 Building optimization models is more of an art than

a science.
◦ Learning how to build models requires logical thought
facilitated by studying examples and observing their
characteristics.
 Key issues:
◦ Formulation
◦ Spreadsheet implementation
◦ Interpreting results
◦ Scenario and sensitivity analysis
◦ Gaining insight for making good decisions
 Simple Bounds
◦ Constraints on values of a single variable
 Limitations
◦ Allocation of scarce resources
 Requirements
◦ Minimum levels of performance
 Proportional Relationships
◦ Requirements for mixtures or blends of materials or strategies
 Balance Constraints
◦ Ensure the flow of material or money is accounted for at
locations or between time periods: input = output
 Process selection models generally involve
choosing among different types of processes to
produce a good.
◦ Example: make or buy decisions
 A mill that operates on a 24/7 basis produces three types
of fabric on a make-to-order basis.
 The key decision is which type of loom to use for each
fabric type over the next 13 weeks.
 The mill has 3 dobbie looms and 15 regular looms.
 If demand cannot be met, the fabric is outsourced.
 Model Formulation
 Di = yards fabric i to produce on dobbie loom
 Ri = yards fabric i to produce on regular loom
 Pi = yards fabric i to outsource
 Objective
 Minimize total cost of milling and outsourcing
 Constraints
 Requirements: Total production and outsourcing of each
fabric = demand
 Limitations: Production on each type of loom cannot
exceed the available production time
 Nonnegativity
 Demand constraints
 Production + outsourcing = demand
◦ Fabric 1: D1 + P1 = 45,000
◦ Fabric 2: D2 + R2 + P2 = 76,500
◦ Fabric 3: D3 + R3 + P3 = 10,000
 Loom capacity limitation constraints
 First convert yards/hour into hours/yard.
E.g., for fabric 1 on the dobbie loom:
hours/yard = 1/(4.7 yards/hour) = 0.213 hours/yard

 Capacity of the three dobbie looms:

(24 hours/day)(7 days/week)(13 weeks)(3 looms) = 6,552 hours
 Constraint on available production time on dobbie looms:
0.213D1 + 0.192D2 0.227D3 ≤ 6,552
 Constraint for regular looms:
0.192R2 + 0.227R3 ≤ 32,760
 Full Model
 Camm Textiles model

 Decision variables
 Objective
Set cell C14 to zero as a constraint because
fabric 1 cannot be produced on a regular loom.
Whenever you restrict a single decision variable
to equal a value or set it as a ≤ or ≥ type of
constraint, Solver considers it as a simple bound.
 Answer Report
 Sensitivity Report
 Solver requires some technical knowledge of
linear optimization concepts and terminology, such
as reduced costs and shadow prices.
 Data visualization can help analysts present
optimization results in forms that are more
understandable and can be easily explained to
managers and clients in a report or presentation.
 Camm Textiles
 Reduced costs: how much the unit production or
purchasing cost must be changed to force the value of a
variable to become positive in the solution.
 Unit cost coefficients: use an Excel Stock Chart (see text
for details).
◦ A stock chart typically shows the “high-low-close” values of daily
stock prices; here we can compute the maximum-minimum-
current values of the unit cost coefficients.

For those lines that have

no maximum limit (the blue
dash) such as with Fabric 1
Purchased, the unit costs
can increase to infinity; for
those that have no lower
limit (the red triangle) such
as Fabric 1 on Dobbie, the
unit costs can decrease
indefinitely.
 Shadow prices show the impact of changing the right-hand side of a
binding constraint. Because the plant operates on a 24/7 schedule,
changes in loom capacity would require in “chunks” (i.e., purchasing
an additional loom) rather than incrementally.
 However, changes in the demand can easily be assessed using the
shadow price information.
 Stock Chart
 Blending problems involve mixing several raw
materials that have different characteristics to
make a product that meets certain specifications.
◦ Dietary planning, gasoline and oil refining, coal and
fertilizer production, and the production of many other
types of bulk commodities involve blending.
 We typically see proportional constraints in
blending models.
 BG Seed Company is developing a new birdseed
mix.
◦ Nutritional requirements specify that the mixture contain
at least 13% protein, at least 15% fat, and no more than
14% fiber.
◦ BG’s objective is to determine the minimum cost mixture
that meets nutritional requirements.
 Formulating the model
 Define Xi = pounds of ingredient i in 1 pound of mix
 Objective function
 minimize 0.22X1 + 0.19X2 + 0.10X3 + 0.10X4 + 0.07X5 +
0.05X6 + 0.26X7 + 0.05X6 + 0.26X7 + 0.11X8
 Protein constraint
 Total pounds of protein provided/total pounds of mix ≥
0.13
◦ (0.169X1 + 0.12X2 + 0.085X3 + 0.154X4 + 0.085X5 + 0.12X6 +
0.18X7 + 0.119X8)/(X1 + X2 + X3 + X4 + X5 + X6 + X7 + X8) ≥ 0.13
 Add constraint X1 + X2 + X3 + X4 + X5 + X6 + X7 + X8 = 1
◦ Protein constraint simplifies to
◦ 0.169X1 + 0.12X2 + 0.085X3 + 0.154X4 + 0.085X5 + 0.12X6 +
0.18X7 + 0.119X8 ≥ 0.13

Formulate other nutritional

constraints in a similar way.
 Complete model
 Solver solution shows the model is infeasible!
 Solver Feasibility Report

A conflict exists in trying to meet both fat and fiber constraints.

Only sunflower seeds and safflower contain enough fat but they
also have a lot of fiber.
 Lower the fat requirement or raise the fiber
limitation

1st Scenario:
Fat requirement is lowered from
15% to 14.5%.
2nd Scenario:
Fiber limitation is raised from
14% to 14.5%.

Optimal Cost per pound:

$0.148 if fat requirement lowered
$0.152 if fiber limitation raised
 Many types of financial investment problems are
modeled and solved using linear optimization.
 Such portfolio investment models problems have
the basic characteristics of blending models.
 Innis Investments manages 6 mutual funds. A client
wants to invest a $500,000 inheritance. The objective is
to minimize risk.
 Constraints:
 Invest no more than $200,000 in any one fund.
 Invest at least $50,000 each in the multinational and balanced
funds.
 Invest at least 40% combined in the income equity and balanced
funds.
 Achieve an average return of at least 5%.
 Model Formulation
 Define Xi = dollar amount invested in fund i
◦ The total risk would be measured by the weighted risk of the
portfolio, where the weights are the proportion of the total
investment in any fund (Xj/500,000)
 Constraints
◦ Invest all money:

◦ Achieve required return:

◦ Have at least 40% in income equity and balanced funds:

◦ At least $50,000 in each of multinational and balanced funds:

◦ Restrict each investment to $200,000, and include nonnegativity:

 Innis Investments
◦ Allowable Increase and Allowable Decrease values for the
weighted return are very small, 0.00906 and 0.00111,
respectively; so any changes in the target return will require re-
solving the model.
 A poorly scaled model is one that computes values of
the objective, constraints, or intermediate results that
differ by several orders of magnitude.
 Poor scaling can cause Solver engines to return
messages such as “Solver could not find a feasible
solution,” “Solver could not improve the current solution,”
or even “The linearity conditions required by this Solver
engine are not satisfied,” or it may return results that are
suboptimal.
◦ In the Solver options, you can check the box Use Automatic
Scaling.
◦ The best way to avoid scaling problems is to carefully choose the
“units” implicitly used in your model so that all computed results
are within a few orders of magnitude of each other.
 Little Investment Advisors is working with a client on
determining an optimal portfolio of bond funds. The client
has $350,000 to invest and wants to achieve the largest
weighted percentage return and keep the weighted risk
measure no greater than 5.00.
 Model
◦ Define X1 through X6 be the amount invested in each of the six
funds.
◦ Maximize (6.11X1 + 7.61X2 + 5.29X3 + 2.79X4 + 7.37X5 +
5.65X6)/350,000
◦ X1 + X2 + X3 + X4 + X5 + X6 = 350,000
◦ (4.62X1 + 7.22X2 + 9.75X3 + 3.95X4 + 6.04X5 + 5.17X6) ≤ 5.00
◦ X1,…,X6 ≥ 0
 Premium Solver solution without scaling, resulting in an
incorrect solution!
 Solver solution after scaling the variables
 The transportation problem involves determining
how much to ship from a set of sources of supply
(factories, warehouses, etc.) to a set of demand
locations (warehouses, customers, etc.) at
minimum cost.
 GAC produces refrigerants at 2 plants and ships to 5
distribution centers.

 Define the decision variables as: Xij = amount shipped

from plant i to distribution center j
 The objective is to minimize the total cost of shipping
between plants and distribution centers.
◦ minimize 12.60X11 + 14.35X12 + 11.52X13 + 17.58X14 + 9.75X21 +
16.26X22 + 8.11X23 + 17.92X24
 Constraints
◦ The amount shipped from each plant cannot exceed its
capacity.
◦ Demand at each distribution center is met.
◦ Nonnegativity
 Depending on how cells in your spreadsheet model are
formatted, the Sensitivity report produced by Solver may
not reflect the accurate values of reduced costs or
shadow prices because an insufficient number of
decimal places may be displayed.
 We highly recommend that after you save the Sensitivity
report to your workbook, you select the reduced cost and
shadow price ranges and format them to have at least
two or three decimal places.
Original Sensitivity Report Reformatted Sensitivity Report
 Reduced costs tell how
much the unit shipping
cost would have to be
reduced to make it
attractive to ship along a
route.
 We cannot increase the
demand at any
distribution center
without creating an
infeasible problem. The
shadow prices reflect the
cost savings that would
occur for a unit decrease
in demand at one of the
distribution centers.
 The GAC solution exhibits a phenomenon called
degeneracy. A solution is degenerate if the right-hand-
side value of any constraint has a zero Allowable
Increase or Allowable Decrease.
◦ Degeneracy can impact the interpretation of sensitivity analysis
information. For example, reduced costs and shadow prices may
not be unique, and you may have to change objective function
coefficients beyond their allowable increases or decreases before
the optimal solution will change.
 The basic decisions are how much to produce in each
time period to meet anticipated demand over each
period.
 Although it might seem obvious to simply produce to the
anticipated level of sales, it may be advantageous to
produce more than needed in earlier time periods when
production costs may be lower and store the excess
production as inventory for use in later time periods,
thereby letting lower production costs offset the costs of
holding the inventory.
 K&L Designs makes hand-painted jewelry boxes.
 Forecasted sales are 150 in autumn, 400 in winter, and 50 in
spring.
 Unpainted boxes cost $20 and each box takes 2 hours to
complete.
 The cost of capital is 6% per quarter.
 Holding cost per item = 0.06(20) = $1.20/quarter
 Labor rates are $5.50, $7.00, and $6.25 per hour during autumn,
winter, and spring, respectively.
 Minimize the combined cost of production and inventory
holding costs.
 Decision variables
◦ Pi = amount to produce in quarter i (1 = autumn; 2 =
winter; 3 = spring)
◦ Ii = inventory at the end of quarter i
 Objective function
◦ The production cost per unit is computed by multiplying the labor
rate by the number of hours required to produce one.
◦ Thus, the unit cost in the autumn is ($5.50)(2) = $11.00; in the
winter, ($7.00)(2) = $14.00; and in the spring, ($6.25)(2) = $12.50.
 Constraints
◦ Satisfy demand using production in a quarter and the inventory
held from the previous time quarter. Any amount in excess of the
demand is held to the next quarter.
◦ Therefore, the constraints take the form of inventory balance
equations:
 Complete model
 To ensure that demand is satisfied, we can set the
cumulative production in each quarter to be at least as
great as the cumulative demand.
◦ This eliminates inventory variables.
 The company’s financial manager needs to ensure that
funds are available to pay expenses yet needs to
maximize investment income.
 Three short-term investments are being considered:
 1-month CD paying 0.25%
 3-month CD paying 1.00% at maturity
 6-month CD paying 2.30% at maturity
 The net expenditures for the next 6 months are forecast
as $50,000, ($12,000), $23,000, ($20,000), $41,000, and
($13,000)
 A cash balance of $10,000 must be maintained.
Currently the cash balance is $200,000.
 Model development
◦ Ai = amount ($) to invest in a 1-month CD at the start of month i
◦ Bi = amount ($) to invest in a 3-month CD at the start of month i
◦ Ci = amount ($) to invest in a 6-month CD at the start of month i
 Optimization model
 Solver handles simple lower bounds (e.g., C ≥ 500) and
upper bounds (e.g., D ≤ 1,000) quite differently from
ordinary constraints in the Sensitivity report.
 Lower and upper bounds are treated in a manner similar
to nonnegativity constraints, which also do not appear
explicitly as constraints in the model.
 This makes it more difficult to interpret the sensitivity
information, because we no longer have the shadow
prices and allowable increases and decreases
associated with these constraints.
 J&M Manufacturing makes 4 models of gas grills
 Determine how many grills to produce in order to
maximize profit.
 Model development
◦ Define A, B, C, and D number of units of models A, B, C, and D
to produce, respectively.
◦ The objective function is to maximize the total net profit:
maximize (250 - 210)A + (300 - 240)B + (400 - 300)C + (650 -
520)D = 40A + 60B + 100C + 130D
 Constraints include limitations on the amount of
production hours available in each department, the
minimum sales requirements, and maximum sales
potential limits.
◦ Watch the dimensions carefully!
 Constraints:
◦ Department capacity

◦ Minimum sales requirements and maximum sales

potential
Note that none of the bound constraints appear in the
Constraints section.
 For product B, the lower bound constraint is B ≥ 0. How much more
would the profit on B have to be in order for it to be economical to
produce anything other than the minimum amount required?
◦ The answer is given by the reduced cost. The unit profit on B would have to be
reduced by at least - $1.905 (that is, increased by at least + $1.905).
 Product D is at its upper bound.
◦ The reduced costs of $19.29 tells how much the unit profit have to be lowered
before it is no longer economical to produce the maximum amount
 Increasing the right-hand-side value of the bound constraint, B ≥ 0,
by 1 unit will result in a profit reduction of $1.905.
 Increasing the right-hand side of the constraint D ≤ 1,000 by 1 will
increase the profit by $19.29.
◦ The reduced cost associated with a bounded variable is the same as the shadow
price of the bound constraint. However, we no longer have the allowable range
over which we can change the constraint values.
 Auxiliary variables are a new set of cells for any
decision variables that have upper- or lower-bound
constraints created by referencing (not copying) the
original changing cells.
 In the Solver model, use auxiliary variable cells—not the
changing variable cells as defined—to define the bound
constraints.
 Auxiliary variables allow easier interpretation of shadow prices for
bounded variables.
 J&M Manufacturing model

Define bound constraints using

the auxiliary variable cells
 Sensitivity
report
 Bound
constraints not
appear in the
Constraints
section
 A production/marketing allocation problem
 Walker Wines buys grapes from local growers and blends the
pressings to make two types of wine (Shiraz and Merlot). Grape
costs are $1.60 per bottle Shiraz and $1.40 per bottle Merlot.
 Their contract requires between 40% and 70% of their wine to be
Shiraz.
 Predicted demand for Shiraz is 1000 bottles but increases by 5
bottles for each dollar spent on advertising; the base demand for
merlot is 2,000 bottles and increases by 8 bottles for each $1 spent
on advertising.
 Production should not exceed demand.
 Shiraz sells to retail stores for $6.25 per bottle and merlot is sold for
$5.25 per bottle.
 $50,000 is available to purchase grapes and advertise products.
 Model formulation
 Define
◦ S = number of bottles of Shiraz produced
◦ M = number of bottles of merlot produced
◦ As = dollar amount spent on advertising Shiraz
◦ Am = dollar amount spent on advertising merlot
 Maximize profit = ($6.25S + $5.25M) - ($1.60S + $1.40M
+ As + Am) = 4.65S + 3.85M - As - Am
 Constraints
 Do not exceed budget
◦ $1.60S + $1.40M + As + Am ≤ $50,000
 Meet contractual requirements
◦ 0.4 ≤ S/(S + M) ≤ 0.7, or expressed in linear form:
0.6S - 0.4M ≥ 0 and 0.3S - 0.7M ≤ 0
 Production must not exceed demand
◦ S ≤ 1,000 + 5As
◦ M ≤ 2,000 + 8Am
 Nonnegativity
 One crucial assumption in interpreting sensitivity
analysis information for changes in model
parameters is that all other model parameters are
held constant.
 Suppose the cost of Shiraz grapes increase $0.05 per bottle.
 A $0.05 increase in cost results in a drop in the unit profit of Shiraz
from $4.65 to $4.60. In the Sensitivity report, however, the change in
the profit coefficient is within the allowable decrease of 0.05328,
thus concluding that no change in the optimal solution will result.
 If the model is re-solved
using the new cost
parameter, the solution
changes dramatically.
 In this case, the unit cost is
also reflected in the
binding budget constraint.
When we change the cost
parameter, the constraint
also changes. This violates
the assumption that all
other model parameters
are held constant.