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Lecture1
MGMT 661
Decision Making: Managing Risks, Serving the
Customer, Examining the Numbers
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What is this course about?What is this course about? To understand
Why do some companies thrive while others struggle or fail? Decision making
WhatWhat resources/what amounts
WhenNeeded/scheduled/ordered
WhereWork to be done
HowDesigned
WhoTo do the work
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Basic Functions of BusinessesBasic Functions of Businesses
The management of systems or processes that create goods and/or provide services
Organization
Finance Operations Marketing
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Value-AddedValue-Added
The difference between the cost of inputs and the value or price of outputs.
Inputs Land Labor Capital
Transformation/Conversion
process
Outputs Goods Services
Control
Feedback
FeedbackFeedback
Value added
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Food ProcessorFood Processor
Inputs Processing Outputs
Raw Vegetables Cleaning Canned vegetables Metal Sheets Making cans
Water CuttingEnergy CookingLabor PackingBuilding LabelingEquipment
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Hospital ProcessHospital Process
Inputs Processing Outputs
Doctors, nurses Examination Healthy patientsHospital Surgery
Medical Supplies MonitoringEquipment MedicationLaboratories Therapy
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Production of Goods Production of Goods vs.vs. Delivery of Services Delivery of Services
Production of goods – tangible output Delivery of services – an act Service job categories
Government Wholesale/retail Financial services Healthcare Personal services Business services Education
U.S. Manufacturing vs Service Employment
0
50
100
Year
Perc
ent Mfg.
Service
Mfg. 79 72 72 68 64 64 58 44 43 35 32 30
Service 21 28 28 32 36 36 42 46 57 65 68 70
45 50 55 60 65 70 75 80 85 90 95 00
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Manufacturing vs ServiceManufacturing vs Service
Characteristic Manufacturing ServiceOutput
Customer contact
Uniformity of input
Labor content
Uniformity of output
Measurement of productivity
Opportunity to correct quality problems
Tangible
Low
High
Low
High
Easy
High
Intangible
High
Low
High
Low
Difficult
LowHigh
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Key Decisions of BusinessesKey Decisions of Businesses What
What resources/what amounts When
Needed/scheduled/ordered Where
Work to be done How
Designed Who
To do the work
Operations Managers The operations function
Consists of all activities directly related to producing goods or providing services
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Operations Management includes: Forecasting Capacity planning Scheduling Managing inventories Assuring quality Deciding where to locate facilities And more . . .
Scope of Operations ManagementScope of Operations Management
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Types of OperationsTypes of Operations
Operations ExamplesGoods Producing Farming, mining, construction,
manufacturing, power generationStorage/Transportation Warehousing, trucking, mail
service, moving, taxis, buses,hotels, airlines
Exchange Retailing, wholesaling, banking,renting, leasing, library, loans
Entertainment Films, radio and television,concerts, recording
Communication Newspapers, radio and televisionnewscasts, telephone, satellites
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Decision MakingDecision Making
System Design Capacity Location Arrangement of departments Product and service planning Acquisition and placement of equipment
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Decision MakingDecision Making
System Operation Management of personnel Inventory planning and control Scheduling Project Management Quality assurance
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Decision MakingDecision Making
Steps of problem solving Models (Simple) Numerical approaches Analysis of trade-offs
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Steps of Problem Solving
(First 5 steps are the process of decision making)
• Define the problem.
• Identify the set of alternative solutions.
• Determine the criteria for evaluating alternatives.
• Evaluate the alternatives.
• Choose an alternative (make a decision).
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• Implement the chosen alternative.
• Evaluate the results.
Problem Solving and Decision MakingProblem Solving and Decision Making
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ModelsModels
A model is an abstraction of reality.
– Iconic – Analog– Mathematical
What are the pros and cons of models?
Tradeoffs
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A Simulation ModelA Simulation Model
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Quantitative Analysis and Decision MakingQuantitative Analysis and Decision Making
Potential reasons for a quantitative analysis approach to decision making• The problem is complex
• The problem is very important
• The problem is new
• The problem is repetitive
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Mathematical ModelsMathematical Models Relate decision variables (controllable inputs) with fixed or
variable parameters (uncontrollable inputs) Maximize or minimize some objective function subject to
constraints Two types
Stochastic if any of the uncontrollable inputs is subject to variation,
Deterministic otherwise Generally, stochastic models are more difficult to analyze Values of the decision variables that provide the
mathematically-best output referred to as optimal solution for the model
Frequently a less complicated (and perhaps less precise) model is more appropriate than a more complex and accurate one due to cost and ease of solution considerations
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Product Mix ExampleProduct Mix Example
Type 1 Type 2
Profit per unit $60 $50
Assembly time per unit
4 hrs 10 hrs
Inspection time per unit
2 hrs 1 hr
Storage space per unit
3 cubic ft 3 cubic ft
Resource Amount available
Assembly time 100 hours
Inspection time 22 hours
Storage space 39 cubic feet
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Objective – profit maximizationMaximize 60X1 + 50X2
Subject toAssembly 4X1 + 10X2 <= 100 hours
Inspection 2X1 + 1X2 <= 22 hours
Storage 3X1 + 3X2 <= 39 cubic feet
X1, X2 >= 0
A Linear Programming ModelA Linear Programming Model
X1 = # of type 1 PC; X2 = # of type 2 PC
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Analysis of Trade-offsAnalysis of Trade-offs
How many more jeans would Levi need to sell to justify the cost of additional robotic tailors?
Cost of additional robotic tailors vs Inventory Holding Cost
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Quantitative ModelsQuantitative Models• Cost-Revenue-Profit models
• Simple break-even analysis
• Analysis of tradeoffs
• Linear programming: optimal allocation of resources
• Project models: planning, coordinating and
controlling large scale projects
• Statistical models: forecasting• Queuing models: analyze waiting lines
• Inventory models: management of inventory
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Models Are BeneficialModels Are Beneficial
Easy to use, less expensive Minimizes risk Require users to organize Systematic approach to problem solving Increase understanding of the problem Enable “what if” questions: simulation models Specific objectives Power of mathematics Standardized format
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The The Management ScientistManagement Scientist Software Software
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Cost, Revenue and Profit ModelsCost, Revenue and Profit Models(Course Pack - Chapter 1)(Course Pack - Chapter 1)(Custom Text – Chapter 5)(Custom Text – Chapter 5)
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Cost Classification CostVariable Costs: Standard miles per gallon Average fuel price per gallon Fuel and oil per mile $0.0689 Maintenance per mile $0.0360 Tires per mile $0.0141
Annual Fixed Costs: Insurance: $372 License & Registration $95
Mixed Costs: Depreciation Fixed portion per year $3,703 Variable portion per mile $0.04
References
20 miles/ gallon$1.34/ gallon
Cost Classification of Owning and Operating a Passenger Car
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Cost-Volume RelationshipCost-Volume Relationship
5,000 10,000 15,000 20,000
Variable costs ($0.1190/mile) $595 $1,190 $1,785 $2,380Mixed costs: Variable portion 200 400 600 800 Fixed portion 3,703 3,703 3,703 3,703Fixed costs: 467 467 467 467Total variable cost 795 1,590 2,385 3,180Total fixed cost 4,170 4,170 4,170 4,170
Total costs $4,965 $5,760 $6,555 $7,350Cost per mile $0.9930 $0.5760 $0.4370 $0.3675
Volume Index (miles)
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Cost-Volume RelationshipCost-Volume Relationship
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Cost-Volume RelationshipsCost-Volume Relationships A
mo
un
t ($
)
0Q (volume in units)
Total cost = VC + FC
Total variable cost (V
C)
Fixed cost (FC)
Am
ou
nt
($)
Q (volume in units)0
Total r
evenue
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Cost-Volume RelationshipsCost-Volume Relationships
Am
ou
nt
($)
Q (volume in units)0 BEP units
Profit
Total r
even
ue
Total cost
VCR
FCQBEP
Formula (5-8) of Course Text
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Example: Ponderosa Development Corp.Example: Ponderosa Development Corp. Ponderosa Development Corporation (PDC) is a small real
estate developer that builds only one style house. The selling price of the house is $115,000. Land for each house costs $55,000 and lumber, supplies, and
other materials run another $28,000 per house. Total labor costs are approximately $20,000 per house.
Ponderosa leases office space for $2,000 per month. The cost of supplies, utilities, and leased equipment runs another $3,000 per month.
The one salesperson of PDC is paid a commission of $2,000 on the sale of each house. PDC has seven permanent office employees whose monthly salaries are given on the next slide.
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Employee Monthly Salary
President $10,000
VP, Development 6,000
VP, Marketing 4,500
Project Manager 5,500
Controller 4,000
Office Manager 3,000
Receptionist 2,000
Example: Ponderosa Development Corp.Example: Ponderosa Development Corp.
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Identify all costs and denote the marginal cost and marginal revenue for each house.
Write the monthly cost function c (x), revenue function r (x), and profit function p (x).
What is the breakeven point for monthly sales of the houses?
What is the monthly profit if 12 houses per month are built and sold?
Determine the BEP for monthly sale of houses graphically.
Example: Ponderosa Development Corp.Example: Ponderosa Development Corp.
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Example: Ponderosa Development Corp.Example: Ponderosa Development Corp.
00
200200
400400
600600
800800
10001000
12001200
00 11 22 33 44 55 66 77 88 99 1010Number of Houses Sold (x)Number of Houses Sold (x)
Th
ousa
nds
of
Dolla
rsTh
ousa
nds
of
Dolla
rs
Break-Even Point = 4 HousesBreak-Even Point = 4 Houses
Total Cost Total Cost = = 40,000 + 40,000 + 105,000x105,000x
Total Total Revenue =Revenue = 115,000x115,000x
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Three locations:Three locations:
AkronAkron $30,000$30,000 $75$75 $180,000$180,000
Bowling GreenBowling Green $60,000$60,000 $45$45 $150,000$150,000
ChicagoChicago $110,000$110,000 $25$25 $160,000$160,000
Selling price Selling price = $120= $120
Expected volumeExpected volume = 2,000 = 2,000 unitsunits
FixedFixed VariableVariable TotalTotalCityCity CostCost CostCost CostCost
Total Cost = Fixed Cost + Variable Cost x VolumeTotal Cost = Fixed Cost + Variable Cost x Volume
Locational Break-Even AnalysisLocational Break-Even Analysis
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–$180,000 $180,000 –
–$160,000 $160,000 –$150,000 $150,000 –
–$130,000 $130,000 –
–$110,000 $110,000 –
––
$80,000 $80,000 ––
$60,000 $60,000 –––
$30,000 $30,000 ––
$10,000 $10,000 ––
An
nu
al c
ost
An
nu
al c
ost
| | | | | | |
00 500500 1,0001,000 1,5001,500 2,0002,000 2,5002,500 3,0003,000
VolumeVolume
Akron Akron lowest lowest costcost
Bowling Green Bowling Green lowest costlowest cost
Chicago Chicago lowest lowest costcost
Chicago cost curve
Chicago cost curve
Akron c
ost
Akron c
ost
curv
e
curv
e
Bowling Green
Bowling Green
cost curve
cost curve
Locational Break-Even Analysis Locational Break-Even Analysis Graph of Break-Even PointsGraph of Break-Even Points
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Example: Step Fixed CostsExample: Step Fixed Costs A manager has the option of purchasing 1, 2 or 3
machines Fixed costs and potential volumes are as follows:
Variable cost = $10/unit and revenue = $40/unit If the projected annual demand is between 580 and 630
units, how many machines should the manager purchase?
# of machines Total annual FC ($) Range of output
1 9600 0 – 300
2 15000 301 – 600
3 20000 601 – 900
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Break-Even Problem with Step Fixed Break-Even Problem with Step Fixed CostsCosts
Quantity
FC + VC = TC
FC + VC = TC
FC + VC =
TC
Step fixed costs and variable costs.
1 machine
2 machines
3 machines
Total RevenueBEVs
Total Cost
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1. One product is involved2. Everything produced can be sold3. Variable cost per unit is the same regardless
of volume4. Fixed costs do not change with volume5. Revenue per unit constant with volume6. Revenue per unit exceeds variable cost per
unit
Assumptions of Cost-Volume AnalysisAssumptions of Cost-Volume Analysis
