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Lecture 1

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75dsyk84nr
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© © All Rights Reserved
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LECTURE 1

INTRODUCTION TO SPREADSHEET
BUSINESS MODELING

1
TODAY’S PLAN

 Syllabus

 Mathematical models to aid decision making


 Topics will be covered in this course
 Basic spreadsheet skills

2
MANAGERIAL DECISION MAKING

Analysis
Model Results

Symbolic

Interpretation
Abstraction

World
Managerial
Real Judgment
World

Management Intuition
Decisions
Situation

3
COMPETING ON ANALYTICS
 Analytics competitors make expert use of statistics and modeling to improve a wide
variety of functions:
Function Description Examples
Supply chain Simulate and optimize supply chain flows; reduce inventory and Dell, Wal-Mart, Amazon
stock-outs.
Customer selection, Identify customers with the greatest profit potential; increase Harrah’s, Capital One,
loyalty, and service likelihood that they will want the product or service offering; Barclays
retain their loyalty.
Pricing Identify the price that will maximize yield, or profit. Progressive, Marriot
Human capital Select the best employees for particular tasks or jobs, at New England Patriots,
particular compensation levels. Oakland A’s, Boston Red
Sox
Product and service Detect quality problems early and minimize them. Honda, Intel
quality
Financial performance Better understand the drivers of financial performance and the MCI,Verizon
effects of non-financial factors.
Research and Improve quality, efficacy, and where applicable, safety of Novartis, Amazon,Yahoo 4
development products and services.

Source: T. H. Davenport, “Competing on Analytics,” HBR, Jan. 2006


A SCIENTIFIC APPROACH

Define the Problem

Identify the Alternatives

Determine the Criteria Modeling


Problem Analysis
Solving Evaluate the Alternatives

Recommend an Alternative

Implement the Decision Decision

Evaluate the Results

5
EXAMPLE

 You operate a bakery and need to determine advertising expenses for November and
December.
 Previous years’ experience tells you that the monthly demand is correlated with the
monthly advertising expenditure. The effectiveness of advertising depends on the
month:
 𝑑𝑒𝑚𝑎𝑛𝑑 𝑑𝑜𝑧𝑒𝑛 𝑎𝑑𝐸𝑓𝑓𝑒𝑐𝑡 ln 𝑎𝑑𝐸𝑥𝑝𝑒𝑛𝑠𝑒
 Past experience tells us that 𝑎𝑑𝐸𝑓𝑓𝑒𝑐𝑡 50, 𝑎𝑑𝐸𝑓𝑓𝑒𝑐𝑡 75
 Selling price: $96/dozen
 Cost of ingredients = $50/dozen
 Other fixed costs = $10,000 per month
6
MATHEMATICAL MODELS
 Model
 Abstraction of a real thing or process; some elements must be omitted
 Contains decision variables and represents a system in mathematical terms
 Finds values of decision variables which will improve system performance
 Used as a guide for aiding decision making
 Uses of Models
 To improve the existing decision
 To increase the understanding of a system
 To explicitly make trade-offs for a decision

7
ELEMENTS OF MODELS

 Decisions: choices, possible actions, controllable variables; decision variables


 Outcomes: performance measures, criteria, eventual consequences; objective
function
 Data: information, environmental conditions, uncontrollable variables;
parameters
 Structure: relations, causes and effects, logics; equations or inequalities

8
DECISIONS, OUTCOMES, DATA - EXAMPLE

 Decisions: choices, possible actions, controllable variables; decision variables


 How much should we spend on advertising in November and December?
 First attempt: $1,000 per month
 Outcomes: performance measures, criteria, eventual consequences; objective
function
 Maximize monthly income (profit) in November and December
 Data: information, environmental conditions, uncontrollable variables; parameters
 Selling price (per dozen cookies)
 Cost of ingredients (per dozen cookies)
 Advertising effectiveness factor 𝑎𝑑𝐸𝑓𝑓𝑒𝑐𝑡
9
STRUCTURE OF MODEL - EXAMPLE

Net income

Revenue Cost

Selling price Production


(dozen) cost

Monthly Cost of Other fixed


demand chocolate (lb) costs

10
Monthly
advertising
expense
STRUCTURE OF MODEL - EXAMPLE

 Structure: relations, causes and effects, logics; equations or inequalities


 Monthly income = 𝑟𝑒𝑣𝑒𝑛𝑢𝑒 – 𝑐𝑜𝑠𝑡𝑠
 Revenue = 𝑠𝑒𝑙𝑙𝑖𝑛𝑔 𝑝𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 𝑑𝑜𝑧𝑒𝑛 𝑑𝑒𝑚𝑎𝑛𝑑 𝑑𝑜𝑧𝑒𝑛)
 Cost of production = 𝑐𝑜𝑠𝑡 𝑝𝑒𝑟 𝑑𝑜𝑧𝑒𝑛 𝑑𝑒𝑚𝑎𝑛𝑑 𝑑𝑜𝑧𝑒𝑛𝑠
 Operating costsmonth = 𝑎𝑑𝐸𝑥𝑝𝑒𝑛𝑠𝑒 𝑜𝑡ℎ𝑒𝑟 𝑓𝑖𝑥𝑒𝑑 𝑐𝑜𝑠𝑡𝑠
 Demand(dozen)month = 𝑎𝑑𝐸𝑓𝑓𝑒𝑐𝑡 ln 𝑎𝑑𝐸𝑥𝑝𝑒𝑛𝑠𝑒

11
SPREADSHEET MODEL

Decisions

Outputs

Inputs

Calculation

12
SPREADSHEET MODEL

Highlight the output to increase user-friendliness.

=$C$13*C24; Use of $ in “C13” creates an “absolute


reference” that doesn’t change when we copy the formula
to the next column.

When we copy this cell to column D, we will see


“=$C$13*D24”

13
BEST PRACTICE GUIDELINES IN SPREADSHEET
DESIGN

 Sketch the spreadsheet


 Organize the spreadsheet into modules
 Isolate input parameters
 Keep it simple
 Avoid long formulas
 Formulas only contain cell references (i.e. not numbers); this simplifies
spreadsheet auditing
 Design for communication
 Use Excel formatting options (outlines, colours, bold font, etc) to highlight
certain cells for quick visual recognition
 Document important data and formulas 14
“WHAT-IF” ANALYSIS
 Questions:
 What if we vary advertising expenses in November and December between $1,000 to
$10,000 (can be different in each month)? Modify the corresponding decision cell (C5,
D5).
 What selling price would result in a total income of $0 (break-even)? Try different
values for the parameter cell C13.
 Better solution: Use scenario analysis functions in Excel.
 Data Tab ⇒ Forecast ⇒ What-if Analysis
 Data table – Re-compute the output as we vary ONE or TWO parameters along a
range of values.
 Scenario manager – Re-compute the output for different scenarios where we may vary
any number of parameters.
 Goal Seek – Determine the parameters that would give us the desired output.
 See “ModelAnalysis.xlsx” 15
WHY SPREADSHEET MODELING ?
 Examples of spreadsheets:
 Microsoft Excel – still the industry standard…
 Numbers
 Google Spreadsheets
 Open office spreadsheet
 Advantages:
 Ubiquity
 Availability of Add-ins
 Low cost alternative to more specialized tools (statistics, optimization)
 Disadvantages:
 Data size limitations, slow calculation speeds (large models)
 Difficult to document and organize models 16

 Often insufficient for advanced analysis

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