What is Optimization?

Document created by toddrollin@fico.com on Nov 24, 2015Last modified by wendyfreitag@fico.com on Aug 2, 2016
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Optimization is the process of finding the best way of using your resources, at the same time not violating any of the constraints that are imposed. By "best" we usually mean highest profit, or lowest cost.

 

Why use optimization?

Optimization is a rigorous approach which takes into account all of the factors that influence decisions in business. Optimization implies careful modeling of the business, a process which itself invariably gives valuable insights. Benefits include operational efficiency, revenue maximization, cost minimization, performance assessment and understanding the effects of changes in input data.

 

Key optimization considerations include:

 

Decision variables. These are the things we can change, the things we need to decide upon. For example, how much product will we make? Where? How should we make it? How should we transport it?

Constraints. These state the limitations on our decisions. For example, in a logistics problem each mode of transport has a maximum speed and maximum payload. Operations may be limited to so many hours in a day.

 

Some problems will not require formal optimization. For example the problem may be simple, or the answer may be obvious, or there may be no decision variables so we have no choices. But most problems are complex, require making decisions, and so need optimization. In addition, as many problems change over time, particularly data, optimization is required on an ongoing basis.

 

Applications

Optimization has a track record across a wide range of industries and commerce. Organizations use optimization to improve the quality of their decision making. Also, optimization functionality is a logical extension to many software products, making them more valuable to their users. In addition, optimization is a must-have tool for consultants engaged in any aspect of business performance or business process improvement.

 

Benefits

These are the main business benefits of optimization:

 

Operational efficiency: We can make decisions that mean we better utilize our resources. For example, we can use optimization to maximize production with existing resources within existing facilities. We can reduce energy consumption; we can reduce transportation manpower, commissions or overhead costs. In finance, we can minimize the number of shares held to track an index.

 

Revenue maximization and cost minimization: Optimization can be used to increase business revenue or earnings, or reduce costs. For example, we can minimize production costs by making more product from existing facilities, or making a product of certain characteristics from the cheapest materials, all without violating the constraints we are under. We can use optimization to increase revenue, i.e., produce the maximum possible from a particular operation, carry as much as possible from one point to another or provide the highest level of insurance cover. We can construct a portfolio with characteristics as close as possible to target characteristics; we can maximize the number of transactions between a given set of sell and buy bids.

 

Understanding and performance assessment: Optimization gives a unique insight into situations where decisions are involved. It can be used to benchmark performance, for example current performance against the best possible. Optimization provides information about the costs of limitations for example, what additional profits could be made if a limit were moved or removed? In the same way it can give insight into the implied costs of policy decisions or arbitrary rules. Further insight is gained when an optimization model of a process or situation is created; making the model is instructive as is performing what-if analyses. Once an optimization model is built, it can be used for what-if analysis, for instance, by modeling the impact of a new opportunity, plant, ingredient, or process.

 

Sensitivities: How does the overall profit change if various data items change? For example, in a production situation, how much does the unit cost of item I at Factory A have to change before we switch production to Factory G?

 

Applications: Optimization has a consistent track record across a wide range of industry and commerce. These include:

  • Process industries (refining, chemicals, pharmaceuticals)
  • Manufacturing industries
  • Energy (oil, gas, coal, etc.)
  • Utilities (gas, electricity, water, telecommunications)
  • Banking, insurance, finance and securities
  • Transport, logistics and distribution
  • E-commerce and ISPs
  • Trading, procurement and sourcing

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