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

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 8. Decision Analysis & Spreadsheets

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

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 8. Decision Analysis & Spreadsheets

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

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 8. Decision Analysis & Spreadsheets

Decision Analysis

MODEL Results

Symbolic World

Interpretation
Abstraction

Managerial/
Researcher
Judgement

Real World

Management
Decisions
Situation

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 8. Decision Analysis & Spreadsheets

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

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 8. Decision Analysis & Spreadsheets

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

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 8. Decision Analysis & Spreadsheets

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

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 8. Decision Analysis & Spreadsheets

Decision Analysis

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 8. Decision Analysis & Spreadsheets

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

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 8. Decision Analysis & Spreadsheets

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

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 8. Decision Analysis & Spreadsheets

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)

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 8. Decision Analysis & Spreadsheets

Example of Model Building

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

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 8. Decision Analysis & Spreadsheets

Example of Model Building

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
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 8. Decision Analysis & Spreadsheets

Example of Model Building

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

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 8. Decision Analysis & Spreadsheets

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

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 8. Decision Analysis & Spreadsheets

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?

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 8. Decision Analysis & Spreadsheets

Building a Descriptive Model

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 8. Decision Analysis & Spreadsheets

Building a Descriptive Model

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
– …

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 8. Decision Analysis & Spreadsheets

Building a Descriptive Model

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)

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 8. Decision Analysis & Spreadsheets

Building a Descriptive Model

1. Use a Data Table

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

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 8. Decision Analysis & Spreadsheets

Building a Descriptive Model

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.

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 8. Decision Analysis & Spreadsheets

Building a Descriptive Model

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

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 8. Decision Analysis & Spreadsheets

Building a Descriptive Model

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 = ?)

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 8. Decision Analysis & Spreadsheets

Building a Descriptive Model

2. Use Goal Seek

– For what response rate does a company break even?

Tools > Goal Seek

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 8. Decision Analysis & Spreadsheets

Building a Descriptive Model

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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