Paris Graduate School of Management (PGSM)

International Executive Master of Business Administration

Paris Graduate School of Management

École Supérieure de Gestion et Commerce International

INTERNATIONAL EXECUTIVE
MASTER OF BUSINESS ADMINISTRATION

IEMBA

Paris Graduate School of Management

École Supérieure de Gestion et Commerce International

INTERNATIONAL EXECUTIVE
MASTER OF BUSINESS ADMINISTRATION
Management Decision Making
January 2024

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 Paris Graduate School of Management (PGSM)
International Executive Master of Business Administration

 Predictive modeling is the heart and soul of business decisions.

 Building decision models is more of an art than a science.
 Creating good decision models requires:
- solid understanding of business functional areas
- knowledge of business practice and research
- logical skills
 It is best to start simple and enrich models as necessary.

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 Paris Graduate School of Management (PGSM)
International Executive Master of Business Administration

 Simple mathematics
◦ “Back-of-the-envelope” calculations can provide the
basis for a more formal model
 Influence diagrams
◦ Introduced in Chapter 1, an influence diagram is a
logical and visual representation of key model
relationships

 A restaurant customer dines 6 times a year and spends an

average of $50 per visit.
 The restaurant realizes a 40% margin on the average bill for
food and drinks.
 Annual gross profit on a customer = $50(6)(0.40) = $120
 30% of customers do not return each year.
 Average lifetime of a customer = 1/0.3 = 3.33 years
 Average gross profit during a customer’s lifetime = $120(3.33)
= $400

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 Paris Graduate School of Management (PGSM)
International Executive Master of Business Administration

 V = value of a loyal customer

 R = revenue per purchase
 F = purchase frequency (number of visits per year)
 M = gross profit margin (expressed as a fraction)
 D = defection rate (fraction of customers not
returning each year)

 Cost = fixed cost + variable cost P = profit p = unit price

C = F + cQ R = revenue c = unit cost
C = cost F = fixed cost
 Revenue = price times quantity sold S = quantity sold
R = pS D = demand
 Quantity sold = Minimum{demand, quantity sold} Q = quantity
produced
S = min{D, Q}
 Profit = Revenue − Cost
P = p*min{D, Q} − (F + cQ) (11.2)

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 Paris Graduate School of Management (PGSM)
International Executive Master of Business Administration

 Principles of good spreadsheet design:

◦ Separate the data, model calculations, and model outputs
clearly in designing a spreadsheet.
◦ Do not use input data in model formulas, but reference the
spreadsheet cells that contain the data. In this way, if the data
change or you want to experiment with the model, you need
not change any of the formulas, which can easily result in
errors.

 (Example 1.8 in Chapter 1)

 The scenario involves a manufacturer who can produce a
part for $125/unit with a fixed cost of $50,000. The
alternative is to outsource production to a supplier at a unit
cost of $175.
 Models for total cost:

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 Paris Graduate School of Management (PGSM)
International Executive Master of Business Administration

 Excel spreadsheet

 A firm wishes to determine the best pricing for one of

its products to maximize revenue.
◦ Sales = -2.9485 × price + 3,240.9
◦ Total revenue = price × sales
= price × (-2.9485 × price + 3,240.9)
= -2.9485 × price2 + 3,240.9 × price

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 Paris Graduate School of Management (PGSM)
International Executive Master of Business Administration

 Assume that unit price = $40, unit cost = $24, fixed cost = $400,000,
and demand = 50,000.
 The decision variable is the quantity produced; assume a value of
40,000 units.

 Building spreadsheet models (called spreadsheet

engineering) is part art and part science.
 Spreadsheets need to be
◦ accurate,
◦ understandable, and
◦ user friendly.
 Verification is the process of ensuring that a model is
accurate and free from logical errors.

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 Paris Graduate School of Management (PGSM)
International Executive Master of Business Administration

 Improve the design and format of the spreadsheet itself.

◦ Sketch a logical design of the spreadsheet.
◦ Break complex formulas into smaller pieces
◦ Design the spreadsheet in a form that the end user can easily
interpret and understand
 Improve the process used to develop a spreadsheet.
◦ Work on one part at a time
◦ Check formula results with simple numbers
 Inspect your results carefully and use appropriate tools
available in Excel.
◦ Use Excel auditing tools

 Gross profit = sales – cost of goods sold

 Operating expenses = administrative expenses
+ selling expenses
+ depreciation expenses
 Net operating income = gross profit
– operating expenses
 Earnings before taxes = net operating income
– interest expense
 Net income = earnings before taxes – taxes

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 Paris Graduate School of Management (PGSM)
International Executive Master of Business Administration

 Simple model:
◦ net income = sales - cost of goods sold - administrative expenses
- selling expenses – depreciation expenses - interest expense -
taxes

 Data-model format

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 Paris Graduate School of Management (PGSM)
International Executive Master of Business Administration

 Pro forma income statement

 A wide variety of practical problems in business

analytics can be modeled using spreadsheets.
 A useful spreadsheet model need not be complex;
often, simple models can provide managers with the
information they need to make good decisions.

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 Paris Graduate School of Management (PGSM)
International Executive Master of Business Administration

 The manager of a loan processing department

wants to know how many employees will be
needed over the next several months to process
a certain number of loan files per month so she
can better plan capacity.
 Different types of products, such as a 30-year
fixed rate mortgage, 7/1 ARM, FHA loan, or a
construction loan, each varying in complexity
and time to complete.
 Data:
◦ Forecasts: 700 loan applications in May, 750 in June,
800 in July, and 825 in August.
Predict the number of full time equivalent
◦ Each employee works productively for 6.5 hours each
(FTE) staff needed each month to ensure that
day, and there are 22 working days in May, 20 in June,
all loans can be processed.
22 in July, and 22 in August.

 Spreadsheet Model

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 Paris Graduate School of Management (PGSM)
International Executive Master of Business Administration

 Many practical models incorporate multiple time

periods that are logically linked together.
 Taking a systematic approach to putting the pieces
together logically can often make a seemingly
difficult problem much easier.

 Moore Pharmaceuticals needs to decide whether to conduct

clinical trials and seek FDA approval for a newly developed drug.
 R&D cost = $700 million
 Clinical trials cost = $150 million
 Market size = 2 million people
 Market size growth = 3% per year
 Market share = 8%
 Market share growth = 20% per year
 Monthly revenue/prescription = $130
 Monthly variable cost/prescription = $40
 Discount rate = 9%

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 Paris Graduate School of Management (PGSM)
International Executive Master of Business Administration

 Spreadsheet Model

 Spreadsheet Formulas

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 Paris Graduate School of Management (PGSM)
International Executive Master of Business Administration

 One-time purchase decisions often must be made in the face

of uncertain demand.
 Newsvendor Problem: How many newspapers to purchase
each day?
 C = cost to purchase a newspaper
 Q = number of newspapers the vendor purchases
 D = number of newspapers demanded
 R = revenue from selling a newspaper
 S = salvage value of unsold newspapers
Net profit = R × quantity sold + S × surplus quantity – C ×Q
= R(min{Q,D}) + S(max{0,Q−D}) − CQ

 A small candy store makes Valentine’s Day gift boxes that

cost $12 and sell for $18.
 In the past, at least 40 boxes have sold by Valentine’s Day but
the actual amount is unknown.
 After the holiday, boxes are discounted 50%.
 C = $12, R = $18, S = $9
 Net profit = R(min{Q,D}) + S(max{0,Q−D}) − CQ
=18(min{Q,D}) + 9(max{0,Q−D}) − 12Q
◦ Note that D is actually uncertain and can be modeled using a
probability distribution.

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 Paris Graduate School of Management (PGSM)
International Executive Master of Business Administration

 Spreadsheet model

 Find the number of reservations to accept to effectively

fill capacity knowing that some customers may not use
their reservations.
 A common practice in these industries is to overbook
reservations.
◦ When more customers arrive than can be handled, the business
usually incurs some cost to satisfy them.
◦ Therefore, the decision becomes how much to overbook to
balance the costs of overbooking against the lost revenue for
underuse.

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 Paris Graduate School of Management (PGSM)
International Executive Master of Business Administration

 A popular resort hotel has 300 rooms.

 The room rate is $120 per night.
 Reservations can be cancelled by 6:00 p.m.
 Cost of overbooking is $100 per occurrence.
 Decision variable = number of reservations to accept.
 Customer demand and cancellations are actually random variables.

 Models cannot capture every detail of the real

problem, and managers must understand the
limitations of models and their underlying
assumptions.
 Validity refers to how well a model represents reality.
 Judging validity:
◦ Identify and examine the assumptions made in a model to see
how they agree with our perception of the real world
◦ Compare model results to observed results

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 Paris Graduate School of Management (PGSM)
International Executive Master of Business Administration

 Start work at age 22, earning $50,000 per year.

 Expect a salary increase of 3% per year.
 Required to contribute 8% to retirement.
 Employer contributes 35% of that amount.
 Expect an annual return of 8% on the portfolio.

 Validity issues:
◦ Whether the assumptions of the annual salary increase
and return on investment are reasonable
◦ Whether they should be assumed to be the same each
year
◦ How the model calculates the return on investment –
Current year balance only? End-of-year balance plus
current-year contributions? Monthly?

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 Paris Graduate School of Management (PGSM)
International Executive Master of Business Administration

 Sources of data
◦ Subjective judgment
◦ Existing databases
◦ Analysis of historical data
◦ Surveys, experiments, or other methods of data
collection

 Many predictive models in business analytics

use empirical data in conjunction with logical
model development.
◦ In other words, we observe some phenomenon and
then try to develop a model that best reflects the data
that we observe.

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 Paris Graduate School of Management (PGSM)
International Executive Master of Business Administration

 In the spring, a department store introduces a new line of bathing

suits that sell for $70.
 The store purchases 1000 of these bathing suits.
 During the prime selling season (50 days), the store sells an average
of 7 units per day at full price.
 Around July 4th, the price is marked down 70% to sell off remaining
inventory.
 During a special sale, the price was reduced to $49 and sales
increased to 32.2 units per day.
 If the stored decides to sell at full retail price for x days and then
discounts the price by y% for the remainder of the selling season,
followed by the clearance sale, what total revenue could they
predict?

 Modeling daily sales as a function of price

◦ Assume a linear trend model between sales and
price:
daily sales = a – b × price
7 = a – b × 70
32.2 = a – b × 49

Daily sales = 91 – 1.2 × price

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 Paris Graduate School of Management (PGSM)
International Executive Master of Business Administration

 Modeling total revenue

1. Sell at full retail price for x days:
◦ Full retail price revenue = 7 units/day × x days ×$70.00 = $490.00x
2. Markdown revenue = units sold x markdown price
◦ Markdown price = $70(100% - y%)
◦ Daily sales = a - b x markdown price = 91 - 1.2 x $70 x (100% - y%)
◦ Units sold at markdown = daily sales x (50 - x), as long as this is less than or
equal to the number of units remaining in inventory from full retail sales.
3. Clearance revenue
◦ Clearance inventory = 1000 - units sold at full retail - units sold at markdown =
1,000 - 7x - [91 - 1.2 × $70.00 × (100% - y%)] × (50 - x)
◦ Clearance price revenue = [1,000 - 7x - [91 - 1.2 × $70.00 × (100% -
y%)] × (50 – x)] × $21.00
 Total revenue = sum of full retail, markdown, and clearance
revenues

 Spreadsheet model

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 Paris Graduate School of Management (PGSM)
International Executive Master of Business Administration

 Useful Excel tools

◦ Data validation
◦ Range Names
◦ Form Controls

 Outsourcing Decision Model

◦ Suppose that we know that the unit cost of any item is at least $10 but no
more than $100. If a cost is $47.50, for instance, a misplaced decimal
would result in either $4.75 or $475, which would clearly be out of range.
 Data > Data Tools > Data Validation
Error alert message

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 Paris Graduate School of Management (PGSM)
International Executive Master of Business Administration

 Suppose that the unit price is stored in cell B13

and quantity sold is in cell B14.
 Suppose you wish to calculate revenue in cell
C15.
◦ Instead of writing the formula =B13*B14, you could
define the name of cell B13 as “UnitPrice” and the
name of cell B14 as “QuantitySold.”
◦ Then in cell C15, write the formula
=UnitPrice*QuantitySold.

 Form controls are buttons, boxes, and other mechanisms for

inputting or changing data on spreadsheets easily that can be
used to design user-friendly spreadsheets.

 Activate the Developer tab on the Excel ribbon: File > Options >
Customize Ribbon and check the box for Developer.

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 Paris Graduate School of Management (PGSM)
International Executive Master of Business Administration

 Button
 Combo box
 Check box
 Spin button
 List box
 Option button
 Group box
 Label
 Scroll bar

 Spin button for the supplier unit cost (which we will assume might
vary between $150 and $200 in increments of $5)
 Scroll bar for the production volume (in unit increments between
500 and 3000 units)
 Developer > Controls > Insert; then click in the spreadsheet. Right
click and set Format Control options.

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 Paris Graduate School of Management (PGSM)
International Executive Master of Business Administration

 Predictive analytical models are based on

assumptions about the future and incorporate
variables that most likely will not be known
with certainty.
 It is usually important to investigate how these
assumptions and uncertainty affect the model
outputs.

 Spreadsheet models allow you to easily evaluate

what-if questions by changing input values and
recalculating model outputs.
 Systematic approaches to what-if analysis that
are available in Excel make the process easier
and more useful.
◦ Data tables
◦ Scenario Manager
◦ Goal Seek

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 Paris Graduate School of Management (PGSM)
International Executive Master of Business Administration

 Uncertain demand in the Profit Model.

 Excel table using formulas:

Visualization
of profit:

 Data Tables summarize the impact of one or

two inputs on a specified output.
◦ A one-way data table evaluates an output variable
over a range of values for a single input variable.
◦ Two-way data tables evaluate an output variable
over a range of values for two different input
variables.

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 Paris Graduate School of Management (PGSM)
International Executive Master of Business Administration

 Create a range of values for some input cell in your model that you
wish to vary.
 Enter the cell reference for the output variable in your model that
you wish to evaluate in the row above the first value and one cell to
the right of the column of input values.
 Select the range of cells that contains both the formulas and values
you want to substitute.
 Data > What-If Analysis > Data Table
 Type the cell reference for the input cell in your model in the
Column input cell box.

1 2
1. Create a column of demand
values (column E). 3
2. Enter =C22 in cell F3 (to
reference the output cell).
3. Highlight the range E3:F11.
4. Data > What-If Analysis > Data
Table
5. Enter B8 for Column input cell in
the Data Table dialog (tells Excel
that column E refers to demand)

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 Paris Graduate School of Management (PGSM)
International Executive Master of Business Administration

 Create a second output column

for revenue.
 Enter =C15 in cell G3.
 Highlight E3:G11.
 Data > What-If Analysis > Data
Table
 Enter B8 for Column input cell in
the Data Table dialog

 Type a list of values for one input variable in a column and a list of input
values for the second input variable in a row, starting one row above and
one column to the right of the column list.
 In the cell in the upper left-hand corner immediately above the column
list and to the left of the row list, enter the cell reference of the output
variable you wish to evaluate.
 Select the range of cells that contain this cell reference and both the row
and column of values.
 In the Row input cell of the dialog box, enter the reference for the input
cell in the model that corresponds to the input values in the row.
 In the Column input cell box, enter the reference for the input cell in the
model that corresponds to the input values in the column.

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 Paris Graduate School of Management (PGSM)
International Executive Master of Business Administration

 Evaluate the impact of both

unit price and unit cost
 Create a column of unit prices.
 Create a row of unit costs.
 Enter =C22 in upper left
corner.
 Select range of data
(not including headings).
 In Data Table dialog
◦ Enter B6 for Row input cell.
◦ Enter B5 for Column input cell.

 Allows creation of scenarios – sets of

values that are saved and can be
substituted in worksheets.
 Data > What-If Analysis > Scenario Manager
 Click Add button to open Add Scenario
dialog
 Enter a Scenario Name
 In Changing Cells box, enter cell references
to include in scenario.
 In the Scenario Values dialog enter values
for each of the changing cells.
 Click Show button to display the results

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 Paris Graduate School of Management (PGSM)
International Executive Master of Business Administration

 Evaluate 4 strategies for pricing and discounts on the

bathing suits in the Markdown Pricing Model.

 If you know the result that you want from a formula but are
not sure what input value the formula needs to get that
result, use the Goal Seek feature in Excel.
 Data > What-If Analysis > Goal Seek
 Set cell contains the cell reference for the formula you want
to resolve
 To value is the target value you want the formula to return.
 By changing cell is the reference of the input value that you
want to change to achieve the set cell value.

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 Paris Graduate School of Management (PGSM)
International Executive Master of Business Administration

 Find the value of demand

for which manufacturing
cost equals purchased
cost
◦ Set cell: B19
◦ To value: 0
◦ By changing cell: B12.

Break-even volume

 Parametric sensitivity analysis is the term used

by Analytic Solver Platform for systematic
methods of what-if analysis.
◦ A parameter is simply a piece of input data in a model.
 You can create data tables and tornado charts.

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 Paris Graduate School of Management (PGSM)
International Executive Master of Business Administration

 Create a one-way data table to evaluate the

profit as the unit price in cell B5 is varied
between $35 and $45 in the profit model.
 Define cell B5 as a parameter by selecting
B5, click Parameters and select Sensitivity.

 In the Function Arguments dialog, specify

the range of values.

 Click the Reports button and click on Parameter Analysis from the
Sensitivity menu. This displays a Sensitivity Report dialog; use the
arrows to move cells into the panes on the right.
One-way data table result

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 Paris Graduate School of Management (PGSM)
International Executive Master of Business Administration

 To create a two-way data table, define both inputs as parameters and in

the Sensitivity Report dialog, be sure to check the box Vary Parameters
Independently near the bottom.
 To create charts to visualize the data tables, click the Charts button, and
then click Parameter Analysis from the Sensitivity menu.
◦ Replace the cell references ($B$5, $B$6, and $C$22) by descriptive names to
facilitate understanding the results.

 A tornado chart shows the impact that variation in a

model input has on some output while holding all
other inputs constant.
◦ Shows which inputs are the least and most influential on the
output.
◦ Helps you select the inputs that you would want to further
analyze.
 Analytic Solver Platform automatically identifies all the
data input cells on which the output cell depends and
creates the chart.

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 Paris Graduate School of Management (PGSM)
International Executive Master of Business Administration

 In the Profit Model spreadsheet, select cell C22; then click

the Parameters button and choose Identify.

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