Quantitative Analysis for Management

Thirteenth Edition

Chapter 14
Simulation Modeling

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Learning Objectives
After completing this chapter, students will be able to:
14.1 Explain the advantages and disadvantages of simulation.
14.2 Understand the five steps of conducting a Monte Carlo
simulation.
14.3 Analyze a simulation model as applied to inventory
control.
14.4 Understand the other two types of simulation models:
operational gaming and systems simulation.

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Chapter Outline
14.1 Advantages and Disadvantages of Simulation
14.2 Monte Carlo Simulation
14.3 Simulation and Inventory Analysis
14.4 Other Simulation Issues

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Introduction (1 of 2)
• Simulation is one of the most widely used quantitative
analysis tools
• To simulate is to try to duplicate the features, appearance,
and characteristics of a real system
– Build a mathematical model that comes as close as
possible to representing the reality of the system
– Physical models can also be built to test systems
– Problems can range from simple to extremely complex

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Introduction (2 of 2)
• Using simulation, a manager should
1. Define a problem
2. Introduce the variables associated with the problem
3. Construct a simulation model
4. Set up possible courses of action for testing
5. Run the simulation experiment
6. Consider the results
7. Decide what courses of action to take

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Process of Simulation
FIGURE 13.1 Process of Simulation

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Advantages and Disadvantages of
Simulation (1 of 2)
• Advantages
1. Relatively straightforward and flexible
2. Recent advances in computer software make
simulation models very easy to develop
3. Can be used to analyze large and complex real-world
situations
4. Allows “what-if?” type questions
5. Does not interfere with the real-world system
6. Enables study of interactions between components
7. Enables time compression
8. Enables the inclusion of real-world complications
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Advantages and Disadvantages of
Simulation (2 of 2)
• Disadvantages
1. Often expensive, may require a long complicated
process to develop the model
2. Does not generate optimal solutions; it is a trial-and-
error approach
3. Requires managers to generate all conditions and
constraints of real-world problem
4. Each model is unique and the solutions and
inferences are not usually transferable to other
problems

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Monte Carlo Simulation (1 of 2)
• When systems contain elements that exhibit chance in their
behavior, the Monte Carlo method of simulation can be applied
• The basis of the Monte Carlo simulation is experimentation on
the probabilistic elements through random sampling
– Some examples are
1. Inventory demand
2. Lead time for inventory
3. Times between machine breakdowns
4. Times between arrivals
5. Service times
6. Times to complete project activities
7. Number of employees absent
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Monte Carlo Simulation (2 of 2)
• Based on these five steps
1. Establishing a probability distribution for important
input variables
2. Building a cumulative probability distribution for each
variable in Step 1
3. Establishing an interval of random numbers for each
variable
4. Generating random numbers
5. Simulating a series of trials

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Harry’s Auto Tire (1 of 13)
• A popular radial tire accounts for a large portion of the
sales
– Determine a policy for managing this inventory
– Simulate the daily demand for a number of days

Step 1: Establishing probability distributions

– One way to establish a probability distribution for a
given variable is to examine historical outcomes
– Managerial estimates based on judgment and
experience can also be used

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Harry’s Auto Tire (2 of 13)
TABLE 13.1 Historical Daily Demand for Radial Tires at
Harry’s Auto Tire and Probability Distribution

DEMAND FOR TIRES FREQUENCY PROBABILITY OF

(DAYS) OCCURRENCE
0 10 10÷200 = 0.05
1 20 20÷200 = 0.10
2 40 40÷200 = 0.20
3 60 60÷200 = 0.30
4 40 40÷200 = 0.20
5 30 30÷200 = 0.15
Blank 200 200÷200 = 1.00

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Harry’s Auto Tire (3 of 13)
• Step 2: Building a cumulative probability distribution for
each variable
– Converting from a regular probability to a cumulative
distribution is an easy job
– A cumulative probability is the probability that a variable
will be less than or equal to a particular value
– A cumulative distribution lists all of the possible values
and the probabilities

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Harry’s Auto Tire (4 of 13)
TABLE 13.2 Cumulative Probabilities for Radial Tires

CUMULATIVE
DAILY DEMAND PROBABILITY PROBABILITY
0 0.05 0.05
1 0.10 0.15
2 0.20 0.35
3 0.30 0.65
4 0.20 0.85
5 0.15 1.00

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Harry’s Auto Tire (5 of 13)
• Step 3: Setting random number intervals
– Assign a set of numbers to represent each possible
value or outcome
– These are random number intervals
– A random number is a series of digits that have been
selected by a totally random process
– The range of the random number intervals corresponds
exactly to the probability of the outcomes
– A cumulative probability graph can help assign random
numbers

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Harry’s Auto Tire (6 of 13)
FIGURE 13.2 Graphical Representation of the Cumulative
Probability Distribution for Radial Tires

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Harry’s Auto Tire (7 of 13)
TABLE 13.3 Assignment of Random Number Intervals for
Harry’s Auto Tire

CUMULATIVE INTERVAL OF
DAILY DEMAND PROBABILITY PROBABILITY RANDOM NUMBERS
0 0.05 0.05 01 to 05
1 0.10 0.15 06 to 15
2 0.20 0.35 16 to 35
3 0.30 0.65 36 to 65
4 0.20 0.85 66 to 85
5 0.15 1.00 86 to 00

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Harry’s Auto Tire (8 of 13)
• Step 4: Generating random numbers
– Random numbers can be generated in several ways
– Large problems will use computer program to generate
the needed random numbers
– For small problems, random processes like roulette
wheels or pulling chips from a hat may be used
– The most common manual method is to use a random
number table
– Everything is random in a random number table so
numbers can be selected from anywhere in the table

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Harry’s Auto Tire (9 of 13)
TABLE 13.4 Table of Random Numbers

52 06 50 88 53 30 10 47 99 37
37 63 28 02 74 35 24 03 29 60
82 57 68 28 05 94 03 11 27 79
69 02 36 49 71 99 32 10 75 21
98 94 90 36 06 78 23 67 89 85
96 52 62 87 49 56 59 23 78 71
33 69 27 21 11 60 95 89 68 48
50 33 50 95 13 44 34 62 64 39
88 32 18 50 62 57 34 56 62 31
90 30 36 24 69 82 51 74 30 35

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Harry’s Auto Tire (10 of 13)
• Step 5: Simulating the experiment
– Select random numbers from Table 13.4
– The number we select will have a corresponding range
in Table 13.3
– Use the daily demand that corresponds to the
probability range aligned with the random number

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Harry’s Auto Tire (11 of 13)
TABLE 13.5 Ten-Day Simulation of Demand for Radial Tires
DAY RANDOM NUMBER SIMULATED DAILY DEMAND
1 52 3
2 37 3
3 82 4
4 69 4
5 98 5
6 96 5
7 33 2
8 50 3
9 88 5
10 90 5
Blank Blank 39 = total 10-day demand
Blank Blank 3.9 = average daily demand for tires

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Simulation and Inventory Analysis
• Previously introduced deterministic inventory models
• In many real-world inventory situations demand and lead
time are variables
• Accurate analysis is difficult without simulation
• An inventory problem with two decision variables and two
probabilistic components
• The owner of a hardware store wants to establish
– Order quantity and reorder point decisions
– Product that has probabilistic daily demand and reorder
lead time
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Simkin’s Hardware Store (1 of 8)
• Find a good, low-cost inventory policy for the Ace electric
drill
• Simkin identifies two types of variables
– Controllable inputs
 Order quantity
 Reorder points
– Uncontrollable inputs
 Daily demand
 Variable lead time

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Simkin’s Hardware Store (2 of 8)
TABLE 13.6 Probabilities and Random Number Intervals for
Daily Ace Drill Demand

(1) (2) (4) (5)

DEMAND FOR FREQUENCY (3) CUMULATIVE INTERVAL OF
ACE DRILL (DAYS) PROBABILITY PROBABILITY RANDOM NUMBERS
0 15 0.05 0.05 01 to 05
1 30 0.10 0.15 06 to 15
2 60 0.20 0.35 16 to 35
3 120 0.40 0.75 36 to 75
4 45 0.15 0.90 76 to 90
5 30 0.10 1.00 91 to 00
Blank 300 1.00 Blank Blank

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Simkin’s Hardware Store (3 of 8)
TABLE 13.7 Probabilities and Random Number Intervals for
Reorder Lead Time

(1) (2) (3) (4) (5)

LEAD TIME FREQUENCY PROBABILITY CUMULATIVE RANDOM NUMBER
(DAYS) (ORDERS) PROBABILITY INTERVAL
1 10 0.20 0.20 01 to 20
2 25 0.50 0.70 21 to 70
3 15 0.30 1.00 71 to 00
Blank 50 1.00 Blank Blank

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Simkin’s Hardware Store (4 of 8)
• The third step is to develop a simulation model
– A flow diagram, or flowchart, is helpful in this process
• The fourth step in the process is to specify the values of
the variables to be tested
– The first policy is an order quantity of 10 with a reorder
point of 5
• The fifth step is to actually conduct the simulation
– The process is simulated for a 10-day period

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Simkin’s Hardware Store (5 of 8)
FIGURE 13.3
Flow Diagram
for Simkin’s
Inventory
Example

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Simkin’s Hardware Store (6 of 8)
• Using the table of random numbers, the simulation is
conducted using a four-step process
1. Begin each day by checking whether an ordered
inventory has arrived (column 2). If it has, increase
the current inventory (in column 3) by the quantity
ordered.
2. Generate a daily demand from the demand probability
distribution by selecting a random number. This
random number is recorded in column 4. The demand
simulated is recorded in column 5.

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Simkin’s Hardware Store (7 of 8)
3. Compute the ending inventory every day and record it in
column 6. Ending inventory equals beginning inventory
minus demand. If on-hand inventory is insufficient to
meet the day’s demand, satisfy as much as possible
and note the number of lost sales (in column 7).
4. Determine whether the day’s ending inventory has
reached the reorder point (5 units). If it has and if there
are no outstanding orders, place an order (column 8).
Lead time for a new order is simulated by first choosing
a random number from Table 13.4 and recording it in
column 9. Finally, we convert this random number into a
lead time by using the distribution in Table 13.7.

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Simkin’s Hardware Store (8 of 8)
TABLE 13.8 Simkin Hardware’s First Inventory Simulation

ORDER QUANTITY = 10 UNITS REORDER POINT = 5 UNITS

(2) (3) (4) (6) (7) (9) (10)
(1) UNITS BEGINNING RANDOM (5) ENDING LOST (8) RANDOM LEAD
DAY RECEIVED INVENTORY NUMBER DEMAND INVENTORY SALES ORDER NUMBER TIME
1 … 10 06 1 9 0 No Blank Blank
2 0 9 63 3 6 0 No Blank Blank
3 0 6 57 3 3 0 Yes 02 1
4 0 3 94 5 0 2 No Blank Blank
5 10 10 52 3 7 0 No Blank Blank
6 0 7 69 3 4 0 Yes 33 2
7 0 4 32 2 2 0 No Blank Blank
8 0 2 30 2 0 0 No Blank Blank
9 10 10 48 3 7 0 No Blank Blank
10 0 7 88 4 3 0 Yes 14 1
Blank Blank Blank Blank Total 41 2 Blank Blank Blank

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Analyzing Simkin’s Inventory Cost (1 of 4)
• The objective is to find a low-cost solution so Simkin must
determine the costs
• Equations for average daily ending inventory, average lost
sales, and average number of orders placed
Average
41 total units
ending   4.1 units per day
10 days
inventory

Average 2 sales lost

  0.2 unit per day
lost sales 10 days

Average
3 orders
number of   0.3 order per day
10 days
orders placed
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Analyzing Simkin’s Inventory Cost (2 of 4)
• Simkin’s store is open 200 days a year
• Estimated ordering cost is $10 per order
• Holding cost is $6 per drill per year
• Lost sales cost $8
Daily order cost = (Cost of placing one order)
×(Number of orders placed per day)
= $10 per order×0.3 order per day = $3
Daily holding cost = (Cost of holding one unit for one day)×
(Average ending inventory)
= $0.03 per unit per day×4.1 units per day
= $0.12

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Analyzing Simkin’s Inventory Cost (3 of 4)
• Simkin’s store is open 200 days a year
• Estimated ordering cost is $10 per order
• Holding cost is $6 per drill per year
• Lost sales cost $8
Daily stockout cost = (Cost per lost sale)
×(Average number of lost sales per day)

= $8 per lost sale×0.2 lost sales per day

= $1.60
Total daily
inventory cost = Daily order cost + Daily
holding cost
+ Daily
Copyright stockout
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Analyzing Simkin’s Inventory Cost (4 of 4)
• For the year, this policy would cost approximately $944
• Simulation should really be extended for many more days
• Even after a larger simulation, the model must be verified
and validated to make sure it truly represents the situation
on which it is based
• If we are satisfied with the model, additional simulations
can be conducted using other values for the variables
• After simulating all reasonable combinations, Simkin
would select the policy that results in the lowest total cost

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Other Simulation Issues
• Simulation models are widely used in business
– Not restricted by assumptions of other models
• Two other types of simulation models
– Operational gaming
– Systems simulation
• Theoretically different but computerized simulation has
tended to blur the differences

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Operational Gaming
• Operational gaming refers to simulation involving two or
more competing players
– Best examples are military games and business games
– Allow the testing of management and decision-making
skills in hypothetical situations of conflict

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Systems Simulation (1 of 2)
• Systems simulation similar to business gaming
– Allows users to test various managerial policies and
decisions to evaluate their effect on the operating
environment
• Models the dynamics of large systems
– Corporate operating system
– Urban government
– Economic systems
• Allows “what-if?” questions to test the effects of various
policies

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Systems Simulation (2 of 2)
FIGURE 13.5 Inputs and Outputs of a Typical Economic
System Simulation

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Verification and Validation
• It is important that a simulation model be checked to see
that it is working properly and providing good
representation of the real-world situation
• Verification involves determining that the computer model
is internally consistent and following the logic of the
conceptual model
– Answers the question “Did we build the model right?”
• Validation compares a simulation model to the real
system it represents to make sure it is accurate
– Answers the question “Did we build the right model?”

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Role of Computers in Simulation
• Computers are critical in simulating complex tasks
• General-purpose programming languages can be used
• Simulation software tools have been developed to make
the process easier
– Arena – ExtendSim
– ProModel– Proof 5
– SIMUL8
• Excel and add-ins can also be used
– @Risk – RiskSim
– Crystal Ball – XLSim
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Copyright

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