Business Analytics 6th Edition Chapter 8 Problem 23p

Chapter 8: Predictive Modeling and Analysis Business Analytics, 1 st edition James R. Evans Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 8 -1

Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 8 -2

Chapter 8 Topics � Logic-Driven Modeling � Data-Driven Modeling � Analyzing Uncertainty and Model Assumptions � Model Analysis Using Risk Solver Platform Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 8 -3

Logic-Driven Modeling � Predictive modeling is the heart and soul of business decisions. � Building decision models is more of an art than a science. � Creating good decision models requires: - solid understanding of business functional areas - knowledge of business practice and research - logical skills � It is best to start simple and enrich models as necessary. Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 8 -4

Logic-Driven Modeling Example 8. 1 The Economic Value of a Customer � A restaurant customer dines 6 times a year and spends an average of $50 per visit. � The restaurant realizes a 40% margin on the average bill for food and drinks. � Annual gross profit on a customer = $50(6)(0. 40) = $120 � 30% of customers do not return each year. � Average lifetime of a customer = 1/. 3 = 3. 33 years � Average gross profit for a customer = $120(3. 33) = $400 Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 8 -5

Logic-Driven Modeling Example 8. 1 (continued) The Economic Value of a Customer V = value of a loyal customer R = revenue per purchase F = purchase frequency (number visits per year) M = gross profit margin D = defection rate (proportion customers not returning each year) Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 8 -6

Logic-Driven Modeling Example 8. 2 A Profit Model Develop a decision model for predicting profit in face of uncertain demand. P = profit R = revenue C = cost p = unit price c = unit cost F = fixed cost S = quantity sold D = demand Q = quantity produced Figure 8. 1 Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 8 -7

Logic-Driven Modeling Example 8. 2 (continued) A Profit Model Cost = fixed cost + variable cost C = F + c. Q Revenue = price times quantity sold R = p. S Quantity sold = Minimum{demand, quantity produced} S = min{D, Q} Profit = Revenue − Cost P = p*min{D, Q} − (F + c. Q) Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 8 -8

Logic-Driven Modeling Example 8. 2 (continued) A Profit Model p = $40 c = $24 F = $400, 000 D = 50, 000 Q = 40, 000 Compute: R = p*min{D, Q} = 40(40, 000) = 1, 600, 000 C = F + c. Q = 1, 360, 000 = 400, 000 + 24(40, 000) P = R − C = 1, 600, 000 – 1, 360, 000 = $240, 000 Figure 8. 2 a Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 8 -9

Logic-Driven Modeling Example 8. 2 (continued) A Profit Model Figure 8. 2 b Figure 8. 2 a Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 8 -10

Logic-Driven Modeling Example 8. 3 New-Product Development � Moore Pharmaceuticals needs to decide whether to conduct clinical trials and seek FDA approval for a newly developed drug. Estimated figures: � R&D cost = $700 million � Clinical trials cost = $150 million � Market size = 2 million people � Market size growth = 3% per year Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 8 -11

Logic-Driven Modeling Example 8. 3 (continued) New-Product Development Additional estimated figures � Market share = 8% � Market share growth = 20% per year (for 5 years) � Revenue from a monthly prescription = $130 � Variable cost for a monthly prescription = $40 � Discount rate for net present value = 9% Moore Pharmaceuticals wants to determine net present value for the next 5 years and to determine how long it will take to recover fixed costs. Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 8 -12

Logic-Driven Modeling Example 8. 3 (continued) New-Product Development Figure 8. 3 b Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 8 -13

Logic-Driven Modeling Example 8. 3 (continued) New-Product Development NPV = $185 million Profitable in 4 th year Figure 8. 3 a Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 8 -14

Logic-Driven Modeling Single-Period Purchase Decisions � One-time purchase decisions often must be made in the face of uncertain demand. Newsvendor Problem: How many newspapers to purchase each day? � C = cost to purchase a newspaper � Q = number of newspapers the vendor purchases � D = number of newspapers demanded � R = revenue from selling a newspaper � S = salvage value of unsold newspapers � Net profit = R(min{Q, D}) + S(max{0, Q−D}) − CQ Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 8 -15

Logic-Driven Modeling Example 8. 4 A Single-Period Purchase Decision Model � A small candy store makes Valentine's Day gift boxes that cost $12 and sell for $18. � In the past, at least 40 boxes have sold by Valentine's Day but the actual amount is unknown. � After the holiday, boxes are discounted 50%. Determine net profit on the gift boxes. � C = 12, R = 18, S = 9 � Net profit = R(min{Q, D}) + S(max{0, Q−D}) − CQ =18(min{Q, D}) + 9(max{0, Q−D}) − 12 Q Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 8 -16

Logic-Driven Modeling Example 8. 4 A Single-Period Purchase Decision Model Net profit =18(min{Q, D}) + 9(max{0, Q−D}) − 12 Q Figure 8. 4 Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 8 -17

Logic-Driven Modeling Example 8. 5 A Hotel Overbooking Model � A popular resort hotel has 300 rooms. � The room rate is $120 per night. � Reservations can be cancelled by 6: 00 p. m. � Cost of overbooking is $100 per occurrence. Determine net revenue on the rooms. � Q = 300, P = 120, C = 100 � D = Reservations − Cancellations � Net revenue = P(min{300, D}) − C(max{0, D−Q}) = 120(min{300, D})− 100(max{0, D− 300}) Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 8 -18

Logic-Driven Modeling Example 8. 5 (continued) A Hotel Overbooking Model Net revenue = 120(min{300, D})− 100(max{0, D− 300}) Figure 8. 5 Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 8 -19

Logic-Driven Modeling Analytics in Practice: Using an Overbooking Model at a Student Health Clinic East Carolina University's health clinic experiences a large number of no-shows. A quality improvement team analyzed an overbooking option. Analytic models developed suggested that an overbooking rate of 7. 3% would result in savings of $95, 000 per semester. Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 8 -20

Logic-Driven Modeling Example 8. 6 A Retirement-Planning Model � Start work at age 22, earning $50, 000 per year. � Expect a salary increase of 3% per year. � Required to contribute 8% to retirement. � Employer contributes 35% of that amount. � Expect an annual return of 8% on the portfolio. Determine the value of the retirement account when the employee is 50 years old. Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 8 -21

Logic-Driven Modeling Example 8. 6 (continued) Retirement-Planning Model � Salary = 1. 03(previous year's salary) � Employee contribution = 0. 08(salary) � Employer contribution = 0. 35(employee contrib. ) � Value of account = 1. 08(previous value) + employee contribution + employer contribution Figure 8. 6 a Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 8 -22

Logic-Driven Modeling Example 8. 6 (continued) Retirement Planning Model Value at 22 years old = $5, 400 Value at 50 years old = $751, 757 Figure 8. 6 b Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 8 -23

Data-Driven Modeling Example 8. 7 Modeling Retail Markdown Pricing Decisions � In the spring, a department store introduces a new line of bathing suits that sells for $70. � The store purchases 1000 of these bathing suits. � During the prime selling season, the store sells an average of 7 units per day at full price (40 days). � On 10 sale days, the price is discounted 30% and sales increase to 32. 2 units per day. � Around July 4 th, the price is marked down 70% to sell off remaining inventory. � Determine total revenue from the bathing suits. Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 8 -24

Data-Driven Modeling Example 8. 7 (continued) Modeling Retail Markdown Pricing Decisions Assume a linear trend model between sales and price: daily sales = a – b(price) 7 = a – b(70) 32. 2 = a – b(49) Daily sales = 91 – 1. 2(price) Figure 8. 7 Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 8 -25

Data-Driven Modeling Example 8. 7 (continued) Revenue from full retail sales = units sold * days * price = (7)*(40)*(70) = $19, 600 Revenue from sale weekends = (32. 2)*(10)*(49) = $15, 778 Revenue from clearance sales = leftovers * price = (1000− 7(40) − 32. 2(10))*(21) = (398)(21) = $8, 358 Figure 8. 7 Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 8 -26

Data-Driven Modeling Example 8. 7 (continued) Modeling Retail Markdown Pricing Decisions Total revenue = $43, 736 Figure 8. 7 Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 8 -27

Data-Driven Modeling Relationships and Trends in Data Create charts to better understand data sets. For cross-sectional data, use a scatter chart. For time series data, use a line chart. Consider using mathematical functions to model relationships. Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 8 -28

Data-Driven Modeling Common mathematical functions used to model relationships in data: Linear y = a + bx Logarithmic y = ln(x) Polynomial (2 nd order) y = ax 2 + bx + c Polynomial (3 rd order) y = ax 3 + bx 2 + dx + e Power y = axb Exponential y = abx Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 8 -29

Data-Driven Modeling Excel Trendline tool Click on a chart � Chart tools � Layout � Trendline Choose a Trendline. Choose whether to display equation and R-squared values closer to 1 indicate better fit of the Trendline to the data. Figure 8. 8 Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 8 -30

Data-Driven Modeling Example 8. 8 Modeling a Price-Demand Function Linear demand function: Sales = -9. 5116(price) + 20512 Figure 8. 9 Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 8 -31

Data-Driven Modeling Example 8. 9 Predicting Crude Oil Prices Line chart of historical crude oil prices Figure 8. 10 Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 8 -32

Data-Driven Modeling Example 8. 9 (continued) Predicting Crude Oil Prices Excel's Trendline tool is used to fit various functions to the data. Logarithmic y = 13 ln(x) + 39 R 2 = 0. 382 Power y = 45. 96 x 0. 0169 R 2 = 0. 397 Exponential y = 50. 5 e 0. 021 x R 2 = 0. 664 Polynomial 2° y = 0. 13 x 2 − 2. 4 x + 68 R 2 = 0. 905 Polynomial 3° y = 0. 005 x 3 − 0. 111 x 2 + 0. 648 x + 59. 5 R 2 = 0. 928 * Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 8 -33

Data-Driven Modeling Example 8. 9 (continued) Predicting Crude Oil Prices Third Order Polynomial Trendline fit to the data Figure 8. 11 Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 8 -34

Analyzing Uncertainty and Model Assumptions What-If Analysis Spreadsheet models allow you to easily evaluate what-if questions. How do changes in model inputs (that reflect key assumptions) affect model outputs? Systematic approaches to what-if analysis make the process easier and more useful. Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 8 -35

Analyzing Uncertainty and Model Assumptions Example 8. 10 Using Excel for What-If Analysis Uncertain demand in the Profit Model. Figure 8. 12 a Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 8 -36

Analyzing Uncertainty and Model Assumptions Example 8. 10 (continued) Using Excel for What-If Analysis Profit increases until demand equals the quantity produced. Figure 8. 12 b Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 8 -37

Analyzing Uncertainty and Model Assumptions Example 8. 10 (continued) Using Excel for What-If Analysis Figure 8. 13 Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 8 -38

Analyzing Uncertainty and Model Assumptions Data Tables � Data Tables summarize the impact of one or two inputs on a specified output. � Excel data table types: One-way data tables – for one input variable Two-way data table – for two input variables To construct a data table: � Data � What-If Analysis � Data Table Figure 8. 14 Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 8 -39

Analyzing Uncertainty and Model Assumptions Example 8. 11 A One-Way Data Table for Uncertain Demand Create a column of demand values (column E). Enter =C 22 in cell F 3 (to reference the output cell). Highlight the range E 3: F 11. Choose Data Table. Enter B 8 for Column input cell. (tells Excel that column E is demand values) Figure 8. 14 Data Table tool computes these values Figure 8. 15 a Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 8 -40

Analyzing Uncertainty and Model Assumptions Example 8. 11 (continued) A One-Way Data Table for Uncertain Demand The Data Table tool computes the profit values in column F (below $240, 000). Figure 8. 15 b Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 8 -41

Analyzing Uncertainty and Model Assumptions Example 8. 12 One-Way Data Tables with Multiple Outputs Create a second output, revenue. Enter =C 15 in cell G 3. Highlight E 3: G 11. Choose Data Table Proceed as in the previous example. Excel computes the revenues values. Figure 8. 15 Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 8 -42

Analyzing Uncertainty and Model Assumptions Example 8. 13 A Two-Way Data Table for the Profit Model Evaluate the impact of both unit price and unit cost Create a column of unit prices (F 5: F 15). Create a row of unit costs (G 4: J 4). Enter =C 22 in cell F 4. Select F 4: J 15. Choose Data Table. Enter B 6 for Row input cell. Enter B 5 for Column input cell. Data Table tool computes these cell values. Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall Figure 8. 17 a 8 -43

Analyzing Uncertainty and Model Assumptions Example 8. 13 (continued) A Two-Way Data Table for the Profit Model Figure 8. 17 b Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 8 -44

Analyzing Uncertainty and Model Assumptions Excel's Scenario Manager Allows creation of scenarios – sets of values that are saved and can be substituted in worksheets. Data What-If Analysis Scenario Manager Add Enter a Scenario Name Changing Cells: Enter cell references to include in scenario. Figure 8. 18 Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 8 -45

Analyzing Uncertainty and Model Assumptions Scenario Manager (continued) � After entering Changing Cells, a Scenario Values dialog box appears. � Enter values for each of the changing cells. � From the Scenario Manager, choose Summary. � Choose a Pivot. Table or Summary. Enter Results cells for the output computations. Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 8 -46

Analyzing Uncertainty and Model Assumptions Example 8. 14 Using the Scenario Manager for the Markdown Pricing Model � Evaluate 4 strategies for pricing and discounts on the bathing suits in the Markdown Pricing Model. � Days at full price Price discount on sale days 10 10% 20 20% 30 30% 40 40% Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 8 -47

Analyzing Uncertainty and Model Assumptions Example 8. 14 (continued) In the Add Scenario dialog box Scenario Name: Ten/ten In the Scenario Values dialog; =E 2 for changing cell B 7 =E 3 for changing cell B 8 Repeat for the other scenarios. Choose Summary. Enter C 33 (total revenue) for the Result cell. A Summary table is generated. Figure 8. 19 Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 8 -48

Analyzing Uncertainty and Model Assumptions Example 8. 14 (continued) Using the Scenario Manager for the Markdown Pricing Model Figure 8. 20 The largest profit results from using the Ten/ten strategy. Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 8 -49

Analyzing Uncertainty and Model Assumptions Goal Seek allows you to alter the data used in a formula in order to find out what the results will be. � Set cell contains the formula that will return the result you're seeking. � To value is the target value you want the formula to return. � By changing cell is the location of the input value that Excel can change to reach the target. Figure 8. 21 Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 8 -50

Analyzing Uncertainty and Model Assumptions Example 8. 15 Finding the Breakeven Point in the Outsourcing Model (using Goal Seek) Find the value of demand at which manufacturing cost equals purchased cost Set cell: B 19 To value: 0 By changing cell: B 12. Figure 8. 21 The breakeven volume is 1000 units. Figure 8. 22 Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 8 -51

Model Analysis Using Risk Solver Platform Example 8. 16 Creating Data Tables with Risk Solver Platform (for Profit Model) Create a one-way data table to evaluate profit as the unit price is varied between $35 and $45. Risk Solver Select cell B 5. Click Parameters in the ribbon. Select Sensitivity. Figure 8. 23 Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 8 -52

Model Analysis Using Risk Solver Platform Example 8. 16 (continued) Creating Data Tables Enter the lower (35) and upper (45) price values. Figure 8. 24 Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 8 -53

Model Analysis Using Risk Solver Platform Example 8. 16 (continued) Creating Data Tables Select cell C 22. Reports Sensitivity Parameter Analysis Figure 8. 25 Figure 8. 2 Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 8 -54

Model Analysis Using Risk Solver Platform Example 8. 16 (continued) Creating Data Table created by Risk Solver Figure 8. 26 Unit price versus profit when unit cost = $24 Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 8 -55

Model Analysis Using Risk Solver Platform Example 8. 16 (continued) Creating Data Tables � 3 D Chart for a twoway data table when both unit price and unit cost are varied. � Charts � Sensitivity Analysis � Parameter Analysis � Vary parameters independently Figure 8. 27 Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 8 -56

Model Analysis Using Risk Solver Platform Tornado Chart Shows the impact that variation in a model input has on some output while holding all other inputs constant. Shows which inputs are the least and most influential on the output. Helps you select the inputs that you would want to further analyze. Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 8 -57

Model Analysis Using Risk Solver Platform Example 8. 17 Creating a Tornado Chart in Risk Solver Platform Profit Model Select cell C 22. Parameters Identify A 10% change in unit price (B 5) affects profit the most. Next is unit cost (B 6). Figure 8. 28 Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 8 -58

Chapter 8 – Key Terms Data table Exponential function Linear function Logarithmic function Newsvendor problem One-way data table Overbook Parametric sensitivity analysis Polynomial function Power function R 2 (R-squared) Scenarios Tornado chart Two-way data table Validity What-if analysis Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 8 -59

Case Study Performance Lawn Equipment (8) Recall that PLE produces lawnmowers and a medium size diesel power lawn tractor. Predict net income for the next 3 years. Determine which variables are uncertain and might change in the future. Discuss any assumptions that you make. Perform what-if, scenario, and parametric sensitivity analysis on the 3 years of net income. Construct a tornado chart and write a formal report summarizing your results. Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 8 -60

Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 8 -61

Business Analytics 6th Edition Chapter 8 Problem 23p

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