Readings Chapter 4 Linear Programming Applications in Marketing

Readings Chapter 4 Linear Programming Applications in Marketing, Finance, and Operations Management BA 452 Lesson A. 8 Marketing and Finance Applications 1

Overview BA 452 Lesson A. 8 Marketing and Finance Applications 2

Overview Media Selection Problems help marketing managers allocate a fixed advertising budget to various advertising media. The objective is to maximize reach, frequency, and quality of exposure. Marketing Research Problems help marketing managers learn about consumer characteristics and preferences, by surveying sufficiently many people at minimum cost. Portfolio Selection Problems with Dynamic Constraints help select specific investments (stocks, bonds, …) over time to either maximize expected return or minimize risk. BA 452 Lesson A. 8 Marketing and Finance Applications 3

Overview Tool Summary n n One possible way to solve a program where some variables are restricted to be integers (like the number of ads in Example 1): Do not restrict the variables to be integers, and maybe the variables at an optimum will be integers. • Warning: This does not always work: without integer restrictions, some variables at an optimum may not be integers --- even if all coefficients in the linear program are integers (like in an Example in Lesson I-3). Use compound variables: • First Example: EFR = number of evening ads on Friday • Second Example: Gi = amount of new investment in government bonds in month i • Third Example: SO 1 = number of standard wheels made with overtime labor in month 1 BA 452 Lesson A. 8 Marketing and Finance Applications 4

Tool Summary n n Use dynamic or recursive constraints: • Second Example: Constrain that Month 2's total investment be limited to principle and interest invested locally in Month 1: G 2 + C 2 + L 2 = 1. 0075 L 1 Use inventory variables: • Second Example: SI = number of standard wheels held in inventory from month 1 to month 2 BA 452 Lesson A. 8 Marketing and Finance Applications 5

Media Selection BA 452 Lesson A. 8 Marketing and Finance Applications 6

Media Selection Overview Media Selection Problems help marketing managers allocate a fixed advertising budget to various advertising media. Potential media include newspapers, magazines, radio, television, and direct mail. The objective is to maximize reach, frequency, and quality of exposure. Constraints may restrict permissible allocations by company policy, contract requirements, and media availability. BA 452 Lesson A. 8 Marketing and Finance Applications 7

Media Selection Question: SMM Company recently developed a new instant salad machine, and has $282, 000 to spend on advertising. The product is to be initially test marketed in the Dallas area. The money is to be spent on a TV advertising blitz during one weekend (Friday, Saturday, and Sunday) in November. The three options available are: daytime advertising, evening news advertising, and Sunday game-time advertising. A mixture of one-minute TV spots is desired. BA 452 Lesson A. 8 Marketing and Finance Applications 8

Media Selection Ad Type Ad Daytime Evening News Sunday Game Estimated Audience Reached With Each Ad 3, 000 4, 000 75, 000 Cost Per $5, 000 $7, 000 $100, 000 SMM wants to take out at least one ad of each type (daytime, evening-news, and game-time). Further, there are only two game-time ad spots available. There are ten daytime spots and six evening news spots available daily. SMM wants to have at least 5 ads per day, but spend no more than $50, 000 on Friday and no more than $75, 000 on Saturday. BA 452 Lesson A. 8 Marketing and Finance Applications 9

Media Selection What should be SMM’s objective? Are you making any implicit assumptions? BA 452 Lesson A. 8 Marketing and Finance Applications 10

Media Selection BA 452 Lesson A. 8 Marketing and Finance Applications 11

Media Selection Define the decision variables DFR = number of daytime ads on Friday DSA = number of daytime ads on Saturday DSU = number of daytime ads on Sunday EFR = number of evening ads on Friday ESA = number of evening ads on Saturday ESU = number of evening ads on Sunday GSU = number of game-time ads on Sunday n Define the objective function Maximize the total audience reached = Max (audience per ad of each type)x(number of ads used of each type) Max 3000 DFR +3000 DSA +3000 DSU +4000 EFR +4000 ESA +4000 ESU +75000 GSU n BA 452 Lesson A. 8 Marketing and Finance Applications 12

Media Selection n Define the constraints to take out at least one ad of each type: (1) DFR + DSA + DSU > 1 (2) EFR + ESA + ESU > 1 (3) GSU > 1 Define the constraints of ten daytime spots available: (4) DFR < 10; (5) DSA < 10; (6) DSU < 10 Define the constraints of six evening news spots available: (7) EFR < 6; (8) ESA < 6; (9) ESU < 6 BA 452 Lesson A. 8 Marketing and Finance Applications 13

Media Selection n n Define the constraint of only two Sunday game-time ad spots available: (10) GSU < 2 Define the constraint of at least 5 ads per day: (11) DFR + EFR > 5; (12) DSA + ESA > 5; (13) DSU + ESU + GSU > 5 Define the constraint of spending no more than $50, 000 on Friday: (14) 5000 DFR + 7000 EFR < 50000 Define the constraint of spending no more than $75, 000 on Saturday: (15) 5000 DSA + 7000 ESA < 75000 Define the constraint of spending no more than $282, 000 in total: (16) 5000 DFR + 5000 DSA + 5000 DSU + 7000 EFR + 7000 ESA + 7000 ESU + 100000 GSU 7 < 282000 BA 452 Lesson A. 8 Marketing and Finance Applications 14

Media Selection Interpretation: Total new audience reached = 199, 000 Number of daytime ads on Friday = 8 Number of daytime ads on Saturday = 5 Number of daytime ads on Sunday = 2 Number of evening ads on Friday = 0 Number of evening ads on Saturday = 0 Number of evening ads on Sunday = 1 Number of game-time ads on Sunday = 2 BA 452 Lesson A. 8 Marketing and Finance Applications 15

Marketing Research BA 452 Lesson A. 8 Marketing and Finance Applications 16

Marketing Research Overview Marketing Research Problems help marketing managers learn about consumer characteristics and preferences. Marketing research firms design and solve such problems to survey sufficiently many people at minimum cost. BA 452 Lesson A. 8 Marketing and Finance Applications 17

Marketing Research Question: C R Market Surveys, Inc. specializes in evaluating consumer reaction to new products and advertising campaigns. A client hired Market Survey Inc. to measure consumer reaction to a recently marketed product. Market Survey Inc. agreed to conduct interviews from households, both with or without children, during either the day or evening. BA 452 Lesson A. 8 Marketing and Finance Applications 18

Marketing Research The client’s contract calls for 1000 interviews under the following quotas: 1. Interview at least 400 households with children. 2. Interview at least 400 households without children. 3. Interview at least as many households at night, as during the day. 4. Of the interviews of households with children, at least 40 percent must be during the evening. 5. Of the interviews of households without children, at least 60 percent must be during the evening. Based on previous studies, here are the estimated interview costs: Household Day Evening Children $20 $25 No Children $18 $20 Formulate the Marketing Research Problem for finding the minimumcost household, time-of-day interview plan satisfying all quotas. BA 452 Lesson A. 8 Marketing and Finance Applications 19

Marketing Research Answer: Define decision variables DC = the number of daytime interviews of households with children DN = the number of daytime interviews of households with no children EC = the number of evening interviews of households with children EN = the number of evening interviews of households with no children BA 452 Lesson A. 8 Marketing and Finance Applications 20

Marketing Research Household Day Evening Children $20 $25 No Children $18 $20 Given cost per unit, minimize total cost: Min 20 DC + 18 DN + 25 EC + 20 EN BA 452 Lesson A. 8 Marketing and Finance Applications 21

Marketing Research Formulate Constraints: 1. Interview at least 1000 households: DC + DN + EC + EN > 1000 2. Interview at least 400 households with children: DC + EC > 400 3. Interview at least 400 households without children: DN + EN > 400 4. Interview at least as many households at night, as during the day: EC + EN > DC + DN 5. Of the interviews of households with children, at least 40 percent must be during the evening: EC > 0. 40(DC + EC) 6. Of the interviews of households without children, at least 60 percent must be during the evening: EN > 0. 60(DN + EN) BA 452 Lesson A. 8 Marketing and Finance Applications 22

Portfolio Selection with Dynamic Constraints BA 452 Lesson A. 8 Marketing and Finance Applications 23

Portfolio Selection with Dynamic Constraints Overview Portfolio Selection Problems with Dynamic Constraints help financial managers select specific investments (stocks, bonds, …) over time to either maximize expected return or minimize risk. Dynamic Constraints may restrict new investment in one period to equal the return from investments in previous periods. For example, there may be no new investments one month if all investments in previous months have not yet matured. BA 452 Lesson A. 8 Marketing and Finance Applications 24

Portfolio Selection with Dynamic Constraints Question: Pepperdine University has $20 million available for investment. It wishes to invest over the next four months in such a way that it will maximize the total interest earned (after all investments mature) as well as have at least $10 million available at the start of the fifth month for a high rise building venture in which it will be participating. For the time being, Pepperdine wishes to invest only in 2 -month government bonds (earning 2% over the 2 -month period) and 3 -month construction loans (earning 6% over the 3 -month period). Each of these is available each month for investment. Funds not invested in these two investments are liquid and earn 3/4 of 1% per month when invested locally. How should Pepperdine invest over the next four months if at no time does it wish to have more than $8 million in either government bonds or construction loans? BA 452 Lesson A. 8 Marketing and Finance Applications 25

Portfolio Selection with Dynamic Constraints Answer: Define the decision variables Gi = amount of new investment in government bonds in month i (for i = 1, 2, 3, 4) Ci = amount of new investment in construction loans in month i (for i = 1, 2, 3, 4) Li = amount invested locally in month i (for i = 1, 2, 3, 4) BA 452 Lesson A. 8 Marketing and Finance Applications 26

Portfolio Selection with Dynamic Constraints n Define the objective function Maximize total interest earned after all investments mature: Max (interest rate on investment) X (amount invested) Max. 02 G 1 +. 02 G 2 +. 02 G 3 +. 02 G 4 +. 06 C 1 +. 06 C 2 +. 06 C 3 +. 06 C 4 +. 0075 L 1 +. 0075 L 2 +. 0075 L 3 +. 0075 L 4 BA 452 Lesson A. 8 Marketing and Finance Applications 27

Portfolio Selection with Dynamic Constraints n Constrain that Month 1's total investment be $20 million: (1) G 1 + C 1 + L 1 = 20, 000 n Constrain that Month 2's total investment be limited to principle and interest invested locally in Month 1: (2) G 2 + C 2 + L 2 = 1. 0075 L 1 , or G 2 + C 2 - 1. 0075 L 1 + L 2 = 0 n Constrain that Month 3's total investment be limited to principle and interest invested in government bonds in Month 1 and locally invested in Month 2: (3) G 3 + C 3 + L 3 = 1. 02 G 1 + 1. 0075 L 2 , or - 1. 02 G 1 + G 3 + C 3 1. 0075 L 2 + L 3 = 0 BA 452 Lesson A. 8 Marketing and Finance Applications 28

Portfolio Selection with Dynamic Constraints n n Constrain that Month 4's total investment be limited to principle and interest invested in construction loans in Month 1, government bonds in Month 2, and locally invested in Month 3: (4) G 4 + C 4 + L 4 = 1. 06 C 1 + 1. 02 G 2 + 1. 0075 L 3 , or - 1. 02 G 2 + G 4 - 1. 06 C 1 + C 4 - 1. 0075 L 3 + L 4 = 0 Constrain that $10 million must be available at start of Month 5: (5) 1. 02 G 3 + 1. 06 C 2 + 1. 0075 L 4 > 10, 000 BA 452 Lesson A. 8 Marketing and Finance Applications 29

Portfolio Selection with Dynamic Constraints n n Constrain that no more than $8 million be in government bonds at any time: (6) G 1 < 8, 000; (7) G 1 + G 2 < 8, 000 (8) G 2 + G 3 < 8, 000; (9) G 3 + G 4 < 8, 000 Constrain that no more than $8 million be in construction loans at any time: (10) C 1 < 8, 000; (11) C 1 + C 2 < 8, 000 (12) C 1 + C 2 + C 3 < 8, 000; (13) C 2 + C 3 + C 4 < 8, 000 BA 452 Lesson A. 8 Marketing and Finance Applications 30

Portfolio Selection with Dynamic Constraints Interpretation: Total interest earned in the 4 -month period = $1, 429, 213. 80. Gi = invested in government bonds Ci = invested in construction loans Li = invested locally, in month i (for i = 1, 2, 3, 4) BA 452 Lesson A. 8 Marketing and Finance Applications 31

BA 452 Analysis Quantitative End of Lesson A. 8 BA 452 Lesson A. 8 Marketing and Finance Applications 32