Operations Management

MATHEMATICAL
MODELS
USED IN
DECISION MAKNG

Productivity
Productivity is a relationship between the
output (product/services) and the
input (resources consumed in providing
them) of a business system.

Productivity (P) =

Output
Input

Input resources may be Wages, Cost of

Equipment, overhead costs etc.
2

Productivity Measures

Partial Measures:

Multifactor Measures:

A ratio of outputs to only one input (e.g.: labor

productivity, machine utilization, energy
efficiency)
output/(single input)
A ratio of outputs to several, but not all, inputs
output/(multiple inputs)

Total Productivity Measures:

The ratio of outputs to all inputs

output/(total inputs)

Productivity Measures
Partial measures of productivity =
Output or Output or Output or Output
Labor
Capital Materials Energy
Multifactor measures of productivity =
Output
.
Output
.
OR
Labor + Capital + Energy
Labor + Capital + Materials
Total Productivity measures =
Output
.
Labor + Capital + Energy + Materials
4

Partial (Labor) Productivity

600 Insurance policies were processed by 3
employees working 8 hours per day, 5 days in a
week
Productivity =

Policies Processed
Employee Hours

600 policies
(3 Employees)(40 Hours/Employee)

5 policies/hour
5

Multifactor Productivity

Convert all inputs & outputs to $ value

400 units of a product were made by a team of

workers at a cost of $10 each. The actual cost
inputs were:$400 labour, $1,000 materials, and
$300 overhead costs
Productivity =
Quantity at selling price
Labour + Material + O/H
=
(400 units)($10/unit)
$400 + $1000 + $300
=
$4,000/$1,700
=
2.35

Interpreting Productivity
Measures

Is the productivity measure of 2.35 in

the previous example good or bad?
Cant tell without a reference point
Compare to previous measures (e.g.:
last week) or to another benchmark

Productivity Growth Rate

Can be used to compare a process

productivity at a given time (P2) to the
same process productivity at an
earlier time (P1)

Growth Rate

P2

P1
P1
8

Productivity Growth Rate

Example:

Last week a company produced 150 units using 200 hours of labor
This week, the same company produced 180 units using 250 hours of
labor

P1
P2

150 units
200 hours

0.75 units / hour

180 units
250 hours

Growth Rate

0.72 units / hour

P2

P1
P1

0.72 0.75
0.75

0.04

or a negative 4% growth rate

9

Break-Even Analysis

Break-even analysis is used to compare

processes by finding the volume at which
two different processes have equal total
costs.
Break-even point is the volume at which
total revenues equal total costs.
Variable costs (c) are costs that vary
directly with the volume of output.
Fixed costs (F) are those costs that remain
constant with changes in output level.

10

Break-Even Analysis

Q is the volume of customers or units,

c is the unit variable cost, F is fixed
costs and p is the revenue per unit
cQ is the total variable cost.
Total cost = F + cQ
Total revenue = pQ
Break-even is where pQ = F + cQ
(Total revenue = Total cost)

11

Break-Even Analysis can tell you

If a forecast sales volume is sufficient

to break even (no profit or no loss)
How low variable cost per unit must be
to break even given current prices and
sales forecast.
How low the fixed cost need to be to
break even.
How price levels affect the break-even
volume.
12

Hospital Example

A hospital is considering a new procedure to be offered

at $200 per patient. The fixed cost per year would be
$100,000, with total variable costs of $100 per patient.
What is the break-even quantity for this service?

Q = F / (p - c) = 100,000 / (200-100) = 1,000 patients

13

Hospital Example
continued

Dollars (in thousands)

400

300

200

Quantity
(patients)
(Q)

Total Annual
Cost ($)
(100,000 + 100Q)

Total Annual
Revenue ($)
(200Q)

0
2000

100,000
300,000

0
400,000

100

|
500

1000
1500
Patients (Q)

|
2000
14

Quantity
(patients)
(Q)

Total Annual
Cost ($)
(100,000 + 100Q)

Total Annual
Revenue ($)
(200Q)

0
2000

100,000
300,000

0
400,000

(2000, 400)

Dollars (in thousands)

400

300

Total annual revenues

200

100

|
500

Quantity
(patients)
(Q)

Total Annual
Cost ($)
(100,000 + 100Q)

Total Annual
Revenue ($)
(200Q)

0
2000

100,000
300,000

0
400,000

1000
1500
Patients (Q)

|
2000
15

Quantity
(patients)
(Q)

Total Annual
Cost ($)
(100,000 + 100Q)

Total Annual
Revenue ($)
(200Q)

0
2000

100,000
300,000

0
400,000

(2000, 400)

Dollars (in thousands)

400

300

Total annual revenues

(2000, 300)
Total annual costs

200

100
Fixed costs

|
500

1000
1500
Patients (Q)

|
2000
16

Quantity
(patients)
(Q)

Total Annual
Cost ($)
(100,000 + 100Q)

Total Annual
Revenue ($)
(200Q)

0
2000

100,000
300,000

0
400,000

(2000, 400)

400

Dollars (in thousands)

Profits
300

Total annual revenues

(2000, 300)
Total annual costs

200

Break-even quantity

100
Fixed costs

Loss
0

|
500

1000
1500
Patients (Q)

|
2000
17

Two Processes and

Make-or-Buy Decisions

Breakeven analysis can be used to choose

between two processes or between an
internal process and buying those services
or materials.
The solution finds the point at which the total
costs of each of the two alternatives are
equal.
The forecast volume is then applied to see
which alternative has the lowest cost for that
volume.
18

Breakeven for
Two Processes

19

Q=
Breakeven for
Two Processes

Q=

Fm Fb
cb cm
12,000 2,400
2.0 1.5

20

Q=
Breakeven for
Two Processes

Fm Fb
cb cm

Q = 19,200 salads

21

Under Certainty

22

Under Certainty

Alternative
Small facility
Large facility
Do nothing

Possible
Future Demand
Low
High
200
160
0

270
800
0

Example A.5
23

Under Certainty

Alternative
Small facility
Large facility
Do nothing

Possible
Future Demand
Low
High
200
160
0

270
800
0

If future demand will be low

Example A.5
24

Under Certainty

Alternative
Small facility
Large facility
Do nothing

Possible
Future Demand
Low
High
200
160
0

270
800
0

If future demand will be low Choose the small facility.

Example A.5
25

Under Certainty

Alternative
Small facility
Large facility
Do nothing

Possible
Future Demand
Low
High
200
160
0

270
800
0

If future demand will be low Choose the small facility.

Example A.5
26

Under Uncertainty

Alternative
Small facility
Large facility
Do nothing

Example A.6

Possible
Future Demand
Low
High
200
160
0

270
800
0

27

Under Uncertainty

Alternative
Small facility
Large facility
Do nothing

Example A.6

Possible
Future Demand
Low
High
200
160
0

270
800
0

Maximin

28

Under Uncertainty

Alternative
Small facility
Large facility
Do nothing

Example A.6

Possible
Future Demand
Low
High
200
160
0

270 Maximin
800
0 Best of the worst

29

Under Uncertainty

Alternative
Small facility
Large facility
Do nothing

Example A.6

Possible
Future Demand
Low
High
200
160
0

270 Maximin Small

800
0 Best of the worst

30

Under Uncertainty

Alternative
Small facility
Large facility
Do nothing

Example A.6

Possible
Future Demand
Low
High
200
160
0

270
800
0

Maximin Small
Maximax

31

Under Uncertainty

Alternative
Small facility
Large facility
Do nothing

Possible
Future Demand
Low
High
200
160
0

270
800
0

Maximin Small
Maximax

Best of the best

Example A.6

32

Under Uncertainty

Alternative
Small facility
Large facility
Do nothing

Possible
Future Demand
Low
High
200
160
0

270
800
0

Maximin Small
Maximax Large

Best of the best

Example A.6

33

Under Uncertainty

Alternative
Small facility
Large facility
Do nothing

Example A.6

Possible
Future Demand
Low
High
200
160
0

270
800
0

Maximin Small
Maximax Large
Laplace

34

Under Uncertainty

Alternative
Small facility
Large facility
Do nothing
Small facility

Example A.6

Possible
Future Demand
Low
High
200
160
0

270
800
0

Maximin Small
Maximax Large
Laplace

0.5(200) + 0.5(270) = 235

Best
weighted
payoff
35

Under Uncertainty

Alternative
Small facility
Large facility
Do nothing
Small facility
Large facility
Example A.6

Possible
Future Demand
Low
High
200
160
0

270
800
0

Maximin Small
Maximax Large
Laplace

0.5(200) + 0.5(270) = 235

0.5(160) + 0.5(800) = 480

Best
weighted
payoff
36

Under Uncertainty

Alternative
Small facility
Large facility
Do nothing
Small facility
Large facility
Example A.6

Possible
Future Demand
Low
High
200
160
0

270
800
0

Maximin Small
Maximax Large
Laplace Large

0.5(200) + 0.5(270) = 235

0.5(160) + 0.5(800) = 480

Best
weighted
payoff
37

Under Uncertainty

Alternative
Small facility
Large facility
Do nothing

Example A.6

Possible
Future Demand
Low
High
200
160
0

270
800
0

Maximin Small
Maximax Large
Laplace Large
Minimax Regret

38

Under Uncertainty
Possible
Future Demand
Low
High

Alternative
Small facility
Large facility
Do nothing

200
160
0

270
800
0

Maximin Small
Maximax Large
Laplace Large
Minimax Regret

Regret
Low Demand
High Demand
Small facility
Example A.6

200 200 = 0

800 270 = 530

Best
worst
regret
39

Under Uncertainty
Possible
Future Demand
Low
High

Alternative
Small facility
Large facility
Do nothing

200
160
0

270
800
0

Maximin Small
Maximax Large
Laplace Large
Minimax Regret

Regret
Low Demand
High Demand
Small facility
Large facility
Example A.6

200 200 = 0
200 160 = 40

800 270 = 530

800 800 = 0

Best
worst
regret
40

Under Uncertainty
Possible
Future Demand
Low
High

Alternative
Small facility
Large facility
Do nothing

200
160
0

270
800
0

Maximin Small
Maximax Large
Laplace Large
Minimax Regret Large

Regret
Low Demand
High Demand
Small facility
Large facility
Example A.6

200 200 = 0
200 160 = 40

800 270 = 530

800 800 = 0

Best
worst
regret
41

Under Uncertainty

Alternative
Small facility
Large facility
Do nothing

Example A.6

Possible
Future Demand
Low
High
200
160
0

270
800
0

Maximin Small
Maximax Large
Laplace Large
Minimax Regret Large

42

Decision Trees

Decision Trees are schematic

models of alternatives available along
with their possible consequences.
They are used in sequential decision
situations.
Decision points are represented by
squares.
Event points are represented by
circles.
43

Decision Trees
After drawing a decision tree, we solve it by working
from right to left, starting with decisions farthest to the
right, and calculating the expected payoff for each of
its possible paths.
We pick the alternative for that decision that has the
best expected payoff.
We saw off, or prune, the branches not chosen by
marking two short lines through them.
The decision nodes expected payoff is the one
associated with the single remaining branch.

44

ANALYZING A DECISION TREE

A retailer must decide whether to build a small or a large facility

at a new location. Demand at a location can be either small or
large with probabilities estimated to be 0.4 and 0.6 respectively.
If a small facility is built and demand proves to be high, the
manager may choose not to expand (payoff = $223,000) or to
expand (payoff = $270,000). If a small facility is built and
demand is low there is no reason to expand and the payoff is
$200,000. If a large facility is built and the demand proves to be
low, the choice is to do nothing ($40,000) or to simulate
demand through local advertising. The response to advertising
may be either modest or sizeable, with their probabilities
estimated to be 0.3 and 0.7 respectively. If it is modest, the
payoff is estimated to be only $20,000; the payoff grows to
$220,000 if the response is sizeable. Finally, if a large facility is
built and demand turns out to be high, th payoff is $800,000.
Analyze with help of a decision tree to determine the
expected payoff for each decision and event node. Then
decide which alternative has the higher expected payoff. 45

ANALYZING A DECISION TREE

1)

The decision tree is shown in the figure with

event probability and payoff for each event. The
decisions are:
To build a small or large facility

2)

To expand now or later (small facility with high

demand)

3)

Whether to advertise or not (large facility with low

demand)

Now we calculate the expected payoffs

46

Drawing the Tree

47

Drawing the Tree

continued
Low demand [0.4]
$200

Dont expand
$223

Expand
$270

48

Completed Drawing
Low demand [0.4]

$200

Dont expand
$223

Expand
$270

Do nothing
$40

Modest response [0.3]

Advertise
Sizable response [0.7]

High demand [0.6]

$800

$20

$220

49

Solving Decision #3
Low demand [0.4]
$200

Dont expand
$223

Expand
$270

Do nothing

0.3 x $20 = $6
$40

Modest response [0.3]

Advertise
Sizable response [0.7]

$6 + $154 = $160

$20

$220

0.7 x $220 = $154

High demand [0.6]
$800

50

Solving Decision #3
Low demand [0.4]

$200

Dont expand
$223

Expand
$270

Do nothing
$40

Modest response [0.3]

Advertise

$160

Sizable response [0.7]

$160

High demand [0.6]

$800

$20

$220

51

Solving Decision #2
Low demand [0.4]

$200

Dont expand
$223

Expand

$270
1

$270

Expanding has a
higher value.

Do nothing
$40

Modest response [0.3]

Advertise

$160

Sizable response [0.7]

$160

High demand [0.6]

$800

$20

$220

52

Solving Decision #1
Low demand [0.4]

$200 x 0.4 = $80

$242

$242

Dont expand
$223

Expand
$270 x 0.6 = $162

$270
1

Do nothing
$40

Modest response [0.3]

Advertise

$160

Sizable response [0.7]

$160

High demand [0.6]

$800

$20

$220

53

Solving Decision #1
Low demand [0.4]

$200

$242
Dont expand
$223

Expand

$270
1

$270
Do nothing
$40

Advertise

$160
0.4 x $160 = $64

$544

Modest response [0.3]

Sizable response [0.7]

$160

High demand [0.6]

$800 x 0.6 = $480

$20

$220

54

Solving Decision #1
Low demand [0.4]
$200

$242

Dont expand
$223

Expand

$270
1

$270
Do nothing
$40

$544

Advertise

$160

Sizable response [0.7]

$160

$544

Modest response [0.3]

$20

$220

High demand [0.6]

$800

55

ANALYZING A DECISION TREE

The best alternative thus is to

build the large facility.
Subsequent decisions can be
made after learning whether
demand is actually low or
high.
56