LESSON 1: INTRODUCTION TO MANAGEMENT SCIENCE:

Management Science is the application of a scientific approach to solving management

problems in order to help managers make better decisions. As implied by this definition,
management science encompasses a number of 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.

Management science 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

Management science encompasses a logical, systematic approach to problem solving,

which closely parallels what is known as the scientific method for attacking problems. This
approach follows a generally recognized and ordered series of steps: (1) observation, (2)
definition of the problem, (3) model construction, (4) model solution, and (5) implementation
of solution results.

Observation

The first step in the management science process 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.

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 actually is.

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.

As an example , consider a business firm that sells a product. The product costs P5 to
produce and sells P20. A model that computes the total profit that will accrue from the items
sold is

Z=20 x−5 x

In this equation , x represents the number of units of the product that are sold, and Z
represents the total profit that results from the sale of the product. The symbols x and Z are
variables. The term variable is used because no set numeric value has been specified for these
items. The number of units sold, x, and the profit, Z, can be any amount (within limits); they can
vary. These two variables can be further distinguished. Z is a dependent variable because its
value is dependent on the number of units sold; x is an independent variable because the
number of units sold is not dependent on anything else (in this equation).

The numbers 20 and 5 in the equation are referred to as parameters. Parameters are
constant values that are generally coefficients of the variables(symbols) in an equation.
Parameters usually remain constant during the process of solving a specific problem. The
parameter values are derived from data (i.e., pieces of information) from the problem
environment. Sometimes the data are readily available and quite accurate. For example,
presumably the selling price of P20 and product cost of P5 could be obtained from the firm’s
accounting department and would be very accurate. However, sometimes data are not as
readily available to the manager or firm, and the parameters must be either estimated or based
on a combination of the available data and estimates. In such cases, the model is only as
accurate as the data used in constructing the model.

The equation as a whole is known as a functional relationship (also called function and
relationship). The term is derived from the fact that profit, Z, is a function of the number of
units sold, x , and the equation relates profit to units sold.
 Because only one functional relationship exists in this example, it is also the model. In
this case the relationship is a model of the determination of profit of the firm. However, this
model does not really replicate a problem. Therefore, we will expand our example to create a
problem situation.

Let us assume that the product is made from steel and that the business firm 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:

4 x=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=20 x−5 x

4 x=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=20 x−5 x

subject to:

4 x=100

This model now represents the manager’s problem of determining the number of units to
produce. Thus, when we determine the value of x, it represents a potential 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.

Model Solution

Once models have been constructed, they are solved using the management science
techniques presented. A management science solution technique usually applies to a specific
type of model. Thus, the model type and solution methods are both part of the management
science technique. We are able to say that a model is solved because the model represents a
problem. When we refer to model solution, we also mean problem solution.
 For the example model developed in the previous section, the solution technique is
simple algebra. Solving the constraint equation for x, we have

4 x=100

100
x=
4

x=25 units

Substituting the value of 25 for x into the profit function results in the total profit:

Z=20 x−5 x

¿ 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 P375 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 make a decision.

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. For example, suppose the business firm in our example desires to know the average
number of units sold each month during a year. The monthly data sales for the past years are as
follows:

Month Sales
January 30
February 40
March 25
April 60
May 30
June 25
July 35
August 50
September 60
October 40
November 35
December 50
Total 480 units
 Monthly sales average is 40 units (480÷12). This result is not a decision; it is information
that describes what is happening in the system.

Implementation

The final step in the management science process for problem solving is implementation. It is
the actual use of the model once it has been developed.

Model Building: Break-Even Analysis

In the previous discussion, we gave a brief, general description of how management science
models are formulated and solved, using a simple algebraic example. In this section, we will
continue to explore the process of building and solving management science models, using
break-even analysis also called to profit analysis.

The purpose of break-even analysis is to determine the number of units of a product to sell or
produce that will equate total revenue with total cost. The point where total revenue equals
total cost is called the break-even point, and at this point the profit is zero. The break-even
point gives a manager a point of reference in determining how many units will be needed to
ensure a profit.

Components of Break-Even Analysis

1. Volume

It is the level of sales or production by a company. It can be expressed as

the numbers of units produced and sold, as the volume of sales, or as a percentage of
total capacity available.

2. Cost
Two types of cost are typically incurred in the production of a product:
fixed costs and variable costs. 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 =vc v
Where c v = variable cost per unit and v =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 ¿ cost+total variable cost
or
TC =c f + v c v
where c f =fixed cost.
As an example, consider the clothing company, which produces denim
jeans. The company incurs the following monthly costs to produce denim jeans:
¿ cost=c f =P 10,000
variable cost=c v =P 8 per pair
If we arbitrarily let the monthly sales volume, v, equal 400 pairs of denim jeans, the total
cost is
TC =c f + vc v =P 10,000+ ( 400 )( 8 )=P 13,200
3. Profit
Profit is the difference between total revenue and total cost. Total
revenue is the volume multiplied by the price per unit,
total revenue=vp
Where p= price per unit .
For our clothing company example, if denim jeans sell for P23 per pair
and we sell 400 pairs per month, then the total monthly revenue is
total revenue=vp=( 400 ) ( 23 )=P 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−(c f +vc v )
¿ vp−c f −vc v
Computing the Break-Even point
For our clothing company example, we have determined total revenue and total cost to be
P9,200 and P13,200, respectively. With these values, there is no profit but, instead, a loss of
P4,000:
total profit =total revenue−total cost=P 9,200−P 13,200=−P 4,000
We can verify this result by using our total profit formula,
Z=vp−c f −vc v
And the values v=400 , p=P 23 , c f =P10,000 ,∧c v =P 8 :
Z=vp−c f −vc v
¿ P ( 400 ) ( 23 )−10,000−( 400 ) ( 8 )
 ¿ 9,200−10,000−3,200
¿−P 4,000
Obviously, the clothing company does not want to operate with a monthly loss of P4,000
because doing so might eventually result in bankruptcy. If we assume that price is static
because of market conditions and that fixed costs and variable cost per unit are not subject to
change, then the only part of our model that can be varied is volume. Using the modeling terms
we developed earlier, 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:
Z=vp−c f −vc v
0=v ( 23 )−10,000−v ( 8 )
0=23 v−10,000−8 v
15 v =10,000
v=666.7 pairs of jeans

Graphical Solution
It is possible to represent many of the management science models
graphically and use these graphical models to solve problems. Graphical models also have the
advantage of providing a “picture” of the model that can sometimes help us understand the
modeling process. We can easily graph the break-even model for our Clothing Company
example because the functions for total cost and total revenue are linear.
In the graph of our previous example (see figure 1.1), the fixed cost, c f ,
has a constant value of P10,000, regardless of the volume. The total cost line, TC, represents
the sum of variable cost and fixed cost. The total cost line increases because variable cost
increases as the volume increases. The total revenue line also
Increases as volume increases, but at a faster rate than total cost. The point where these two
lines intersect indicates that total revenue equals total cost. The volume , v, that corresponds to
this point is the break-even volume. The break-even volume is 666.7 pairs of denim jeans.

Figure 1.1. Break-even Model