Week 1-2: Introduction to Management Science

(currency used for this module is US dollars, it was not replaced for consistency purposes)

Management science, an approach to decision making based on the scientific method, makes extensive
use of quantitative analysis. A variety of names exists for the body of knowledge involving quantitative
approaches to decision making; in addition to management science, two other widely known and
accepted names are operations research and decision science. Today, many use the terms management
science, operations research, and decision science interchangeably.

The scientific management revolution of the early 1900s, initiated by Frederic W. Taylor, provided the
foundation for the use of quantitative methods in management. But modern management science
research is generally considered to have originated during the World War II period, when teams were
formed to deal with strategic and tactical problems faced by the military. These teams, which often
consisted of people with diverse specialties (e.g., mathematicians, engineers, and behavioral scientists),
were joined together to solve a common problem by utilizing the scientific method. After the war, many
of these team members continued their research in the field of management science.

Two developments that occurred during the post–World War II period led to the growth and use of
management science in nonmilitary applications. First, continued research resulted in numerous
methodological developments. Probably the most significant development was the discovery by George
Dantzig, in 1947, of the simplex method for solving linear programming problems. At the same time these
methodological developments were taking place, digital computers prompted a virtual explosion in
computing power. Computers enabled practitioners to use the methodological advances to solve a large
variety of problems. The computer technology explosion continues, and personal computers can now be
used to solve problems larger than those solved on mainframe computers in the 1990s.

PROBLEM SOLVING AND DECISION MAKING

Problem solving can be defined as the process of identifying a difference between the actual and the
desired state of affairs and then taking action to resolve the difference. For problems important enough
to justify the time and effort of careful analysis, the problem- solving process involves the following seven
steps:

1. Identify and define the problem.

2. Determine the set of alternative solutions.

3. Determine the criterion or criteria that will be used to evaluate the alternatives.

4. Evaluate the alternatives.

5. Choose an alternative.

6. Implement the selected alternative.

7. Evaluate the results to determine whether a satisfactory solution has been obtained.
Decision making is the term generally associated with the first five steps of the problem- solving process.
Thus, the first step of decision making is to identify and define the problem. Decision making ends with
the choosing of an alternative, which is the act of making the decision.

Model Development

Models are representations of real objects or situations and can be presented in various forms. For
example, a scale model of an airplane is a representation of a real airplane. Similarly, a child’s toy truck is
a model of a real truck. The model airplane and toy truck are examples of models that are physical replicas
of real objects. In modeling terminology, physical replicas are referred to as iconic models.

A second classification includes models that are physical in form but do not have the same physical
appearance as the object being modeled. Such models are referred to as analog models. The speedometer
of an automobile is an analog model; the position of the needle on the dial represents the speed of the
automobile. A thermometer is another analog model representing temperature.

A third classification of models—the type we will primarily be studying—includes representations of a

problem by a system of symbols and mathematical relationships or expressions. Such models are referred
to as mathematical models and are a critical part of any quantitative approach to decision making. For
example, the total profit from the sale of a product can be determined by multiplying the profit per unit
by the quantity sold. If we let x represent the number of units sold and P the total profit, then, with a
profit of $10 per unit, the following mathematical model defines the total profit earned by selling x units:

P = 10x (1.1)

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. For example, an airplane designer might test an iconic model of a new
airplane in a wind tunnel to learn about the potential flying characteristics of the full-size airplane.
Similarly, a mathematical model may be used to make inferences about how much profit will be earned if
a specified quantity of a particular product is sold. According to the mathematical model of equation (1.1),
we would expect selling three units of the product (x = 3) would provide a profit of P = 10(3) = $30. In
general, experimenting with models requires less time and is less expensive than experimenting with the
real object or situation. A model airplane is certainly quicker and less expensive to build and study than
the full-size airplane. Similarly, the mathematical model in equation (1.1) allows a quick identification of
profit expectations without actually requiring the manager to produce and sell x units. Models also have
the advantage of reducing the risk associated with experimenting with the real situation. In particular,
bad designs or bad decisions that cause the model airplane to crash or a mathematical model to project
a $10,000 loss can be avoided in the real situation.

The value of model-based conclusions and decisions is dependent on how well the model represents the
real situation. The more closely the model airplane represents the real airplane, the more accurate the
conclusions and predictions will be. Similarly, the more closely the mathematical model represents the
company’s true profit-volume relationship, the more accurate the profit projections will be.

Because this text deals with quantitative analysis based on mathematical models, let us look more closely
at the mathematical modeling process. When initially considering a managerial problem, we usually find
that the problem definition phase leads to a specific objective, such as maximization of profit or
minimization of cost, and possibly a set of restrictions or constraints, such as production capacities. The
success of the mathematical model and quantitative approach will depend heavily on how accurately the
objective and constraints can be expressed in terms of mathematical equations or relationships.

A mathematical expression that describes the problem’s objective is referred to as the objective function.
For example, the profit equation P = 10x would be an objective function for a firm attempting to maximize
profit. A production capacity constraint would be necessary if, for instance, 5 hours are required to
produce each unit and only 40 hours of production time are available per week. Let x indicate the number
of units produced each week. The production time constraint is given by:

The value of 5x is the total time required to produce x units; the symbol Š indicates that the production
time required must be less than or equal to the 40 hours available.

The decision problem or question is the following: How many units of the product should be scheduled
each week to maximize profit? A complete mathematical model for this simple production problem is

In the preceding mathematical model, the profit per unit ($10), the production time per unit (5 hours), and
the production capacity (40 hours) are environmental factors that are not under the control of the manager
or decision maker. Such environmental factors, which can affect both the objective function and the
constraints, are referred to as uncontrollable inputs to the model. Inputs that are controlled or determined
by the decision maker are referred to as controllable inputs to the model. In the example given, the
production quantity x is the controllable input to the model. Controllable inputs are the decision alternatives
specified by the manager and thus are also referred to as the decision variables of the model.
Once all controllable and uncontrollable inputs are specified, the objective function and constraints can be
evaluated and the output of the model determined. In this sense, the output of the model is simply the
projection of what would happen if those particular environmental factors and decisions occurred in the
real situation. A flowchart of how controllable and uncontrollable inputs are transformed by the
mathematical model into output is shown in Figure 1.4.
 FIGURE 1.4 FLOWCHART OF THE PROCESS OF TRANSFORMING MODEL INPUTS
INTO OUTPUT

Uncontrollable Inputs
(Environmental Factors)

Controllable
Mathematica Outpu
Inputs
(Decision Variables) l Model (Projected
t Results)

A similar flowchart showing the specific details of the pro- duction model is shown in Figure 1.5.
As stated earlier, the uncontrollable inputs are those the decision maker cannot influence. The specific
controllable and uncontrollable inputs of a model depend on the particular problem or decision-making
situation. In the production problem, the production time available (40) is an uncontrollable input. However,
if it were possible to hire more employees or use overtime, the number of hours of production time would
become a controllable input and therefore a decision variable in the model.

Uncontrollable inputs can either be known exactly or be uncertain and subject to variation. If all
uncontrollable inputs to a model are known and cannot vary, the model is referred to as a deterministic
model. Corporate income tax rates are not under the influence of the manager and thus constitute an
uncontrollable input in many decision models. Because these rates are known and fixed (at least in the short
run), a mathematical model with corporate income tax rates as the only uncontrollable input would be a
deterministic model. The distinguishing feature of a deterministic model is that the uncontrollable input
values are known in advance.
If any of the uncontrollable inputs are uncertain and subject to variation, the model is referred to as a
stochastic or probabilistic model. An uncontrollable input to many production planning models is demand
for the product. A mathematical model that treats future demand—which may be any of a range of values—
with uncertainty would be called a stochastic model. In the production model, the number of hours of
production time re- quired per unit, the total hours available, and the unit profit were all uncontrollable
inputs. Because the uncontrollable inputs were all known to take on fixed values, the model was
deterministic. If, however, the number of hours of production time per unit could vary from 3 to 6 hours
depending on the quality of the raw material, the model would be stochastic. The distinguishing feature of
a stochastic model is that the value of the output cannot be determined even if the value of the controllable
input is known because the specific values of the uncontrollable inputs are unknown. In this respect,
stochastic models are often more difficult to analyze.

Data Preparation
Another step in the quantitative analysis of a problem is the preparation of the data required by the model.
Data in this sense refer to the values of the uncontrollable inputs to the model. All uncontrollable inputs or
data must be specified before we can analyze the model and recommend a decision or solution for the
problem.
In the production model, the values of the uncontrollable inputs or data were $10 per unit for profit, 5 hours
per unit for production time, and 40 hours for production capacity. In the development of the model, these
data values were known and incorporated into the model as it was being developed. If the model is relatively
small and the uncontrollable input values or data required are few, the quantitative analyst will probably
combine model development and data preparation into one step. In these situations the data values are
inserted as the equations of the mathematical model are developed.
However, in many mathematical modeling situations, the data or uncontrollable input values are not readily
available. In these situations, the management scientist may know that the model will need profit per unit,
production time, and production capacity data, but the values will not be known until the accounting,
production, and engineering departments can be consulted. Rather than attempting to collect the required
data as the model is being developed, the analyst will usually adopt a general notation for the model
development step, and then a separate data preparation step will be performed to obtain the uncontrollable
input values required by the model.
Using the general notation
c = profit per unit
a = production time in hours per unit
b = production capacity in hours
the model development step of the production problem would result in the following general model:

A separate data preparation step to identify the values for c, a, and b would then be necessary to complete
the model.

Many inexperienced quantitative analysts assume that once the problem has been defined and a general
model developed, the problem is essentially solved. These individuals tend to believe that data preparation
is a trivial step in the process and can be easily handled by clerical staff. Actually, this assumption could
not be further from the truth, especially with large-scale models that have numerous data input values. For
example, a small linear programming model with 50 decision variables and 25 constraints could have more
than 1300 data elements that must be identified in the data preparation step. The time required to prepare
these data and the possibility of data collection errors will make the data preparation step a critical part of
the quantitative analysis process. Often, a fairly large database is needed to support a mathematical model,
and information systems specialists may become involved in the data preparation step.

Model Solution
Once the model development and data preparation steps are completed, we can proceed to the model
solution step. In this step, the analyst will attempt to identify the values of the decision variables that provide
the “best” output for the model. The specific decision-variable value or values providing the “best” output
will be referred to as the optimal solution for the model. For the production problem, the model solution
step involves finding the value of the production quantity decision variable x that maximizes profit while
not causing a violation of the production capacity constraint.
One procedure that might be used in the model solution step involves a trial-and-error approach in which
the model is used to test and evaluate various decision alternatives. In the production model, this procedure
would mean testing and evaluating the model under various production quantities or values of x. Note, in
Figure 1.5, that we could input trial values for x and check the corresponding output for projected profit
and satisfaction of the production capacity constraint. If a particular decision alternative does not satisfy
one or more of the model constraints, the decision alternative is rejected as being infeasible, regardless of
the objective function value. If all constraints are satisfied, the decision alter- native is feasible and a
candidate for the “best” solution or recommended decision. Through this trial-and-error process of
evaluating selected decision alternatives, a decision maker can identify a good—and possibly the best—
feasible solution to the problem. This solution would then be the recommended decision for the problem.
Table 1.2 shows the results of a trial-and-error approach to solving the production model of Figure 1.5. The
recommended decision is a production quantity of 8 because the feasible solution with the highest projected
profit occurs at x = 8.

Although the trial-and-error solution process is often acceptable and can provide valuable information for
the manager, it has the drawbacks of not necessarily providing the best solution and of being inefficient in
terms of requiring numerous calculations if many decision alternatives are tried. Thus, quantitative analysts
have developed special solution procedures for many models that are much more efficient than the trial-
and-error approach. Throughout this text, you will be introduced to solution procedures that are applicable
to the specific mathematical models that will be formulated. Some relatively small models or problems can
be solved by hand computations, but most practical applications require the use of a computer.
Model development and model solution steps are not completely separable. An analyst will want both to
develop an accurate model or representation of the actual problem situation and to be able to find a solution
to the model. If we approach the model development step by attempting to find the most accurate and
realistic mathematical model, we may find the model so large and complex that it is impossible to obtain a
solution. In this case, a simpler and perhaps more easily understood model with a readily available solution
procedure is preferred even if the recommended solution is only a rough approximation of the best decision.
As you learn more about quantitative solution procedures, you will have a better idea of the types of
mathematical models that can be developed and solved.
After a model solution is obtained, both the management scientist and the manager will be interested in
determining how good the solution really is. Even though the analyst has undoubtedly taken many
precautions to develop a realistic model, often the goodness or accuracy of the model cannot be assessed
until model solutions are generated. Model testing and validation are frequently conducted with relatively
small “test” problems that have known or at least expected solutions. If the model generates the expected
solutions, and if other output information appears correct, the go-ahead may be given to use the model on
the full-scale problem. However, if the model test and validation identify potential problems or inaccuracies
inherent in the model, corrective action, such as model modification and/or collection of more accurate
input data, may be taken. Whatever the corrective action, the model solution will not be used in practice
until the model has satisfactorily passed testing and validation.
MODELS OF COST, REVENUE, AND PROFIT
Some of the most basic quantitative models arising in business and economic applications are those
involving the relationship between a volume variable—such as production volume or sales volume—and
cost, revenue, and profit. Through the use of these models, a manager can determine the projected cost,
revenue, and/or profit associated with an established production quantity or a forecasted sales volume.
Financial planning, production planning, sales quotas, and other areas of decision making can benefit from
such cost, revenue, and profit models.

Cost and Volume Models

The cost of manufacturing or producing a product is a function of the volume produced. This cost can
usually be defined as a sum of two costs: fixed cost and variable cost. Fixed cost is the portion of the total
cost that does not depend on the production volume; this cost remains the same no matter how much is
produced. Variable cost, on the other hand, is the portion of the total cost that is dependent on and varies
with the production volume. To illustrate how cost and volume models can be developed, we will
consider a manufacturing problem faced by Nowlin Plastics.
Nowlin Plastics produces a variety of compact disc (CD) storage cases. Nowlin’s best- selling product is
the CD-50, a slim, plastic CD holder with a specially designed lining that protects the optical surface of
the disc. Several products are produced on the same manufacturing line, and a setup cost is incurred each
time a changeover is made for a new product. Suppose that the setup cost for the CD-50 is $3000. This
setup cost is a fixed cost that is incurred regardless of the number of units eventually produced. In
addition, suppose that variable labor and material costs are $2 for each unit produced. The cost-volume
model for producing x units of the CD-50 can be written as

C(x) = 3000 + 2x

where
x = production volume in units
C(x) = total cost of producing x units
Once a production volume is established, the model in equation (1.3) can be used to compute the total
production cost. For example, the decision to produce x = 1200 units would result in a total cost of
C(1200) = 3000 + 2(1200) = $5400.
Marginal cost is defined as the rate of change of the total cost with respect to production volume. That is,
it is the cost increase associated with a one-unit increase in the pro- duction volume. In the cost model of
equation (1.3), we see that the total cost C(x) will increase by $2 for each unit increase in the production
volume. Thus, the marginal cost is $2. With more complex total cost models, marginal cost may depend
on the production volume. In such cases, we could have marginal cost increasing or decreasing with the
production volume x.

Revenue and Volume Models

Management of Nowlin Plastics will also want information on the projected revenue associated with selling
a specified number of units. Thus, a model of the relationship between revenue and volume is also needed.
Suppose that each CD-50 storage unit sells for $5. The model for total revenue can be written as
R(x) = 5x

where
x = sales volume in units
R(x) = total revenue associated with selling x units

Marginal revenue is defined as the rate of change of total revenue with respect to sales volume. That is, it
is the increase in total revenue resulting from a one-unit increase in sales volume. In the model of equation
(1.4), we see that the marginal revenue is $5. In this case, marginal revenue is constant and does not vary
with the sales volume. With more complex models, we may find that marginal revenue increases or
decreases as the sales volume x increases.

Profit and Volume Models

One of the most important criteria for management decision making is profit. Managers need to be able to
know the profit implications of their decisions. If we assume that we will only produce what can be sold,
the production volume and sales volume will be equal. We can combine equations and to develop a profit-
volume model that will determine the total profit associated with a specified production-sales volume. Total
profit, denoted P(x), is total revenue minus total cost; therefore, the following model provides the total
profit associated with producing and selling x units:
P(x) = R(x) - C(x)
= 5x - (3000 + 2x) = -3000 + 3x
Thus, the profit-volume model can be derived from the revenue-volume and cost-volume models.
Breakeven Analysis
Using equation (1.5), we can now determine the total profit associated with any production volume x. For
example, suppose that a demand forecast indicates that 500 units of the prod- uct can be sold. The
decision to produce and sell the 500 units results in a projected profit of
P(500) = -3000 + 3(500) = -1500
In other words, a loss of $1500 is predicted. If sales are expected to be 500 units, the man- ager may
decide against producing the product. However, a demand forecast of 1800 units would show a projected
profit of
P(1800) = -3000 + 3(1800) = 2400

This profit may be enough to justify proceeding with the production and sale of the product.
We see that a volume of 500 units will yield a loss, whereas a volume of 1800 provides a profit. The
volume that results in total revenue equaling total cost (providing $0 profit) is called the breakeven point.
If the breakeven point is known, a manager can quickly infer that a volume above the breakeven point
will result in a profit, whereas a volume below the breakeven point will result in a loss. Thus, the
breakeven point for a product provides valu- able information for a manager who must make a yes/no
decision concerning production of the product.
Let us now return to the Nowlin Plastics example and show how the total profit model in equation (1.5)
can be used to compute the breakeven point. The breakeven point can be found by setting the total profit
expression equal to zero and solving for the production vol- ume. Using equation (1.5), we have
P(x) = -3000 + 3x = 0
3x = 3000
x = 1000
With this information, we know that production and sales of the product must be greater than 1000 units
before a profit can be expected. The graphs of the total cost model, the total revenue model, and the
location of the breakeven point are shown in Figure 1.6.
MANAGEMENT SCIENCE TECHNIQUES

In this section we present a brief overview of the management science techniques covered in this text. Over
the years, practitioners have found numerous applications for the following techniques:
Linear Programming Linear programming is a problem-solving approach developed for situations
involving maximizing or minimizing a linear function subject to linear constraints that limit the degree to
which the objective can be pursued. The production model developed in Section 1.3 (see Figure 1.5) is an
example of a simple linear programming model.
Integer Linear Programming 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 the decision variables be
integer values.
Distribution and Network Models A network is a graphical description of a problem consisting of circles
called nodes that are interconnected by lines called arcs. Specialized solution procedures exist for these
types of problems, enabling us to quickly solve problems in such areas as transportation system design,
information system design, and project scheduling.
Nonlinear Programming Many business processes behave in a nonlinear manner. For example, the price
of a bond is a nonlinear function of interest rates; the quantity demanded for a product is usually a nonlinear
function of the price. Nonlinear programming is a technique that allows for maximizing or minimizing a
nonlinear function subject to nonlinear constraints.
Project Scheduling: PERT/CPM In many situations, managers are responsible for planning, scheduling,
and controlling projects that consist of numerous separate jobs or tasks performed by a variety of
departments, individuals, and so forth. The PERT (Program Evaluation and Review Technique) and CPM
(Critical Path Method) techniques help man- agers carry out their project scheduling responsibilities.
Inventory Models Inventory models are used by managers faced with the dual problems of maintaining
sufficient inventories to meet demand for goods and, at the same time, incurring the lowest possible
inventory holding costs.
Waiting-Line or Queueing Models Waiting-line or queueing models have been developed to help
managers understand and make better decisions concerning the operation of systems involving waiting
lines.
Simulation Simulation is a technique used to model the operation of a system. This technique employs a
computer program to model the operation and perform simulation computations.
Decision Analysis Decision analysis can be used to determine optimal strategies in situations involving
several decision alternatives and an uncertain or risk-filled pattern of events.
Goal Programming Goal programming is a technique for solving multicriteria decision problems, usually
within the framework of linear programming.
Analytic Hierarchy Process This multicriteria decision-making technique permits the inclusion of
subjective factors in arriving at a recommended decision.
Forecasting Forecasting methods are techniques that can be used to predict future aspects of a business
operation.
Markov Process Models 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.
Problem solving The process of identifying a difference between the actual and the desired state of affairs
and then taking action to resolve the difference.
Decision making The process of defining the problem, identifying the alternatives, determining the
criteria, evaluating the alternatives, and choosing an alternative.
Single-criterion decision problem A problem in which the objective is to find the “best” solution with
respect to just one criterion.
Multicriteria decision problem A problem that involves more than one criterion; the objective is to find
the “best” solution, taking into account all the criteria.

Definition of Terms
Decision The alternative selected.
Model A representation of a real object or situation.
Iconic model A physical replica, or representation, of a real object.
Analog model Although physical in form, an analog model does not have a physical appearance similar
to the real object or situation it represents.
Mathematical model Mathematical symbols and expressions used to represent a real situation.
Constraints Restrictions or limitations imposed on a problem.
Objective function A mathematical expression that describes the problem’s objective.
Uncontrollable inputs The environmental factors or inputs that cannot be controlled by the decision
maker.
Controllable inputs The inputs that are controlled or determined by the decision maker.
Decision variable Another term for controllable input.
Deterministic model A model in which all uncontrollable inputs are known and cannot vary.
Stochastic (probabilistic) model A model in which at least one uncontrollable input is uncertain and
subject to variation; stochastic models are also referred to as probabilistic models.
Optimal solution The specific decision-variable value or values that provide the “best” output for the
model.
Infeasible solution A decision alternative or solution that does not satisfy one or more constraints.
Feasible solution A decision alternative or solution that satisfies all constraints.
Fixed cost The portion of the total cost that does not depend on the volume; this cost remains the same no
matter how much is produced.
Variable cost The portion of the total cost that is dependent on and varies with the volume.
Marginal cost The rate of change of the total cost with respect to volume.
Marginal revenue The rate of change of total revenue with respect to volume. Breakeven point The
volume at which total revenue equals total cost.

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