Analytics, Data Science and A I:

Systems for Decision Support

Eleventh Edition

Chapter 8
Prescriptive Analytics: Optimization
and Simulation

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Introduction
• This chapter extends the analytics applications beyond reporting
and predictive analytics. It includes coverage of selected
techniques that can be employed in combination with predictive
models to help support decision making.
• We focus on techniques that can be implemented relatively
easily using either spreadsheet tools or by using stand-alone
software tools.
• Of course, there is much additional detail to be learned about
management science models, but the objective of this chapter is
to simply illustrate what is possible and how it has been
implemented in real settings.

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Introduction
• We present this material with a note of caution: Modeling can
be a difficult topic and is as much an art as it is a science. The
purpose of this chapter is not necessarily for you to master the
topics of modeling and analysis.
• Rather, the material is geared toward gaining familiarity with
the important concepts as they relate to prescriptive analytics
and their use in decision making.
• It is important to recognize that the modeling we discuss here is
only cursorily related to the concepts of data modeling. You
should not confuse the two.

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Introduction
• We walk through some basic concepts and definitions of
decision modeling. We next introduce the idea of modeling
directly in spreadsheets.
• We then discuss the structure and application of two successful
time-proven models and methodologies: linear programming
and discrete event simulation.
• As noted earlier, one could take multiple courses just in these
two topics, but our goal is to give you a sense of what is
possible.

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Learning Objectives (1 of 2)
8.1 Understand the applications of prescriptive analytics
techniques in combination with reporting and predictive
analytics
8.2 Understand the basic concepts of analytical decision
modeling
8.3 Understand the concepts of analytical models for
selected decision problems, including linear
programming and simulation models for decision
support
8.4 Describe how spreadsheets can be used for analytical
modeling and solutions

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Learning Objectives (2 of 2)
8.5 Explain the basic concepts of optimization and
when to use them
8.6 Describe how to structure a linear programming model
8.7 Explain what is meant by sensitivity analysis, what-if
analysis, and goal seeking
8.8 Understand the concepts and applications of different
types of simulation
8.9 Understand potential applications of discrete
event simulation

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Opening Vignette (1 of 2)
School District of Philadelphia Uses
Prescriptive Analytics to Find Optimal Solution
for Awarding Bus Route Contracts

• Background and the problem

• The solution…
• The results…

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Opening Vignette (2 of 2)
Questions for the Opening Vignette:
1. What decision was being made in this vignette?
2. What data (descriptive and or predictive) might one need
to make the best allocations in this scenario?
3. What other costs or constraints might you have to
consider in awarding contracts for such routes?
4. Which other situations might be appropriate for
applications of such models?

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Model Based Decision Making (1 of 2)
• Use models/representations of real-world to make
decision on real-world situations
• Plenty of examples exist in many domains
• Its name changes but the purpose stays the same:
support the decision making process
• I NFO RM S publications has plenty of cutting edge, model-
based decision making examples
– Interfaces (new name-Journal of Applied Analytics),
O RM S Today, and Analytics Magazine

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Application Case 8.1
Canadian Football League Optimizes Game
Schedule
Questions for Discussion:
1. List three ways in which Solver-based scheduling of
games could result in more revenue as compared to the
manual scheduling.
2. In what other ways can CF L leverage the Solver
software to expand and enhance their other business
operations?
3. What other considerations could be important in
scheduling such games?

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Model Based Decision Making (2 of 2)
• Prescriptive analytics model examples
– Mathematical models for decision recommendation
• Idenitification of the problem
– Environmental scanning and analysis
– Variable identification
• Forecasting
– As part of prescriptive analytics
– What is likely to happen
– Influencing the decision made for the future

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Application Case 8.2
Ingram Micro Uses Business Intelligence
Applications to Make Pricing Decisions
Questions for Discussion:
1. What were the main challenges faced by Ingram Micro in
developing a BI C?
2. List all the business intelligence solutions developed by
Ingram to optimize the prices of their products and to
profile their customers.
3. What benefits did Ingram receive after using the newly
developed B I applications?

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Model Categories
• Static versus dynamic models
– Time dependent / time independent
• Model management
• Knowledge-based modeling
• Current trends in modeling
– Model libraries
– Cloud-based modeling tools/platforms
– Model transparency / multi-dimensional modeling
– Influence diagrams for better modeling

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Categories of Models
Table 8.1 Categories of Models.
Category Process and Objective Representative Techniques
Optimization of problems Find the best solution from a small Decision tables, decision trees,
with few alternatives number of alternatives analytic hierarchy process
Optimization via Find the best solution from a large Linear and other mathematical
algorithm number of alternatives, using a programming models, network
step-by-step improvement process models
Optimization via an Find the best solution in one step, Some inventory models
analytic formula using a formula
Simulation Find a good enough solution or the Several types of simulation
best among the alternatives
checked, using experimentation
Heuristics Find a good enough solution, using Heuristic programming, expert
rules systems
Predictive models Predict the future for a given Forecasting models, Markov
scenario analysis
Other models Solve a what-if case, using a Financial modeling, waiting
formula lines

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Structure of Mathematical Models for
Decision Support (1 of 2)
• Quantitative Models: Mathematically links decision
variables, uncontrollable variables, and result variables
– Non-quantitative models: qualitative models
 captures symbolic relationships between decision
variables, uncontrollable variables and result
variables.
• Result (outcome variable):
– Result variables are dependent on chosen
combination of decision variables and uncontrollable
variables

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Structure of Mathematical Models for
Decision Support (1 of 2)
• Decision variables
– Decision variables describe alternative of choices.
• Uncontrollable variable (or parameters)
– Uncontrollable variables are outside of decision-
maker’s control
• Intermediate results
– Intermediate Result Variable reflect intermediate
outcomes in mathematical model

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Structure of Mathematical Models for
Decision Support (2 of 2)

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Examples of Components of Models
Table 8.2 Examples of Components of Models.
Uncontrollable Variables
Area Decision Variables Result Variables
and Parameters
Financial Investment alternatives Total profit, risk Rate of Inflation rate Prime rate
investment and amounts return on investment Competition
(RO I) Earnings per
share 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 Quality level Machine capacity
produce Inventory levels Employee satisfaction Technology Materials
Compensation programs prices
Accounting Use of computers Data processing cost Computer technology
Audit schedule Error rate Tax rates Legal
requirements
Transportation Shipments schedule use Total transport cost Delivery distance
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: Profit
where P = profit, R = revenue, and C = cost
– Example - Simple Present-Value -
F 100, 000
P   62, 092
(1  i ) n
(1  0.1) 5

where P = present value, F = future cash-flow,

i = interest-rate, and n = number of period (years)

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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 for each course of action
– May yield optimal solution
• Uncertainty
– Several outcomes for each decision/course of action
– Probability of occurrence of each outcome is unknown
– Knowledge would lead to less uncertainty
• Risk analysis (probabilistic decision making)
– Consider several possible outcomes for each alternative,
each with a given probability of occurrence.

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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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Application Case 8.3
American Airlines Uses Should-Cost Modeling
to Assess the Uncertainty of Bids for Shipment
Routes
Questions for Discussion:
1. Besides reducing the risk of overpaying or underpaying
suppliers, what are some other benefits A A would derive from
its “should-be” model?
2. Can you think of other domains besides air transportation
where such a model could be used?
3. Discuss other possible methods with which A A could have
solved its bid overpayment and underpayment problem.

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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
– Seamless integration of model and data
– Incorporates both static and dynamic models
– Examples: Microsoft Excel (with Solver add-in)

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Application Case 8.4
Pennsylvania Adoption Exchange Uses
Spreadsheet Model to Better Match Children
with Families
Questions for Discussion:
1. What were the challenges faced by PA E while making
adoption matching decisions?
2. What features of the new spreadsheet tool helped PA E
solve their issues of matching a family with a child?

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Application Case 8.5
Metro Meals on Wheels Treasure Valley Uses
Excel to Find Optimal Delivery Routes

Questions for Discussion:

1. What were the challenges faced by Metro Meals on
Wheels Treasure Valley related to meal delivery before
adoption of the spreadsheet-based tool?
2. Explain the design of the spreadsheet-based model.
3. What are the intangible benefits of using the Excel-
based model to Metro Meals on Wheels?

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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 – effect of prepayment)

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Mathematical Programming
Optimization
• 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
– Distribution of machine time among various products
(allocation problem)

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Mathematical Programming
Optimization
• Linear programming (L P):
• A mathematical model for the optimal solution of resource
allocation problems.
• Linear programming (LP) is the best-known technique in a
family of optimization tools called mathematical programming;
in LP, all relationships among the variables are linear.
• LP models have many important applications in practice. These
include supply chain management, product mix decisions,
routing, and so on.
• Special forms of the models can be used for specific
applications.

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Application Case 8.6
Mixed-Integer Programming Model Helps the
University of Tennessee Medical Center with
Scheduling Physicians
Questions for Discussion:
1. What was the issue faced by the Regional Neonatal
Associates group?
2. How did the HPS M model solve all of the physician’s
requirements?

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L P Problem Characteristics
1. Limited quantity of economic resources
2. Resources are used in the production of products or
services
3. Two or more ways (solutions, programs) to use the
resources
4. Each activity (product or service) yields a return in terms
of the goal
5. Allocation is usually restricted by constraints

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Mathematical Programming
Optimization
• Allocation problems typically have a large number of
possible solutions. Depending on the underlying
assumptions, the number of solutions can be either infinite
or finite. Usually, different solutions yield different rewards.
• Of the available solutions, at least one is the best, in the
sense that the degree of goal attainment associated with it
is the highest (i.e., the total reward is maximized). This is
called an optimal solution, and it can be found by using a
special algorithm.

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Linear Programming (L P) Steps
1. Identify the …
– Decision variables
– Objective function
– Objective function coefficients
– Constraints
 Capacities / Demands / …
2. Represent the model
– LI ND O: Write mathematical formulation
– EXCE L: Input data into specific cells in Excel
3. Run the model and observe the results

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L P Modeling – Example (1 of 3)
The Product-Mix Linear Programming Model
• MB I Corporation
• Decision variable: How many computers to build next month?
• Two types of mainframe computers: C C-7 and C C-8
• Constraints: Labor limits, Materials limit, Marketing lower limits
CC-7 CC-8 Rel Limit
Labor (days) 300 500 <= 200,000 /mo
Materials ($) 10,000 15,000 <= 8,000,000 /mo
Units 1 >= 100
Units 1 >= 200
Profit ($) 8,000 12,000 Max

Objective: Maximize Total Profit / Month

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L P Modeling – Example (2 of 3)

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L P Modeling – Example (3 of 3)
Figure 8.6 Excel Solver Solution to the Product-Mix
Example.

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Illustrating the Power of Spreadsheet
Modeling
• Election Resource Allocation Problem

Analysis of “swing states” for the 2012 election…

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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 6)
• Multiple Goals
– Simple-goal vs. multiple goals
– Vast majority of managerial problems has multiple
goals (objectives) to achieve
 Attaining simultaneous goals
– Methods of handling multiple goals
 Utility theory
 Goal programming
 Expression of goals as constraints, using L P
 A points system

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Multiple Goals, Sensitivity Analysis,
What-If Analysis, and Goal Seeking
(2 of 6)
• 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
– Goals change in response to other changes
– 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 6)
• Sensitivity analysis
– It is the process of assessing the impact of change in
inputs on outputs
– Helps to …
 eliminate (or reduce) variables
 revise models to eliminate too-large sensitivities
 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 6)
• What-if analysis
– Assesses solutions based on changes in variables or
assumptions (scenario analysis)
– What if we change our capacity at the milling station by
40% [what would be the impact]
• 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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Multiple Goals, Sensitivity Analysis,
What-If Analysis, and Goal Seeking
(5 of 6)
Figure 8.10 Example of a What-If Analysis Done in an
Excel Worksheet.

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Multiple Goals, Sensitivity Analysis,
What-If Analysis, and Goal Seeking
(6 of 6)
Figure 8.11 Goal-Seeking Analysis.

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Decision Analysis with Decision
Tables and Decision Trees
• Decision situations that involve a finite and usually not too
large number of alternatives are modeled through an
approach called decision analysis.
• Using this approach, the alternatives are listed in a table
or a graph, with their forecasted contributions to the
goal(s) and the probability of obtaining the contribution.
These can be evaluated to select the best alternative.
• Single-goal situations can be modeled with decision tables
or decision trees.
• Multiple goals (criteria) can be modeled with several other
techniques, described later in this chapter.

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Decision Analysis with Decision
Tables and Decision Trees
• Decision Tables – a tabular representation of the decision
situation (alternatives)
• Investment Example
– Investing in one of three alternatives: bonds, stocks
and certificate of deposit (CD)
– 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
(1 of 2)
1. If solid growth in the economy, bonds yield 12%; stocks
15%; time deposits 6.5%
2. If stagnation, bonds yield 6%; stocks 3%; time deposits
6.5%
3. If inflation, bonds yield 3%; stocks lose 2%; time
deposits yield 6.5%

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Decision Table: Investment Example
(2 of 2)
• Payoff decision variables (alternatives)
• Uncontrollable variables (states of economy)
• Result variables (projected yield)
• Tabular representation:

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Decision Table
Investment Example: Treating Certainty,
Uncertainty and Risk
• Certainty
• Treating Uncertainty
– Optimistic approach
– Pessimistic approach

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Decision Table
Investment Example: Treating Certainty,
Uncertainty and Risk
• Treating Risk:
– Use known probabilities
– Risk analysis: compute expected values

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Decision Table: Investment Example
(Multiple Goals)
• Multiple goals
– Yield, safety, and liquidity

Alternative Yield (%) Safety Liquidity

Bonds 8.4 High High
Stocks 8.0 Low High
CDs 6.5 Very high High

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Decision Trees
• Graphical representation of relationships
• Multiple criteria approach
• Demonstrates complex relationships
• Cumbersome, if many alternatives exists
• Tools include
– Mind Tools Ltd., mindtools.com
– TreeAge Software Inc., treeage.com
– Palisade Corp., palisade.com

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Decision Trees – An Example

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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 DS S 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 for other DS S
techniques

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Application Case 8.7
Steel Tubing Manufacturer Uses a Simulation-
Based Production Scheduling System
Questions for Discussion:
1. Explain the advantages of using Simio’s simulation model
over traditional methods.
2. In what ways has the predictive analysis approach helped
management achieve the goals of analyzing the production
schedules?
3. Besides the steel manufacturing industry, in what other
industries could such a modeling approach help improve
quality and service?

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Major Characteristics of Simulation
• Imitates reality and captures its richness both in shape
and behavior
• “Represent” versus “Imitate”
• Technique for conducting experiments
• Descriptive, not normative tool
• Often to “solve” [i.e., analyze] very complex
systems/problems
• Simulation should be used only when a numerical
optimization is not possible

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Advantages of Simulation
• The theory is fairly straightforward
• Great deal of time compression
• 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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Disadvantages of Simulation
• Cannot guarantee an optimal solution
• Slow and costly construction process
• Cannot transfer solutions and inferences to solve other
problems (problem specific)
• So easy to explain/sell to managers, may lead to
overlooking analytical solutions
• Software may require special skills

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Simulation Methodology
Steps:
1. Define problem 5. Conduct experiments
2. Construct the model 6. Evaluate results
3. Test and validate model 7. Implement solution
4. Design experiments

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Simulation Types
• Probabilistic/Stochastic vs. Deterministic Simulation
– Uses probability distributions
• Time-dependent vs. Time-independent Simulation
– Monte Carlo technique (X = A + B)
[A, B, and X are all distributions]
• Discrete Event vs. Continuous Simulation
• Simulation Implementation
– Visual Simulation and/or Object-Oriented Simulation

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Application Case 8.8
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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Visual Interactive Simulation (VI S)
• Visual interactive modeling (VI M), also called Visual
Interactive Simulation or Visual interactive problem solving
• Uses computer graphics to present the impact of different
management decisions
• Often integrated with 3G and G I S
• Users can perform sensitivity analysis
• Static or dynamic (animation) systems
• Virtual reality, immersive, …

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Simulation Software
• Stand-alone desktop simulation tools
• Web-based simulation tools
• See O R/M S Today for software reviews
• Examples:
– Simio
– Arena
– ExtendSim
– SA S Simulation Studio
– …

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Application Case 8.9
Improving Job-Shop Scheduling Decisions
through R F I D: A Simulation-Based Assessment
Questions for Discussion:
1. In situations such as what this case depicts, what other
approaches can one take to analyze investment
decisions?
2. How would one save time if an RFI D chip can tell the
exact location of a product in process?
3. Research to learn about the applications of RFI D sensors
in other settings. Which one do you find most interesting?

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Application Case 8.9 – Simio Model
(1 of 4)
Figure 8.13 Simio Interface View of the Simulation System.

Source: Used with permission from Simio LL C.

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Application Case 8.9 – Simio Model
(2 of 4)
Figure 8.14 Process View of the Simulation Model.

Back End - Process

Source: Used with permission from Simio LL C.

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Application Case 8.9 – Simio Model
(3 of 4)
Figure 8.15 Standard Report View.

Source: Used with permission from Simio LL C.

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Application Case 8.9 – Simio Model
(4 of 4)
Figure 8.16 Pivot Grid Report from a Simio Run.

OUTPUT

Source: Used with permission from Simio LL C.

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