Lecture 1

Introduction to Quantitative Analysis

2008 Prentice-Hall, Inc.

Learning Objectives
After completing this chapter, students will be able to: 1. Describe the quantitative analysis approach 2. Understand the application of quantitative analysis in a real situation 3. Describe the use of modeling in quantitative analysis 4. Use computers and spreadsheet models to perform quantitative analysis 5. Discuss possible problems in using quantitative analysis 6. Perform a break-even analysis
2009 Prentice-Hall, Inc. 12

Lecture Outline
1.1 1.2 1.3 1.4 Introduction What Is Quantitative Analysis? The Quantitative Analysis Approach How to Develop a Quantitative Analysis Model 1.5 The Role of Computers and Spreadsheet Models in the Quantitative Analysis Approach 1.6 Possible Problems in the Quantitative Analysis Approach 1.7 Implementation Not Just the Final Step

2009 Prentice-Hall, Inc.

13

Introduction
Mathematical tools have been used for

thousands of years Quantitative analysis can be applied to a wide variety of problems Its not enough to just know the mathematics of a technique One must understand the specific applicability of the technique, its limitations, and its assumptions
2009 Prentice-Hall, Inc. 14

Examples of Quantitative Analyses

Taco Bell saved over $150 million using

forecasting and scheduling quantitative analysis models NBC television increased revenues by over $200 million by using quantitative analysis to develop better sales plans Continental Airlines saved over $40 million using quantitative analysis models to quickly recover from weather delays and other disruptions
2009 Prentice-Hall, Inc. 15

What is Quantitative Analysis?

Quantitative analysis is a scientific approach to managerial decision making whereby raw data are processed and manipulated resulting in meaningful information

Raw Data

Quantitative Analysis

Meaningful Information

2009 Prentice-Hall, Inc.

16

What is Quantitative Analysis?

Quantitative factors might be different investment alternatives, interest rates, inventory levels, demand, or labor cost Qualitative factors such as the weather, state and federal legislation, and technology breakthroughs should also be considered
Information may be difficult to quantify but

can affect the decision-making process

2009 Prentice-Hall, Inc.

17

The Quantitative Analysis Approach

Defining the Problem Developing a Model Acquiring Input Data Developing a Solution Testing the Solution Analyzing the Results
Figure 1.1

Implementing the Results

2009 Prentice-Hall, Inc. 18

Defining the Problem

Need to develop a clear and concise statement that gives direction and meaning to the following steps
This may be the most important and difficult

step It is essential to go beyond symptoms and identify true causes May be necessary to concentrate on only a few of the problems selecting the right problems is very important Specific and measurable objectives may have to be developed
2009 Prentice-Hall, Inc. 19

Developing a Model
Quantitative analysis models are realistic, solvable, and understandable mathematical representations of a situation
$ Sales

$ Advertising

There are different types of models

Scale models Schematic models
2009 Prentice-Hall, Inc. 1 10

Developing a Model
Models generally contain variables

(controllable and uncontrollable) and parameters Controllable variables are generally the decision variables and are generally unknown Parameters are known quantities that are a part of the problem

2009 Prentice-Hall, Inc.

1 11

Acquiring Input Data

Input data must be accurate GIGO rule
Garbage In

Process Garbage Out Data may come from a variety of sources such as company reports, company documents, interviews, on-site direct measurement, or statistical sampling
2009 Prentice-Hall, Inc. 1 12

Developing a Solution
The best (optimal) solution to a problem

is found by manipulating the model variables until a solution is found that is practical and can be implemented Common techniques are
Solving equations Trial and error trying various approaches

and picking the best result Complete enumeration trying all possible values Using an algorithm a series of repeating steps to reach a solution
2009 Prentice-Hall, Inc. 1 13

Testing the Solution

Both input data and the model should be tested for accuracy before analysis and implementation
New data can be collected to test the model Results should be logical, consistent, and

represent the real situation

2009 Prentice-Hall, Inc.

1 14

Analyzing the Results

Determine the implications of the solution
Implementing results often requires change

in an organization The impact of actions or changes needs to be studied and understood before implementation

Sensitivity analysis determines how much the results of the analysis will change if the model or input data changes
Sensitive models should be very thoroughly

tested
2009 Prentice-Hall, Inc. 1 15

Implementing the Results

Implementation incorporates the solution into the company
Implementation can be very difficult People can resist changes Many quantitative analysis efforts have failed

because a good, workable solution was not properly implemented

Changes occur over time, so even successful implementations must be monitored to determine if modifications are necessary
2009 Prentice-Hall, Inc. 1 16

Modeling in the Real World

Quantitative analysis models are used extensively by real organizations to solve real problems
In the real world, quantitative analysis

models can be complex, expensive, and difficult to sell Following the steps in the process is an important component of success

2009 Prentice-Hall, Inc.

1 17

How To Develop a Quantitative Analysis Model

An important part of the quantitative

analysis approach Lets look at a simple mathematical model of profit

Profit = Revenue Expenses

2009 Prentice-Hall, Inc.

1 18

How To Develop a Quantitative Analysis Model

Expenses can be represented as the sum of fixed and variable costs and variable costs are the product of unit costs times the number of units

Profit = Revenue (Fixed cost + Variable cost) Profit = (Selling price per unit)(number of units sold) [Fixed cost + (Variable costs per unit)(Number of units sold)] Profit = sX [f + vX] Profit = sX f vX
where s = selling price per unit f = fixed cost

v = variable cost per unit X = number of units sold

2009 Prentice-Hall, Inc. 1 19

How To Develop a Quantitative Analysis Model

Expenses can be represented as the sum of fixed and variable costs and variable costs are the product of The parameters of this model unit costs times the number units are f, v,of and s as these are the inputscost inherent in the cost) model Profit = Revenue (Fixed + Variable The decision variable Profit = (Selling price per unit)(number of of units interest is X sold) [Fixed cost + (Variable costs per unit)(Number of units sold)] Profit = sX [f + vX] Profit = sX f vX
where s = selling price per unit f = fixed cost

v = variable cost per unit X = number of units sold

2009 Prentice-Hall, Inc. 1 20

Pritchetts Precious Time Pieces

The company buys, sells, and repairs old clocks. Rebuilt springs sell for $10 per unit. Fixed cost of equipment to build springs is $1,000. Variable cost for spring material is $5 per unit. s = 10 f = 1,000 v=5 Number of spring sets sold = X Profits = sX f vX If sales = 0, profits = $1,000 If sales = 1,000, profits = [(10)(1,000) 1,000 (5)(1,000)]

= $4,000
2009 Prentice-Hall, Inc. 1 21

Pritchetts Precious Time Pieces

Companies are often interested in their break-even point (BEP). The BEP is the number of units sold that will result in $0 profit.

0 = sX f vX,

or

0 = (s v)X f

Solving for X, we have f = (s v) X

f X= sv
Fixed cost BEP = (Selling price per unit) (Variable cost per unit)
2009 Prentice-Hall, Inc. 1 22

Pritchetts Precious Time Pieces

Companies are often interested in their break-even point (BEP). The BEP is the number of units sold BEP for Pritchetts Precious Time Pieces that will result in $0 profit. = f$1,000/($10 $5) 200 units 0 BEP = sX vX, or 0 = (= s v) X f

Salesfor of less than 200 units of rebuilt springs Solving X, we have will result in a loss f = (s v) X Sales of over 200 unitsfof rebuilt springs will result in a profit X = sv
Fixed cost BEP = (Selling price per unit) (Variable cost per unit)
2009 Prentice-Hall, Inc. 1 23

Advantages of Mathematical Modeling

1. Models can accurately represent reality 2. Models can help a decision maker formulate problems 3. Models can give us insight and information 4. Models can save time and money in decision making and problem solving 5. A model may be the only way to solve large or complex problems in a timely fashion 6. A model can be used to communicate problems and solutions to others
2009 Prentice-Hall, Inc. 1 24

Models Categorized by Risk

Mathematical models that do not involve

risk are called deterministic models

We know all the values used in the model

with complete certainty

Mathematical models that involve risk,

chance, or uncertainty are called probabilistic models

Values used in the model are estimates

based on probabilities

2009 Prentice-Hall, Inc.

1 25

Computers and Spreadsheet Models

QM for Windows
An easy to use

decision support system for use in POM and QM courses

This is the main

menu of quantitative models

Program 1.1
2009 Prentice-Hall, Inc. 1 26

Computers and Spreadsheet Models

Excel QMs Main Menu (2003)
Works automatically within Excel spreadsheets

Program 1.2A
2009 Prentice-Hall, Inc. 1 27

Computers and Spreadsheet Models

Excel QMs Main Menu (2007)

Program 1.2B
2009 Prentice-Hall, Inc. 1 28

Computers and Spreadsheet Models

Excel QM for the BreakEven Problem

Priteg

Program 1.3A
2009 Prentice-Hall, Inc. 1 29

Computers and Spreadsheet Models

Excel QM Solution to the BreakEven Problem

Program 1.3B
2009 Prentice-Hall, Inc. 1 30

Computers and Spreadsheet Models

Using Goal Seek in the BreakEven Problem

Program 1.4
2009 Prentice-Hall, Inc. 1 31

Possible Problems in the Quantitative Analysis Approach

Defining the problem
Problems are not easily identified Conflicting viewpoints

Impact on other departments

Beginning assumptions Solution outdated

Developing a model
Fitting the textbook models Understanding the model
2009 Prentice-Hall, Inc. 1 32

Possible Problems in the Quantitative Analysis Approach

Acquiring input data
Using accounting data Validity of data

Developing a solution
Hard-to-understand mathematics Only one answer is limiting

Testing the solution Analyzing the results

2009 Prentice-Hall, Inc. 1 33

Implementation Not Just the Final Step

Lack of commitment and resistance to change
Management may fear the use of

formal analysis processes will reduce their decision-making power Action-oriented managers may want quick and dirty techniques Management support and user involvement are important

2009 Prentice-Hall, Inc.

1 34

Implementation Not Just the Final Step

Lack of commitment by quantitative analysts
An analysts should be involved with

the problem and care about the solution Analysts should work with users and take their feelings into account

2009 Prentice-Hall, Inc.

1 35

Summary
Quantitative analysis is a scientific

approach to decision making The approach includes

Defining the problem Acquiring input data Developing a solution Testing the solution Analyzing the results Implementing the results
2009 Prentice-Hall, Inc. 1 36

Summary
Potential problems include Conflicting viewpoints The impact on other departments Beginning assumptions Outdated solutions Fitting textbook models Understanding the model Acquiring good input data Hard-to-understand mathematics Obtaining only one answer Testing the solution Analyzing the results
2009 Prentice-Hall, Inc. 1 37

Summary
Implementation is not the final step Problems can occur because of Lack of commitment to the approach Resistance to change

2009 Prentice-Hall, Inc.

1 38

End of Lecture 1

2008 Prentice-Hall, Inc.