Business Models

and Application

Chapter 1. Introduction
 Chapter 1. Introduction
1. Define the term management science.

2. Describe the nature of management science.

3. Explain what a mathematical model is.

4. Use a mathematical model to perform break-even analysis.

5. Use a spreadsheet model to perform break-even analysis.

6. The relationship between analytics and management science

7. Summary
1.1. Define the term management science
Management Science: management and science approach
Break-even point: The production and sales volume for a
product that must be exceeded to achieve a profit
Analytics: A discipline closely related to management
science that makes extensive use of data to analyze trends,
make forecasts, and apply optimization techniques
Constraint An inequality or equation in a mathematical model
that expresses some restrictions on the values that can be
assigned to the decision variables
1.1. Define the term management science

Total Total
cost cost

Variable Variable
Fixed cost Fixed cost
cost cost

Unit Production
variable cost volume

Variable cost: a cost that varies with the production

volume is called a variable cost.
Fixed cost: A cost that remains the same regardless of
the production volume is referred to as a fixed cost
1.1. Define the term management science
Decision support system: An interactive computer based
system that aids managerial decision making
Decision variable: An algebraic variable that represents a
quantifiable decision to be made
Mathematical model: An approximate representation of
Ex: a business problem that is expressed in terms of
mathematical symbols and expressions
Operations research: The traditional name for management
science that still is widely used outside of business schools
1.2 The nature of management science
Management Science Is a Discipline
Management science is a whole body of knowledge and techniques that
are based on a scientific foundation
Management Science Aids Managerial Decision Making
Management scientists don’t make managerial decisions. Managers do
Provides an analysis and recommendations, based on the quantitative
factors involved in the problem, as input to the cognizant managers
Managers must also take into account various intangible considerations
that are outside the realm of management science and then use their
best judgment to make the decision
1.2 The nature of management science
Management Science Uses a Scientific Approach
Based strongly on some scientific fields, including
mathematics, statistics, and computer science
Draws on the social sciences, especially economics
A management scientist should have solid training in business
administration
Use the scientific method in conducting its study
Includes careful data gathering, developing and testing
hypotheses about the problem
1.2 The nature of management science
Management Science Uses a Scientific Approach
Conduct this systematic investigation:

Step 2: Formulate a Step 3: Develop a

computer-based
Step 1: Define the model (typically a
procedure for deriving
problem and gather mathematical model)
solutions to the
data to represent the problem from the
problem model

Step 6: Help to Step 5: Apply the

implement the team’s model to analyze the Step 4: Test the
recommendations problem and develop model and refine it as
that are adopted by recommendations for needed
management management
1.3 Mathematical model
Mathematical models are approximate representations, but they
are expressed in terms of mathematical symbols and expressions
Ex: laws of physics as F = ma and E = mc2

==>The mathematical model of a business problem is the

system of equations and related mathematical expressions
that describes the essence of the problem

The modeling process is typically an evolutionary process that begins

with a simple “verbal model” to define the essence of the problem
and then gradually evolves into increasingly more complete
mathematical models
1.4 Break-even analysis
▪ The Special Products Company produces expensive and unusual gifts
▪ The last new-product proposal is an iWatch with wireless internet

Data:
- If they go ahead with this product, a fixed cost of 10
million is incurred
- The variable cost is $ 1.000 per iWatch produced
- Each iWatch sold would generate $ 2.000 in revenue
- Each sales forecast will be obtained

Should they produce the iWatch, and if so, how many?

1.4 Break-even analysis
▪ Expressing the problem mathematically
Decision variable
• Q = Number of iWatch to produce
Cost
• Fixed cost = $ 10 million
• Variable cost = $ 1.000 x Q
==>Total cost = Fixed cost + Variable cost
= $ 10 million + $ 1.000Q
Revenue
• Total revenue= $ 2.000 x Q = $ 2.000Q
Should they produce the iWatch, and if so, how many?
1.4 Break-even analysis
Profit
• Profit = total revenue – total cost
= $ 2.000Q – $ 1.000Q – $ 10 million
= $ 1.000Q – $ 10 million
Spreadsheet Modeling of the Problem
1.4 Break-even analysis

Spreadsheet Modeling of the Problem

1.4 Break-even analysis
Analysis of the Problem
Profit = −$10 million + $1,000Q = 0 (break-even point)
==>Q = $10 million / $1,000Q = 10.000
1.4 Break-even analysis

Incorporating the Break-Even Point into the Spreadsheet Model

A key finding of the above mathematical model is its formula for the
break-even point

Once both the quantities in this formula and the sales forecast have
been carefully estimated, the solution for the mathematical model
specifies what the production quantity should be
1.5 Use a spreadsheet model to perform break-even analysis
1.6 The relationship between analytics and management science

Any application of analytics draws on any of the quantitative decision sciences

that can be most helpful in analyzing a given problem.
Therefore, a company’s analytics group might include members with titles such
as mathematician, statistician, computer scientist, data scientist, information
technologist, business analyst, industrial engineer, management scientist, and
operations research analyst
Descriptive analytics: Analyzing data to improve descriptions of what has
been happening
Predictive analytics: Using predictive models to improve predictions of what
is likely to happen in the future
Prescriptive analytics: Using prescriptive models, including optimization
models, to improve managerial decision making
1.6 The relationship between analytics and management science

The top management of numerous business organizations now understand

the impact that this approach can have on the bottom line and they are
interested in increasing the role of their analytics group in their
organization.

==>Require many more people trained in analytics and management

science
The momentum of the analytics movement is indeed continuing to grow
rapidly. Because management science is at the core of advanced analytics,
the usage of the powerful techniques of management science introduced in
this book also should continue to grow rapidly
1.6 The relationship between analytics and management science

Management science has made a significant contribution to increasing the

productivity of the economies of various countries
Management science has had numerous applications of various types in
business and industry
Ex: many hundreds of management scientists work on such airline problems as
how to most effectively assign airplanes and crews to flights and how to develop
fare structures that maximize revenue

Impact in the health care area, with applications involving improved

management of health care delivery and operations, disease modeling,
clinical diagnosis and decision making, radiation therapy
Some applications were military applications, including logistical planning
and war gaming
1.7 Summary
❖ Management science is a discipline area that attempts to aid managerial
decision making by applying a scientific approach to managerial
problems that involve quantitative factors.
❖ The rapid development of this discipline began in the 1940s and 1950s.
❖ The onslaught of the computer revolution has since continued to give great
impetus to its growth.
❖ Further impetus now is being provided by the widespread use of
spreadsheet software, which greatly facilitates the application of
management science by managers and others
❖ A major management science study involves conducting a systematic
investigation that includes careful data gathering, developing and
testing hypotheses about the problem (typically in the form of a
mathematical model), and applying sound logic in the subsequent analysis.
1.7 Summary

❖ The management science team then presents its recommendations to

the managers who must make the decisions about how to resolve the
problem. Smaller studies might be done by managers themselves with the
aid of spreadsheets
❖ A major part of a typical management science study involves incorporating
the quantitative factors into a mathematical model (perhaps
incorporated into a spreadsheet) and then applying mathematicalprocedures
to solve the model
❖ Management science has had an impressive impact on improving the
efficiency of numerous organizations around the world. In fact, many
award-winning applications have resulted in annual savings in the
millions, tens of millions, or even hundreds of millions of dollars