Spreadsheet Modeling
& Decision Analysis
A Practical Introduction to
Business Analytics
7th edition
Cliff T. Ragsdale
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be scanned, copied or duplicated, or posted to a publicly
accessible website, in whole or in part.
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.
© 2014 Cengage Learning. All Rights Reserved. May not
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accessible website, in whole or in part.
What is Business Analytics?
 A field of study that uses computers,
statistics, and mathematics to solve
business problems.
 Also known as:
– Operations research
– Management Science
– Decision science
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accessible website, in whole or in part.
Home Runs
in Business Analytics
 Proctor & Gamble
– Developed multi-echelon inventory
planning tool for safety stock optimization
– Lowers inventory while maintain customer
service
– Benefits:
Reduced inventory investments by $1.5 billion
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accessible website, in whole or in part.
Home Runs
in Business Analytics
 New Brunswick (CA) Dep’t of Transportation
– Developed linear programming-based strategic
planning tool
– Includes long-term objectives and operational
constraints on costs, timings, asset life cycle
– Benefits:
Estimated $72 million in annual savings from a $2
million investment
© 2014 Cengage Learning. All Rights Reserved. May not
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accessible website, in whole or in part.
Home Runs
in Business Analytics
 Industrial and Commercial Bank of China
– World’s largest publicly traded bank
– 16,000 branch locations
– Worked with IBM to develop a tool to predict
where new branches should be opened
– Implemented in 40 cities throughout China
– Benefits:
Estimated $1 billion in new deposits in typical
major cities
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accessible website, in whole or in part.
Home Runs in
Business Analytics
 Midwest Independent Transmission
System Operator (MISO)
– Manages power generation in 13 U.S.
midwest states
– Uses optimization model to determine when
various plants should be running
– Other models predict energy output & prices
– Benefits:
 Improved plant efficiency & grid reliability
 Savings of ~$3 billion from 2007-2010
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accessible website, in whole or in part.
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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accessible website, in whole or in part.
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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accessible website, in whole or in part.
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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accessible website, in whole or in part.
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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accessible website, in whole or in part.
Example of a Mathematical Model
Profit = Revenue - Expenses
or
Profit = f(Revenue, Expenses)
or
Y = f(X1, X2)
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accessible website, in whole or in part.
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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accessible website, in whole or in part.
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).
© 2014 Cengage Learning. All Rights Reserved. May not
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accessible website, in whole or in part.
Categories of Mathematical Models
Model
Category
Prescriptive
Form of f(.)
Independent
Variables
OR/MS
Techniques
known,
well-defined
known or under
decision maker’s
control
LP, Networks, IP,
CPM, EOQ, NLP,
GP, MOLP
Predictive
unknown,
ill-defined
known or under
decision maker’s
control
Regression Analysis,
Time Series Analysis,
Discriminant Analysis,
Neural Networks,
Affinity Analysis, etc.
Descriptive
known,
well-defined
unknown or
uncertain
Simulation, PERT,
Queueing,
Inventory Models
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accessible website, in whole or in part.
The Problem-Solving Framework for
Leveraging Business Opportunities
Identify
Problem
“Probortunity”
Formulate &
Implement
Model
Analyze
Model
Test
Results
unsatisfactory
results
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accessible website, in whole or in part.
Implement
Solution
The Psychology of Decision Making
 Models can be used for structurable
aspects of decision problems.
 Other aspects cannot be structured
easily, requiring intuition and judgment.
 Caution: Human judgment and intuition
is not always rational!
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accessible website, in whole or in part.
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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accessible website, in whole or in part.
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
$1,500
Alternative A
Initial state
Heads (50%)
Alternative B
(Flip coin)
Tails (50%)
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accessible website, in whole or in part.
$2,000
$1,000
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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accessible website, in whole or in part.
Decisions & Outcomes
Outcome Quality
Decision
Quality
Good
Bad
Good
Deserved Success
Bad Luck
Bad
Dumb Luck
Poetic Justice
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accessible website, in whole or in part.
End of Chapter 1
© 2014 Cengage Learning. All Rights Reserved. May not
be scanned, copied or duplicated, or posted to a publicly
accessible website, in whole or in part.
The Analytic Solver Platform
software featured in this book is
provided by Frontline Systems.
http://www.solver.com
© 2014 Cengage Learning. All Rights Reserved. May not
be scanned, copied or duplicated, or posted to a publicly
accessible website, in whole or in part.