PRESENTATION OF CONTENTS

Definitions of Management Science

 It is the application of a scientific approach to solving management problems to help managers make
better decisions.
 As implied by this definition, management science encompasses several mathematically
oriented techniques that have either been developed within the field of management science or
been adapted from other disciplines, such as the natural sciences, mathematics, statistics, and
engineering.
 It is a recognized and established discipline in business.
 The applications of management science techniques are widespread, and they have been
frequently credited with increasing the efficiency and productivity of business firms. In various
surveys of businesses, many indicate that they use management science techniques, and most rate
the results to be very good.
 Management science (also referred to as operations research, quantitative methods, quantitative
analysis, and decision sciences) is part of the fundamental curriculum of most programs in business.

The Management Science Approach to Problem Solving

 The steps of scientific method are:

1. OBSERVATION
 It is the identification of a problem that exists in the
system (organization).
 The system must be continuously and closely
observed so that problems can be identified as soon as
they occur or are anticipated.
 Problems are not always the result of a crisis that must
be reacted to but, instead, frequently involve an
anticipatory or planning situation. The person who
normally identifies a problem is the manager because
managers work in places where problems might occur.
 However, problems can often be identified by a
management scientist, a person skilled in the
techniques of management science and trained to
identify problems, who has been hired specifically to
solve problems using management science techniques.

2. DEFINITION OF THE PROBLEM

 Once it has been determined that a problem exists, the problem must be clearly and concisely
defined.
 Improperly defining a problem can easily result in no solution or an inappropriate solution.
Therefore, the limits of the problem and the degree to which it pervades other units of the
organization must be included in the problem definition.
 Because the existence of a problem implies that the objectives of the firm are not being met
in some way, the goals (or objectives) of the organization must also be clearly defined. A
stated objective helps to focus attention on what the problem is.
 3. MODEL CONSTRUCTION
 A management science model is an abstract representation of an existing problem
situation. It can be in the form of a graph or chart, but most frequently a management
science model consists of a set of mathematical relationships.
 These mathematical relationships are made up of numbers and symbols.
 Illustrative Examples:
1. Consider a business firm that sells a product. The product costs $5 to produce and sells
for $20. A model that computes the total profit that will accrue from the items sold is
Z=$20-5x
A variable is a symbol In this equation, the variable
used to represent an • x represents number of units of the product that are sold; an
item that can take on independent variable because the number of units sold is not
any value. dependent on anything else.
Parameters are
• Z represents the total profit that results from the sale of the
constant values that are product ; a dependent variable because its value is dependent
generally coefficients of on the number of units sold.
the variables.
The numbers $20 and $5 in the equation are referred to as parameters. The
Data are pieces of
information from the parameter values are derived from data from the problem environment.
problem environment. The equation is known as a functional relationship (also called function and
A model is a
relationship). The term is derived from the fact that profit, Z, is a function of
functional relationship the number of units sold, x, and the equation relates profit to units sold.
that includes variables, Because only one functional relationship exists in this example, it is also
parameters &equations.
the model. In this case the relationship is a model of the determination of
profit for the firm. However, this model does not really replicate a problem.

2. Let us assume that the product is made from steel & that the business has 100 pounds of steel
available. If it takes 4 pounds of steel to make each unit of the product, we can develop an
additional mathematical relationship to represent steel usage:
4x = 100 lb. of steel
This equation indicates that for every unit produced, 4 of the available 100 pounds of steel
will be used. Now our model consists of two relationships:
Z = $20x - 5x
4x = 100
We say that the profit equation in this new model is an objective function, and the resource
equation is a constraint. In other words, the objective of the firm is to achieve as much
profit, Z, as possible, but the firm is constrained from achieving an infinite profit by the
limited amount of steel available. To signify this distinction between the two relationships in
this model, we will add the following notations:
maximize Z = $20x - 5x
subject to
4x = 100
This model now represents the manager’s problem of determining the number of units to
produce. You will recall that we defined the number of units to be produced as x. Thus, when
we determine the value of x, it represents a potential (or recommended) decision for the
manager. Therefore, x is also known as a decision variable. The next step in the management
science process is to solve the model to determine the value of the decision variable.
4. MODEL SOLUTION
 A management science solution technique usually applies to a specific type of model.
Thus, the model type and solution method are both part of the management science
technique. We can say that a model is solved because the model represents a
problem. When we refer to model solution, we also mean problem solution.
 Illustrative Examples:
1. For the example model developed in the previous section,
maximize Z = $20x - 5x
subject to: 4x=100
The solution technique is simple algebra. Solving the constraint equation for x,
4x = 100
x = 100/4
x = 25 units
Substituting the value of 25 for x into the profit function results in the total profit:
Z = $20x - 5x
= 20(25) - 5(25)
= $375
Thus, if the manager decides to produce 25 units of the product and all 25 units sell,
the business firm will receive $375 in profit. Note, however, that the value of the
decision variable does not constitute an actual decision; rather, it is information that
serves as a recommendation or guideline, helping the manager decides.
Some management science techniques do not generate an answer or a recommended
decision. Instead, they provide descriptive results: results that describe the system
being modeled.
2. Suppose the business firm in our example desires to know the average number of
units sold each month during a year. The monthly data (i.e., sales) for the past year
are as follows:

Month Sales Month Sales

January 30 July 35
February 40 August 50
March 25 September 60
April 60 October 40
May 30 November 35
June 25 December 50
Total 480
units

Monthly sales average 40 units (480/12). This result is not a decision; it is

information that describes what is happening in the system.
 5. IMPLEMENTATION
 It is the actual use of the model once it has been developed or the solution to the
problem the model was developed to solve.
 This is a critical but often overlooked step in the process.
 It is not always a given that once a model is developed or a solution found, it is
automatically used.
 Frequently the person responsible for putting the model or solution to use is not the
same person who developed the model, and thus, the user may not fully understand
how the model works or exactly what it is supposed to do.
 If the management science model and solution are not implemented, then the effort
and resources used in their development have been wasted.

Model Building: Break-Even Analysis

 Concepts of Break-Even Analysis
 It is also called profit analysis.
 It is a modeling technique to determine the number of units to sell or produce that will
result in zero profit.
 It is the point where the total revenue equals total cost and at this point profit is zero.
 It gives a manager a point of reference in determining how many units will be needed
to ensure a profit.

 Components of Break-even Analysis

 The three components of break-even analysis are volume, cost, and profit.
- Volume is the level of sales or production by a company. It can be expressed as the
number of units produced and sold, as the dollar volume of sales, or as a percentage
- Cost incurred by a business to produce a specific quantity of a product or offer a
service.
 Fixed costs are generally independent of the volume of units produced and
sold. That is, fixed costs remain constant, regardless of how many units of
product are produced within a given range. Fixed costs can include such items
as rent on plant and equipment, taxes, staff and management salaries,
insurance, advertising, depreciation, heat and light, and plant maintenance.
Taken together, these items result in total fixed costs.
 Variable costs are determined on a per-unit basis. Thus, total variable costs
depend on the number of units produced. Variable costs include such items as
raw materials and resources, direct labor, packaging, material handling, and
freight. Total variable costs are a function of the volume and the variable cost
per unit. This relationship can be expressed mathematically as
total variable cost = variable cost/ unit x volume (number of units) sold

 The total cost of an operation is computed by summing total fixed cost and total
variable cost, as follows:
total cost = total fixed cost + total variable cost
- Profit is the difference between total revenue and total cost.
Total revenue is the volume multiplied by the price per unit,
Profit = Total Revenue- Total Cost
 Illustrative Example:
Western Clothing Company produces denim jeans. The company incurs the following
monthly costs too produce denim jeans:
fixed cost= = $10,000
variable cost= vcv = $8 per pair

If we arbitrarily let the monthly sales volume, v, equal 400 pairs of denim jeans,
the total cost is = $10,000 + (400) (8) = $13,200

If denim jeans sell for $23 per pair and we sell 400 pairs per month,
then the total monthly revenue is Total revenue = vp = (400) (23) =
$9,200

Now that we have developed relationships for total revenue and total cost, profit (Z) can be
computed as follows:
total profit = total revenue - total cost
Z = vp – (fc + vcv)

total profit = total revenue - total cost

= $9,200 - $13,200
= - $4,000 (The clothing company incurred a loss of $4,000.

 Computing the Break-even Point

 If the clothing company does not want to operate with a monthly loss of $4,000 because
doing so might eventually result in bankruptcy. If we assume that price is static because of
market conditions and that fixed costs and the variable cost per unit is not subject to change,
then the only part of our model that can be varied is volume.
 Using the modeling terms developed, price, fixed costs, and variable costs are parameters,
whereas the volume, v, is a decision variable. In break-even analysis we want to compute the
value of v that will result in zero profit.
 At the break-even point, where total revenue equals total cost, the profit, Z, equals zero.
Thus, if we let profit, Z, equal zero in our total profit equation and solve for v, we can
determine the break-even volume:

 In other words, if the company produces and sells 666.7 pairs of jeans, the profit (and
loss) will be zero and the company will break even. This gives the company a point of
reference from which to determine how many pairs of jeans it needs to produce and sell
to gain a profit (subject to any capacity limitations).
  For example, a sales volume of 800 pairs of denim jeans will result in the following
monthly profit:

Graphical Solution
 Graphical models have the advantage of providing a “picture” of the model that can sometimes
help us understand the modeling process better than mathematics alone can.
 We can easily graph the break-even model for Western Clothing Company example because
the functions for total cost and total revenue are linear.
 That means we can graph each relationship as a straight line on a set of coordinates, as
shown in the succeeding figures.

Fig. 2.1 Break-even model

Sensitivity Analysis
 We have now developed a general relationship for determining the break-even volume,
which was the objective of our modeling process. This relationship enables us to see how the
level of profit (and loss) is directly affected by changes in volume. However, when we
developed this model, we assumed that our parameters, fixed and variable costs and price,
were constant. Such parameters are frequently uncertain and can rarely be assumed to be
constant, and changes in any of the parameters can affect the model solution.
 The study of changes on a management science model is called sensitivity analysis—that is,
seeing how sensitive the model is to changes.
 Sensitivity analysis can be performed on all management science models in one form or
another. In fact, companies develop models for the primary purpose of experimentation to
see how the model will react to different changes the company is contemplating or that
management might expect to occur in the future. As a demonstration of how sensitivity
analysis works, we will look at the effects of some changes on break-even model.

 The first thing we will analyze is price. As an example, we will increase the price for denim
jeans from $23 to $30. As expected, this increases the total revenue, and it therefore reduces
the break-even point from 666.7 pairs of jeans to 454.5 pairs of jeans:

Fig 2.2 The effect of price change on break-even volume

 Although a decision to increase price looks inviting from a strictly analytical point of view,
it must be remembered that the lower break-even volume and higher profit are possible but
not guaranteed. A higher price can make it more difficult to sell the product. Thus, a
change in price often must be accompanied by corresponding increases in costs, such as
those for advertising, packaging, and possibly production (to enhance quality). However,
even such direct changes as these may have little effect on product demand because price is
often sensitive to numerous factors, such as the type of market, monopolistic elements, and
product differentiation.

 When we increased price, we mentioned the possibility of raising the quality of the product
to offset a potential loss of sales due to the price increase. For example, suppose the
stitching on the denim jeans is changed to make the jeans more attractive and stronger.
This change results in an increase in variable costs of $4 per pair of jeans, thus raising the
variable cost per unit, to $12 per pair.
  This change (in conjunction with our previous price change to $30) results in a new break-
even volume:

Fig. 2.3 This new break-even volume and the change in the total cost line that occurs
because of the variable cost change.
In general, an increase in
variable costs will increase
the break-even point, all
other things held constant.
Next let us consider an increase in advertising expenditures to offset the
potential loss in sales resulting from a price increase. An increase in advertising
expenditures is an addition to fixed costs. For example, if the clothing company
increases its monthly advertising budget by $3,000, then the total fixed cost
becomes $13,000. Using this fixed cost, as well as the increased variable cost per
unit of $12 and the increased price of $30, we compute the break-even volume as
follows:

In general, an increase in
fixed costs will increase the
break-even point, all other
things held constant.

Fig. 2.4 Break-even model with a change in fixed cost

Management Science Modeling Techniques

A. Linear Mathematical Programming Techniques

 Linear programming models help managers determine solutions (i.e., make
decisions) for problems that will achieve some objective in which there are
restrictions, such as limited resources or a recipe or perhaps production guidelines.

B. Probabilistic Techniques
 These techniques are distinguished from mathematical programming techniques in
that the results are probabilistic.
 Mathematical programming techniques assume that all parameters in the models are
known with certainty. Therefore, the solution results are assumed to be known with
certainty, with no probability that other solutions might exist.
 A technique that assumes certainty in its solution is referred to as deterministic.
 In contrast, the results from a probabilistic technique do contain uncertainty, with
some possibility that alternative solutions might exist.
 In the model solution presented earlier in this chapter, the result of the first example
(units to produce) is deterministic, whereas the result of the second example
(estimating an average of 40 units sold each month) is probabilistic.

C. Network Techniques
 Consisting of models that are represented as diagrams rather than as strictly
mathematical relationships. As such, these models offer a pictorial representation of
the system under analysis. These models represent either probabilistic or
deterministic systems.

D. Other Techniques
• Analytical Hierarchy Process
• Nonlinear programming
• Simulation
• Forecasting
• Inventory Management
Business Usage of Management Science Techniques
 Some techniques are used quite frequently by business practitioners and managers; others
are used less often. The most frequently used techniques are linear and integer programming,
simulation, network analysis (including critical path method/project evaluation and review
technique [CPM/PERT]), inventory control, decision analysis, and queuing theory, as well as
probability and statistics.
 The variety and breadth of management science applications and of the potential for
applying management science, not only in business and industry but also in government,
health care, and service organizations, are extensive.
 Areas of application include project planning, capital budgeting, production planning,
inventory analysis, scheduling, marketing planning, quality control, plant location,
maintenance policy, personnel management, and product demand forecasting, among others.
 A small portion of the thousands of applications of management science that occur each year
are recorded in various academic and professional journals. Frequently, these journal articles
are as complex as the applications themselves and are very difficult to read.
- However, one journal, Interfaces, is devoted specifically to the application of
management science and is written not just for college professors but for
businesspeople, practitioners, and students as well.
- Interfaces is published by INFORMS (Institute for Operations Research and Management
Sciences), an international professional organization whose members include college
professors, businesspeople, scientists, students, and a variety of professional people
interested in the practice and application of management science and operations
research.
- Interfaces regularly publishes articles that report on the application of management
science to a wide variety of problem.