the real situation by
studying and analyzing the model.
ROLE OF QUALITATIVE & QUANTITATIVE ANALYSIS
● Experimenting with models requires less time and is
less expensive than experimenting with the real
WHY QUANTITATIVE APPROACH MIGHT BE USED object or situation.
IN THE DECISION-MAKING PROCESS ● Models also have the advantage of reducing the risk
associated with experimenting with the real
1. The problem is complex, and the manager cannot situation.
develop a good solution without the aid of ● The value of model-based conclusions and decisions
quantitative analysis. is dependent on how well the model represents the
2. The problem is especially important, and the real situation.
manager desires a thorough analysis before ● The more closely the mathematical model represents
attempting to make a decision. the company's true profit-volume relationship, the
3. The problem is new, and the manager has no more accurate the profit projections will be.
previous experience from which to draw. ● The success of the mathematical model and
4. The problem is repetitive, and the manager saves quantitative approach will depend heavily on how
time and effort by relying on quantitative procedures accurately the objective and constraints (production
to make routine decision recommendations. capacities) can be expressed in terms of
mathematical equations or relationships.

1.3 QUANTITATIVE ANALYSIS Objective function

- mathematical expression that describes the problem’s
The more the analyst is involved in the process of objective
structuring the problem, the more likely the ensuing Example:
quantitative analysis will make an important P = 10x is an objective function for a firm attempting to
contribution to the decision-making process. maximize profit
To successfully apply quantitative analysis to decision
making, the manager/user of the result & A production capacity constraint would be necessary if
management scientist work together: 5 hours are required to produce each unit and only 40
● problem has been adequately structured hours of production time are available per week. Let x
● make a model to represent a problem indicate the number of units produced each week.
mathematically 5x ≤ 40
● best solution for the model then becomes a Value:
recommendation to the decision maker 5x total time required to produce x units
≤ production time required must be less than or equal
The process of developing and solving models is the
to 40 hours available
essence of the quantitative analysis process.
40 no. of hrs. available in a week/production capacity

MODEL DEVELOPMENT
Question: How many units of the product should be
scheduled each week to maximize profit?
Models are representations of real objects or situations
and can be presented in various forms.
 Linear Programming Model When data or uncontrollable input values are not readily
available, analyst will usually adapt a general notation
Maximize P = 10x objective function
for the model development, and then a separate data
subject to (s.t.)
preparation step will be performed to obtain the
5x ≤ 40 constraints
uncontrollable input values required by the model.
x≥0
Using the general notation
x ≥ 0 constant requires production quantity x to be
greater than or equal to zero (means there’s no zero c = profit per unit
number of units) a = production time in hours per unit
b = production capacity in hours
the model development step of the production process
CONTROLLABLE INPUTS TO THE MODEL
would result in the following general model:
- environmental factors that are controlled or
determined by the decision maker Max cx
- decision alternatives specified by the manager s.t.
- referred as Decision Variables ax ≤ b
- e.g., production quantity x x≥0
UNCONTROLLABLE INPUTS TO THE MODEL
A separate data preparation step to identify the values
- environmental factors which can affect both the
for c, a, and b would then be necessary to complete the
objective function and the constraints; cannot be
model.
influenced by the decision maker
- e.g., profit per unit ($10), production time per unit (5
hours), production capacity (40 hours) MODEL SOLUTION

- identifying the values of the decision variables that

provide the “best” output for the model
Optimal solution - the specific decision-variable value
or values providing the “best” output
For the production problem, the model solution step
involves finding the value of the production quantity
decision variable x that maximizes the profit while not
causing a violation of the production capacity constraint.

FLOWCHART OF THE PRODUCTION MODEL Trial and error approach - the model is used to test and
evaluate various decision alternatives; this would
➔ DETERMINISTIC MODEL identify a good-and possibly the best-feasible solution
- all uncontrollable inputs to a model are known and to the problem
cannot vary a. feasible - all constraints are satisfied, the
- distinguishing feature of a deterministic model is that decision alternative and a candidate for the
the uncontrollable input values are known in advance “best” solution or recommended decision
- e.g., corporate income tax rates b. infeasible - decision alternative is rejected if a
particular decision alternative does not satisfy
one or more of the model constraints
➔ STOCHASTIC/PROBABILISTIC MODEL
- uncontrollable inputs are uncertain and subject to Model development and model solution are not completely
variation separable.
- distinguishing feature is that the value of the output
cannot be determined even if the value of the
controllable input is known
- e.g., demand for product

DATA PREPARATION

Data - values of the uncontrollable inputs to the model TRIAL-AND-ERROR SOLUTION FOR THE PRODUCTION MODEL

Data:
Model testing and validation are frequently conducted
● $10 per unit for profit
with relatively small “test” problems that have known or
● 5 hours per unit for production time
at least expected solutions.
● 40 hours for production capacity
 RESULT OF THE APPLICATION OF ALTERNATIVES made for a new product. Suppose that the setup cost for
the Viper is $3000. This setup cost is a fixed cost that is
Model and output of information
incurred regardless of the number of units eventually
Incorrect Correct produced. In addition, suppose that variable labor and
potential problems/inaccuracies material costs are $2 for each unit produced.

corrective action such as the “go-ahead” may be

model modification given to use the model COST AND VOLUME MODELS
and/or collection of more on the full-scale problem
accurate input data may The cost of manufacturing or producing a product is a
be taken function of the volume produced.
● Fixed cost - portion of the total cost that does not
Whatever corrective action, the model solution will not depend on the production volume; this cost remains
be used in practice until the model has satisfactorily the same no matter how much is produced
passed testing and validation. ● Variable cost - portion of the total cost that is
dependent on and varies with the production volume
REPORT GENERATION
C(x) = 300 + 2x
- preparation of managerial reports based on the
model’s solution where: x = production volume in units
- the results of the model must appear in a managerial C(x) = total cost of producing x units
report that can be easily understood by the decision
maker Once a production volume is established, compute the
- the report includes the recommended decision and total production cost:
other pertinent information about the results that may
be helpful to the decision maker C(1,200) = 300 + 2(1,200) = $5,400

● Marginal cost - rate of change of the total cost with

A NOTE REGARDING IMPLEMENTATION respect to production volume. ; it is the cost increase
associated with a one-unit increase in the production
● The manager should continue to monitor the volume
contribution of the model during the
implementation and follow-up. In the cost model of equation, the total cost C(x) will
● If the results of the quantitative analysis process increase by $2 for each unit increase in the production
are not correctly implemented, the entire effort volume, thus, the marginal cost is $2.
may be of no value.
● One of the most effective ways to ensure REVENUE AND VOLUME MODELS
successful implementation is to include users
throughout the modeling process.
A revenue model is a framework for generating financial
income. It identifies which revenue source to pursue,
1.4 MODELS OF COST, REVENUE, AND PROFIT what value to offer, how to price the value, and who pays
for the value.

BENEFITS OF MATHEMATICAL MODELS Management of Nowlin Plastics also want information of

projected revenue associated with selling a specific
● Financial planning - help executives explore number of units.
results of various business strategies
● Production planning - development of Suppose that each CD-50 storage unit sells for $5. The
strategic/tactical model for the distribution of model for total revenue can be written as
production
● Sales Quotas - set expectations and motivate sales R(x) = 5x
reps to hit a given level of activity where:
● Decision-making - enables the decision maker to x = sales volume in units
make the best decisions that could greatly impact R(x) = total revenue associated with selling x units
the firm
● Marginal revenue - rate of change of total revenue
ILLUSTRATION USED IN THE MODELS
with respect to sales volume; increase in total
Nowlin Plastics produces a line of cell phone covers. revenue resulting from a one-unit increase in sales
Nowlin's best-selling cover is its Viper Model, a slim but volume
very durable black and gray plastic cover. Several
In the cost model of equation, wee see that the marginal
products are produced on the same manufacturing line,
revenue is $5. In this case, marginal revenue is constant
and a setup cost is incurred each time a changeover is
and does not vary with the sales volume.
 PROFIT AND VOLUME MODELS

One of the most important criteria for management

decision-making is profit.

We can combine equations (1) and (2) to develop a

profit-volume model that will determine the total profit
associated with a specified production-sales volume.
Total profit, P(x), is total revenue minus total cost;
therefore, the following model provides the total profit
associated with producing and selling x units: GRAPH OF THE BREAKEVEN ANALYSIS FOR NOWLIN PLASTICS

P(x) = R(x) - C(x) 1.5 MANAGEMENT SCIENCE TECHNIQUES

= 5x - (3,000 + 2x)
= -3,000 + 3x 1. Linear Programming - is a problem-solving
approach developed for situations involving
The profit-volume model can be derived from the maximizing or minimizing a linear function subject to
revenue-volume and cost-volume models. linear constraints that limit the degree to which the
objective can be pursued
P(x) = -3,000 + 3x 2. Integer Linear Programming - is an approach used
for problems that can be set up as linear programs,
with the additional requirement that some or all of
Examples:
the decision variables be integer values
● Demand forecast indicates that 500 units of the
3. Distribution and Network Models - a network is a
product can be sold.
graphical description of a problem consisting of
circles called nodes that are interconnected by lines
P(500) = -3,000 + 3(500) called arcs
= -1,500 4. Nonlinear Programming - a technique that allows
for maximizing or minimizing a nonlinear function
A loss of 1,500 projected profit is predicted. subject to nonlinear constraints
5. Project Scheduling: PERT/CPM - (Program
● Demand forecast of 1,800 units. Evaluation and Review Technique) and CPM (Critical
Path Method) techniques help managers carry out
P(1,800) = -3,000 + 3(1,800) their project scheduling responsibilities
= 2,400 6. Inventory Models - are used by managers faced with
the dual problems of maintaining sufficient
inventories to meet demand for goods and, at the
This profit may be enough to justify proceeding with
same time, in cutting the lowest possible inventory
the production and sale of the product.
holding costs
7. Waiting-Line or Queueing Models - have been
BREAKEVEN ANALYSIS developed to help managers understand and make
better decisions concerning the operation of systems
Breaking point involving waiting lines
8. Simulation - is a technique used to model the
- the volume that results in total revenue operation of a system. This technique employs a
equalling total cost (providing $0 profit) computer program to model the operation and
- provides valuable information for a manager perform simulation computations
who must make a yes/no decision concerning 9. Decision Analysis - can be used to determine
the production of the product optimal strategies in situations involving several
decision alternatives and an uncertain or risk-filled
pattern of events
P(x) = -3,000 + 3x = 0
10. Goal Programming - is a technique for solving multi
3x = 3,000
criteria decision problems, usually within the
breakeven point x = 1,000
framework of linear programming
11. Analytic Hierarchy Process - this multicriteria
Therefore, the manager can quickly infer that a volume decision-making technique permits the inclusion of
above the breakeven point will result in a profit, whereas subjective factors in arriving at a recommended
a volume below the breakeven point will result in a loss. decision
12. Forecasting - methods are techniques that can be
used to predict future aspects of a business
operation
13. Markov Process Models - are useful in studying the
evolution of certain systems over repeated trials For
example, Markov processes have been used to
describe the probability that a machine, functioning
in one period, will function or break down in another
period

METHODS USED FREQUENTLY

- linear programming, integer programming,
network models (including supply chain
models), and simulation

SUMMARY

★ Management science may be used to help managers

make better decisions.

★ Mathematical models are abstractions of real-world

situations and, as such, cannot capture all the
aspects of the real situation. However, if a model can
capture the major relevant aspects of the problem
and can then provide a solution recommendation, it
can be a valuable aid to decision-making.

★ In carrying out the quantitative analysis, we shall be

attempting to develop procedures for finding the
"best" or optimal solution.