MMGT6012

MMGT6012
Business Tools for Management
TOPIC 8: Decision Analysis & Spreadsheets

Dr. Matthew Beck
ITLS, Business School
The University of Sydney Page 1

8. Decision Analysis & Spreadsheets
Decision Analysis
Management decisions are often complex because they involve:

– Risk and uncertainty
– Multiple objectives
– A complex structure
– Multiple stakeholders
The mind has limited information processing capacity and memory:

– To cope with complexity we tend to simplify problems
– This can lead to inconsistency and biases

Decision Analysis
Choosing a holiday:
– liveliest nightlife
– least crowded beaches
– most sunshine
– most modern hotels
– lowest cost
Choosing a supplier:
– best after-sales service
– fastest delivery time
– lowest prices
– best reputation for reliability

Decision Analysis
Modelling helps breakdown complex problems:

– More easily understood
– Less confronting to analyse
– Provides a logical basis for a decision
Modelling does not replace the human element:

– A means to overcome intuitive limitations
– Used in conjunction with reasoned insight and past experience

Decision Analysis
MODEL Results
Symbolic World
Interpretation
Abstraction
Managerial/
Researcher
Judgement
Real World
Management
Decisions
Situation

Decision Analysis
The best way to attack a complex problem:

– Start with a verbal description
– Use this to develop a flowchart
– Try and use math to express the links in the flowchart

Decision Analysis
No model is never 100% perfect:

– All models abstract reality
Incorporate enough detail into your model so that:

– The result meets your needs
– It can be analysed in the time you have to devote the process
– It is consistent with the data you have available

Decision Analysis
Descriptive Models:
– Describe what happens in a system when something changes
Deterministic Model:
– A model in which all data are known with certainty
– Determines an optimal outcome / strategy
Probabilistic Model
– Data is not fixed rather occurs up to a probability
– We examine how likely different outcomes are

Decision Analysis

Spreadsheet Principles
Start with a simple model and then layer in complexity
Make sure your model is neat and tidy:

– No one will use it if they can’t understand it
Understand the terminology:

– Inputs: Values that are given to us (we cannot control them)
– Decision Variables: Inputs into the model over which we do have control
– Outputs: Results of the modelling process which we use for decision making

Spreadsheet Principles
You must:
– Use a clear & logical layout to the overall model
– Have clear headings for different sections of the model and for all inputs,
decision variables and outputs
– Use relevant cell formatting to highlight the key components
You should maybe:

– Put different parts of a model on separate sheets
– Use range names
– Use cell comments
– Text boxes for assumptions, lists, or explanations

Example of Model Building
Step 1: Study and Understand the Problem
– Simon is a desert pie wholesaler.
– Simon must make a profit in order to stay in business (desired output)
– Marketing and manufacturing constraints mean that he cannot alter the size
or quality of the pies (inputs)
– The retail price of pies is a markup of the wholesale cost.
– Simon concludes the wholesale pie price is his most critical decision (decision
variable)

Step 2: Identify the relevant factors in the Real World
– Don't think about the model at this stage, rather what you want from the
model and what you need to put into the model
– Profit is the performance measure – what contributes to profit?
Pie Price
Cost of fillings
Cost of dough Model PROFIT
Processing Cost
Fixed Cost

Step 3: Construct the flowchart or visual representation

Profit
Revenue Total Cost
Processing
Cost
Ingredients
Cost
Required
Ingredients
Quantities
Pies
Demanded
Unit Pie Unit Cost Unit Cost

Pie Price Fixed Cost
Processing Cost Filling Dough
Step 4: Create mathematical formulas to replace links:

– Profit = Revenue – Total Cost;
– Revenue = Pie Price*Pies Demanded;
– Total Cost = Processing Cost + Ingredients Cost + Fixed Cost

Building a Descriptive Model
The Great Threads Company sells jumpers by mail order:

– Planning to print a brochure and undertake a direct mail campaign
The costs of printing the brochure are:

– Fixed cost of $20,000 for setting up the print run
– Additional charge of $0.10 a catalog for printing
– Cost of postage is $0.15 per brochure
– Also include a reply paid envelope will will cost $0.20 if used for an order
The average size of a customer order is $40:

– Based on past sales cost of the order is 80% of value

The plan is to send 100,000 catalogs
Build a spreadsheet model to answer the following questions:
1. How does a change in the response rate affect profit?
2. For what response rate does a company break even?
3. If the company estimates a response rate of 3%, should it proceed?


Enter the input values that we are given:

– These are located in Column B
– What we don’t know yet is the response rate
Use formulas to link the inputs to create outputs:

– Number of orders = Response Rate * Brochures Posted
– Revenue = Average Order Size * Orders
– Variable Costs (Mail) = (Printing + Posting Costs)*Brochures Posted
– …

1. Use a Data Table

– How does a change in the response rate
affect profit?
– Enter a sequence of possible values for

the response rate starting in D19 and
enter a link to the profit value in Cell E13
(see the previous slide)
– Highlight the entire table, including the

cell where we just entered the link
(D18:E29)

1. Use a Data Table

– How does a change in the response rate affect profit?

1. Use a Data Table

– How does a change in the response rate
affect profit?
– Enter the cell reference for the response

rate from the original table (B12) in the
column input cell. Column is used because
the response rates are in a column in our
data table.

1. Use a Data Table

Great Threads Direct Mail Example
Profit vs Response Rate
$40,000
$30,000
$20,000
$10,000
$0
Profit
0% 2% 4% 6% 8% 10% 12%
-$10,000
-$20,000
-$30,000
-$40,000
-$50,000
Response rate

2. Use Goal Seek

– For what response rate does a company break even?
From the data table in the first question:

– Profit goes from negative to positive when the response rate is somewhere
between 5% and 6%.
We want to pursue a goal (profit = 0), buy seeking a value that

gives us that result (response rate = ?)

2. Use Goal Seek

– For what response rate does a company break even?
Tools > Goal Seek

3. What if predicted response rate = 3%?

– On the surface we would say no (3% = a loss)
– This may only be short term thinking
– People who response to direct mail are more likely to order again
– The company makes $7.80 per order. If each of the respondents ordered
two or more times, say, the company would earn 3000 x $7.80 X 2 =
$46,800 more than appears in the model, and profit would then be
positive.
– The moral is that we must not use the model results alone, but use them
as a compliment to decisions we make.

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Business Tools for Management

TOPIC 8: Decision Analysis & Spreadsheets

The University of Sydney Page 1

Management decisions are often complex because they involve:

The mind has limited information processing capacity and memory:

The University of Sydney Page 2

The University of Sydney Page 3

Modelling helps breakdown complex problems:

Modelling does not replace the human element:

The University of Sydney Page 4

The University of Sydney Page 5

The best way to attack a complex problem:

The University of Sydney Page 6

No model is never 100% perfect:

Incorporate enough detail into your model so that:

The University of Sydney Page 7

The University of Sydney Page 8

The University of Sydney Page 9

Start with a simple model and then layer in complexity

Make sure your model is neat and tidy:

Understand the terminology:

The University of Sydney Page 10

You should maybe:

The University of Sydney Page 11

Example of Model Building

Step 1: Study and Understand the Problem

– Simon is a desert pie wholesaler.

– Simon must make a profit in order to stay in business (desired output)

– The retail price of pies is a markup of the wholesale cost.

The University of Sydney Page 12

Example of Model Building

Step 2: Identify the relevant factors in the Real World

– Profit is the performance measure – what contributes to profit?

The University of Sydney Page 13

Example of Model Building

Step 3: Construct the flowchart or visual representation

Revenue Total Cost

Unit Pie Unit Cost Unit Cost

Example of Model Building

Step 4: Create mathematical formulas to replace links:

The University of Sydney Page 15

Building a Descriptive Model

The Great Threads Company sells jumpers by mail order:

The costs of printing the brochure are:

The average size of a customer order is $40:

The University of Sydney Page 16

Building a Descriptive Model

The plan is to send 100,000 catalogs

Build a spreadsheet model to answer the following questions:

1. How does a change in the response rate affect profit?

2. For what response rate does a company break even?

3. If the company estimates a response rate of 3%, should it proceed?

The University of Sydney Page 17

Building a Descriptive Model

The University of Sydney Page 18

Building a Descriptive Model

Enter the input values that we are given:

Use formulas to link the inputs to create outputs:

The University of Sydney Page 19

Building a Descriptive Model

1. Use a Data Table

– Enter a sequence of possible values for