Business Intelligence, Analytics, and Data
Science: A Managerial Perspective
Chapter 6
Prescriptive Analytics: Optimization and Simulation
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Learning Objectives
6.1 Understand the applications of prescriptive analytics
techniques in combination with reporting and predictive
analytics
6.2 Understand the basic concepts of analytical decision
modeling
6.3 Describe how spreadsheets can be used for analytical
modeling and solutions
6.4 Explain the basic concepts of optimization and when to
use them
6.5 Explain what is meant by sensitivity analysis, what-if
analysis, and goal seeking
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Model-Based Decision Making
• Prescriptive analytics – making decision using some kind
of analytical model
– Descriptive and predictive analytics creates the
foundation (i.e., choice alternatives) for prescriptive
analytics (i.e., making best possible decision)
• Descriptive and Predictive leads to Prescriptive
• Example
– Profit maximization based on optimal spending on
promotions and product/service pricing
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Traveling Salesman Problem
• Read the TSP
• https://towardsdatascience.com/basic-ai-algorithms-a760
7b9ecdce
• Discuss the other optimization possible solutions
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Application Case
Optimal Transport for ExxonMobil Downstream
through a Decision Support System (DSS)
Questions for Discussion
1. List three ways in which manual scheduling of ships could
result in more operational costs as compared to the tool
developed.
2. What are some strategic decisions that could be made by
decision makers using the tool developed?
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Major Modeling Issues
• Problem identification (information collection)
• Variable identification
– Influence diagrams, cognitive maps
• Multiple models: A decision system can include several
models, each of which representing a different part of the
decision-making problem
– Static versus dynamic models
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Categories of Models
Category Process and Objective Representative Techniques
Optimization of problems with few Find the best solution from a small Decision tables, decision trees,
alternatives number of alternatives analytic hierarchy process
Optimization via algorithm Find the best solution from a large Linear and mathematical
number of alternatives programming models, network
Models
Optimization via an analytic Find the best solution in one step, Some inventory models
formula using a formula
Simulation Find a good enough solution or the Several types of simulation
best among the alternatives checked,
using experimentation
Predictive models Predict the future for a given Forecasting models
scenario
Other models Solve a what-if case Financial modeling
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Structure of Mathematical Models for
Decision Support
• Non-Quantitative Models (Qualitative): Strategy
• Quantitative Models: Mathematically links decision
variables, uncontrollable variables, and result variables
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Examples - Components of Models
Examples of Components of Models
Uncontrollable Variables
Area Decision Variables Result Variables and Parameters
Financial Investment alternatives Total profit, risk Inflation rate
investment and amounts Rate of return on investment (R OI) Prime rate
Earnings per share Competition
Liquidity level
Marketing Advertising budget Market share Customer’s income
Where to advertise Customer satisfaction Competitor’s actions
Manufacturing What and how much to Total cost Machine capacity
produce Inventory levels Quality level Technology
Compensation programs Employee satisfaction Materials prices
Accounting Use of computers Data processing cost Computer technology
Audit schedule Error rate Tax rates
Legal requirements
Transportation Shipments schedule Total transport cost Delivery distance
Use of smart cards Payment float time Regulations
Services Staffing levels Customer satisfaction Demand for services
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The Structure of a Mathematical Model
• The components of a quantitative model are linked
together by mathematical (algebraic) expressions—
equations or inequalities.
• Example: P = R − C
– where P = profit, R = revenue, and C = cost
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Modeling and Decision Making - Under
Certainty, Uncertainty, and Risk (1 of 2)
• Certainty
– Assume complete knowledge
– All potential outcomes are known
– May yield optimal solution
• Uncertainty
– Several outcomes for each decision
– Probability of each outcome is unknown
– Knowledge would lead to less uncertainty
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Modeling and Decision Making - Under
Certainty, Uncertainty, and Risk (2 of 2)
• The zones of decision making
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Decision Modeling with Spreadsheets
• Spreadsheet
– Most popular end-user modeling tool
– Flexible and easy to use
– Powerful functions (add-in functions)
– Programmability (via macros)
– What-if analysis and goal seeking
– Simple database management
– Examples: Microsoft Excel, Lotus 1-2-3
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Excel Spreadsheet - Static Model Example
Simple loan calculation of monthly payments
F P 1 i
n
i 1 i n
A P
1 i 1
n
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Excel Spreadsheet - Dynamic Model
Example
Simple loan calculation of monthly payments & effects
of prepayment
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Optimization via Mathematical
Programming
• Mathematical Programming
– A family of tools designed to help solve managerial
problems in which the decision maker must allocate
scarce resources among competing activities to
optimize a measurable goal
• Optimal solution: The best possible solution to a modeled
problem
– Linear programming (LP): A mathematical model for
the optimal solution of resource allocation problems.
All the relationships are linear.
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Linear Programming Steps
1. Identify the …
– Decision variables
– Objective function
– Objective function coefficients
– Constraints
▪ Capacities / Demands / …
2. Represent the model
– LINDO: Write mathematical formulation
– EXCEL: Input data into specific cells in Excel
3. Run the model and observe the results
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Common Optimization Models
• Assignment (best matching of objects)
• Dynamic programming
• Goal programming
• Investment (maximizing rate of return)
• Linear and integer programming
• Network models for planning and scheduling
• Nonlinear programming
• Replacement (capital budgeting)
• Simple inventory models (e.g., economic order quantity)
• Transportation (minimize cost of shipments)
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Multiple Goals, Sensitivity Analysis, What-
If Analysis, and Goal Seeking (1 of 4)
• Multiple Goals
– Simple-goal vs. multiple goals
– Vast majority of managerial problems has multiple
goals (objectives) to achieve
▪ Attaining all goals simultaneously
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Multiple Goals, Sensitivity Analysis, What-
If Analysis, and Goal Seeking (2 of 4)
• Certain difficulties may arise when analyzing multiple
goals:
– Difficult to obtain a single organizational goal
– The importance of goals change over time
– Goals and sub-goals are viewed differently
– Dynamics of groups of decision makers
– Assessing the importance (priorities)
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Multiple Goals, Sensitivity Analysis, What-
If Analysis, and Goal Seeking (3 of 4)
• Sensitivity analysis
– It is the process of assessing the impact of change in
inputs on outputs
– Helps to …
▪ eliminate (or reduce) variables
▪ adding details about sensitive variables or scenarios
▪ obtain better estimates of sensitive variables
▪ alter a real-world system to reduce sensitivities
▪…
– Can be automatic or trial and error
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Multiple Goals, Sensitivity Analysis, What-
If Analysis, and Goal Seeking (4 of 4)
• What-if analysis
– Assesses solutions based on changes in variables
– What if we change our capacity at the milling station by
40% [what would be the impact on output?]
• Goal seeking
– Backwards approach, starts with the goal and
determines values of inputs needed
– Example is break-even point determination
▪ In order to break even (profit = 0), how many
products do we have to sell each month?
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Decision Analysis with Decision Tables and
Decision Trees
• Decision Tables – a tabular representation of the
decision situation (alternatives)
• Investment example:
– Goal: maximize the yield after one year
– Yield depends on the status of the economy (the
state of nature)
▪ Solid growth
▪ Stagnation
▪ Inflation
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Decision Table – Investment Example:
Possible Situations
1. If solid growth in the economy, bonds yield 12%;
stocks 15%
2. If stagnation, bonds yield 6%; stocks 3%
3. If inflation, bonds yield 3%; stocks lose 2%
Alternative Solid Growth (%) Stagnation (%) Inflation (%)
Bonds 12.0 6.0 3.0
Stocks 15.0 3.0 –2.0
CDs 6.5 6.5 6.5
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Decision Trees
• Graphical representation of relationships
– Can be induced (driven) from data [data mining]
– Can be driven from experts [knowledge-driven]
• Demonstrates complex relationships
• Many tools exist:
– Mind Tools Ltd., mindtools.com
– TreeAge Software Inc., treeage.com
– Palisade Corp., palisade.com
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5 Minutes
Simulation: Application Case
Cosan Improves Its Renewable Energy Supply Chain
Using Simulation
Questions for Discussion
1. What type of supply chain disruptions might occur in
moving the sugar cane from the field to the production
plants to develop sugar and ethanol?
2. What types of advanced planning and prediction might
be useful in mitigating such disruptions?
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Simulation
• Simulation is the “appearance” of reality
• It is often used to conduct what-if analysis on the model of
the actual system
• It is a popular DSS technique for conducting experiments
with a computer on a comprehensive model of the system
to assess its dynamic behavior
• Often used when the system is too complex
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Advantages of Simulation
• The theory is fairly straightforward
• Experiment with different alternatives
• The model reflects manager’s perspective
• Can handle wide variety of problem types
• Can include the real complexities of problems
• Produces important performance measures
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Simulation Methodology
Model Development Steps: 4. Design experiments
1. Define problem 5. Conduct experiments
2. Construct the model 6. Evaluate results
3. Test and validate model 7. Implement solution
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Simulation Types
• Stochastic vs. Deterministic Simulation
– Uses probability distributions
• Time-dependent vs. Time-independent Simulation
– Monte Carlo Simulation X A B
[A, B, and X are all probability distributions]
• Discrete Event vs. Continuous Simulation vs. Agent-
Based Simulation
• Simulation Implementation
– Visual Simulation and/or Object-Oriented Simulation
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Visual Interactive Simulation (VIS)
• Visual interactive modeling (V IM), also called Visual
Interactive Simulation or Visual Interactive Problem
Solving
• Goal is to address conventional simulation modeling
inadequacies
• Uses computer graphics and animation
• Often integrated with RFID and GIS
• Allows for interactive/immersive sensitivity analysis
• Virtual reality
• Immersive presence
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Application Case (investment decisions using
RFID) (1 of 5)
Improving Job-Shop Scheduling Decisions through R FID: A
Simulation-Based Assessment
Questions for Discussion
1. How would one save time if an RFID chip can tell the exact
location of a product in process?
2. Research to learn about the applications of RFID sensors
in other settings. Which one do you find most interesting?
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Application Case (2 of 5)
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Application Case (3 of 5)
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Application Case (4 of 5)
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Application Case (5 of 5)
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Simulation Software
• A comprehensive list can be found at
– orms-today.org/surveys/Simulation/Simulation.html
• Simio LLC, simio.com
• SAS Simulation [SAS OR], sas.com
• Lumina Decision Systems, lumina.com
• Oracle Crystal Ball, oracle.com
• Palisade Corp., palisade.com
• Rockwell Software, arenasimulation.com …
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