Spreadsheet Modelling

IIM Raipur ePGP -

Session 3

Sivamani
Recap of last class
Agenda

• PEMDAS
• Coffee Problem - Price Sensitivity (What-if-Scenarios)
• Systematically Building a Spreadsheet Model
• Influence Diagram
• Black-box Diagram
PEMDAS

Please excuse my dear aunty Sally

• Parenthesis
• Exponential
• Multiplication
• Division
• Addition
• Subtraction
Introduction to Influence Line Diagrams
• We refer to a decision-making process generally as a problem-solving process.
• A key challenge that modelers face in a problem-solving process is how to translate an
initial vague understanding of a problem into a concrete model.
Influence Line Diagrams
• A simple diagram that shows what outcome variables the model will generate and
how these outputs are calculated from necessary inputs
• Helps to bring clarity to the initial stages of the model formulation process
• Encourages to focus on what to include and what to exclude from the model
• Provides a high-level view of the entire model that can be comprehended at a glance
• Enables modelers to separate the design of the model from the design of the spreadsheet
that implements the model
• However, does not provide numerical results
Step 1
• Start with the performance measure (outcome).
• To decide which variable this is ask what single variable the decision maker will use to measure the success
of a plan of action.
• If there are more than one, begin with the most critical one and then continue with the rest.

PROFIT
Step 2

TOTAL
• Decompose the performance REVENUE
measure into two or more
intermediate variables from which
it is mathematically derived
PROFIT
directly.
• Each of these variables should be
independent of the other, but
together they should be sufficient
to determine the result. TOTAL
COST
 Step 3
Similarly, further decompose each
intermediate variable into more intermediate
variables until the input variables are TOTAL
reached. REVENUE

VARIABLE
PROFIT
COST

TOTA
L
COST
FIXED
COST

Remember that a variable should appear only

once in the diagram.
Step 3
TOTAL
REVENU
E
QUANTIT
Y SOLD
PROFI
T
VARIABL
E COST

TOTA
UNIT L
COST
COS
T FIXE
D
COST
Step 3
PRICE

TOTAL
REVENU
E

QUANTIT
Y SOLD
PROFI
T
VARIABL
E COST

TOTA
L
UNIT COST
COST
FIXE
D
COST
Step 4 Identify all input variables (parameters and decision variables).

PRICE

TOTAL
REVENUE

QUANTITY
SOLD
PROFIT

VARIABLE
COST

TOTAL Performance measure

COST
UNIT
COST Decision variable
FIXED COST
Parameters

Consequences
 Modelling Choices
This is a highly simplified example. But even here, we are making a number of modeling choices.
• First, in this case, the fixed cost is a known quantity because we do not assume variables that are needed to
determine it.
• The fixed cost would depend on the choice of technology and the chart would need to reflect this complexity.
• We use the fact that quantity sold determines revenue. This means we are assuming that production and sales are
simultaneous. If, on the other hand, it were our practice to produce to stock and sell from inventory, we would
need to modify our chart.
• Third, we assume the fact that quantity sold is independent of price, at least within a reasonable range of prices.
Instead, we could have also assumed that we face a price-dependent market and shown in our model that price
and price elasticity influence the quantity sold.

These three examples of assumptions show that influence diagrams help the modeler make explicit
decisions about what is included in the model and how the variables interact to determine the output.
Common Error
• The most common error in drawing influence charts is to draw an arrow from the output back to the decisions.
The thinking here seems to be that the outcome will be used to determine the best decisions.
• Remember, however, that an influence chart is simply a description of how we will calculate outcomes for any set
of decisions and other parameters. It is not intended to be used to find the best decisions. That is a separate
process, requiring an actual model, not simply a diagram.
An alternative diagram for Pricing Problem when we assume Price and Price Elasticity both
influence Quantity Sold.

PRIC
E
TOTAL
REVENU
E
QUANTITY
SOLD
PROFI
T
VARIABL
E COST
ELASTICIT TOTA Performance
Y measure
L
UNIT
COST Decision variable
COST
FIXE
Parameters
D
COST
Consequences
 An alternative diagram for Pricing Problem when the fixed cost
is determined by the choice of technology.
PRICE

TOTAL
REVENUE

QUANTITY
SOLD
PROFIT

VARIABLE
COST

TOTA
Performance measure
L
UNIT
COST
COST Decision variable
FIXED
COST Parameters
CHOICE OF
TECHNOLOGY Consequences
Black Box Model
• A black-box diagram is a simple diagram that summarizes the input and output variables, hiding the
“spider-web” of relationships among the variables into the “black” box.
• The variables can be classified as follows:
• Decisions are controllable input variables, the values of which are to be decided by the user.
• Parameters/Data are uncontrollable input variables with values given by external parties.
• Consequence variables are output variables and their values are produced by mathematical calculations.
• Performance measures are output variables and their values are of key interest to the user, answering
the main objective of building the model.
Black Box Model

INPUTS
Decisions OUTPUTS
(controllable) E.g., Performance
Pricing, Measures E.g.,
expansion/no profit, net
expansion, etc. income after tax, etc.

Parameters Consequence
(uncontrollable) Variables E.g.,
E.g., unit cost, fixed revenue,
cost, etc. variable costs etc.
Summarizing
Before you even open an Excel file,
• Read the problem carefully
• Identify all variables through brainstorming:
• What are inputs and outputs?

• Which of the inputs are given? Which ones must you decide on?

• Which of the outputs are the key performance indicators? Which ones are intermediate variables?

• Establish the Influence Diagram

• Summarize and confirm the findings as a Black-box diagram
• One can start by establishing the Black-box diagram. However, in many problems, it may not be
evident from the beginning which variables are inputs and which are outputs.
3 key things

• What Goals (Maximize or Minimize)

• What do we Control? (Decision Variables)
• What Constraints?
Influence Diagrams

• Different elements connecting together

• From Right to Left

• Output(Goals- Octagon)
• Decisions(Rectangles)
• External Data Inputs(Triangles)
• Other Intermediate variables(Ovals)