Chapter 1

Introduction to
Business Analytics
Business Analytics

(Business) Analytics is the use of:

data,
information technology,
statistical analysis,
quantitative methods, and
mathematical or computer-based models
to help managers gain improved insight about
their business operations and make better,
fact-based decisions.
Examples of Applications
Pricing
◦ setting prices for consumer and industrial goods, government
contracts, and maintenance contracts
Customer segmentation
◦ identifying and targeting key customer groups in retail, insurance,
and credit card industries
Merchandising
◦ determining brands to buy, quantities, and allocations
Location
◦ finding the best location for bank branches and ATMs, or where to
service industrial equipment
Social Media
◦ understand trends and customer perceptions; assist marketing
managers and product designers
Evolution of Business Analytics

Business intelligence
Information Systems
Statistics
Operations research/Management science
Decision support systems
A Visual Perspective of Business
Analytics
Impacts and Challenges
Benefits
◦ …reduced costs, better risk management, faster
decisions, better productivity and enhanced bottom-line
performance such as profitability and customer
satisfaction.
Challenges
◦ …lack of understanding of how to use analytics,
competing business priorities, insufficient analytical skills,
difficulty in getting good data and sharing information,
and not understanding the benefits versus perceived
costs of analytics studies.
Scope of Business Analytics

Descriptive analytics: the use of data to

understand past and current business
performance and make informed decisions
Predictive analytics: predict the future by
examining historical data, detecting patterns or
relationships in these data, and then extrapolating
these relationships forward in time.
Prescriptive analytics: identify the best
alternatives to minimize or maximize some
objective
Tools
Database queries and analysis
Dashboards to report key performance measures
Data visualization
Statistical methods
Spreadsheets and predictive models
Scenario and “what-if” analyses
Simulation
Forecasting
Data and text mining
Optimization
Social media, web, and text analytics
Example 1.1: Retail Markdown Decisions

Most department stores clear seasonal inventory

by reducing prices.
Key question: When to reduce the price and by
how much to maximize revenue?
Potential applications of analytics:
Descriptive analytics: examine historical data for similar
products (prices, units sold, advertising, …)
Predictive analytics: predict sales based on price
Prescriptive analytics: find the best sets of pricing and
advertising to maximize sales revenue
Software Support
IBM Cognos Express
◦ An integrated business intelligence and planning solution
designed to meet the needs of midsize companies,
provides reporting, analysis, dashboard, scorecard,
planning, budgeting and forecasting capabilities.
SAS Analytics
◦ Predictive modeling and data mining, visualization,
forecasting, optimization and model management,
statistical analysis, text analytics, and more.
Tableau Software
◦ Simple drag and drop tools for visualizing data from
spreadsheets and other databases.
Data for Business Analytics

Data: numerical or textual facts and figures that

are collected through some type of measurement
process.
Information: result of analyzing data; that is,
extracting meaning from data to support
evaluation and decision making.
Examples of Data Sources and Uses

Annual reports
Accounting audits
Financial profitability analysis
Economic trends
Marketing research
Operations management performance
Human resource measurements
Web behavior
page views, visitor’s country, time of view, length of time,
origin and destination paths, products they searched for and
viewed, products purchased, what reviews they read, and
many others.
Data Sets and Databases
Data set - a collection of data.
◦ Examples: Marketing survey responses, a table of
historical stock prices, and a collection of measurements
of dimensions of a manufactured item.
Database - a collection of related files containing
records on people, places, or things.
◦ A database file is usually organized in a two-dimensional
table, where the columns correspond to each individual
element of data (called fields, or attributes), and the rows
represent records of related data elements.
Example 1.2: A Sales Transaction
Database File

Records

Entities Fields or Attributes

Big Data
Big data to refer to massive amounts of business data
from a wide variety of sources, much of which is
available in real time, and much of which is uncertain or
unpredictable. IBM calls these characteristics volume,
variety, velocity, and veracity.
“The effective use of big data has the potential to
transform economies, delivering a new wave of
productivity growth and consumer surplus. Using big
data will become a key basis of competition for existing
companies, and will create new competitors who are
able to attract employees that have the critical skills for a
big data world.” - McKinsey Global Institute, 2011
Metrics and Data Classification

Metric - a unit of measurement that provides a

way to objectively quantify performance.
Measurement - the act of obtaining data
associated with a metric.
Measures - numerical values associated with a
metric.
Types of Metrics
Discrete metric - one that is derived from
counting something.
◦ For example, a delivery is either on time or not; an order
is complete or incomplete; or an invoice can have one,
two, three, or any number of errors. Some discrete
metrics would be the proportion of on-time deliveries; the
number of incomplete orders each day, and the number
of errors per invoice.
Continuous metrics are based on a continuous
scale of measurement.
◦ Any metrics involving dollars, length, time, volume, or
weight, for example, are continuous.
Measurement Scales

Categorical (nominal) data - sorted into

categories according to specified characteristics.
Ordinal data - can be ordered or ranked
according to some relationship to one another.
Interval data - ordinal but have constant
differences between observations and have
arbitrary zero points.
Ratio data - continuous and have a natural zero.
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Example 1.3: Classifying Data Elements

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Data Reliability and Validity
Reliability - data are accurate and consistent.
Validity - data correctly measures what it is supposed to measure.
Examples:
◦ A tire pressure gage that consistently reads several pounds of pressure
below the true value is not reliable, although it is valid because it does
measure tire pressure.
◦ The number of calls to a customer service desk might be counted
correctly each day (and thus is a reliable measure) but not valid if it is
used to assess customer dissatisfaction, as many calls may be simple
queries.
◦ A survey question that asks a customer to rate the quality of the food in a
restaurant may be neither reliable (because different customers may
have conflicting perceptions) nor valid (if the intent is to measure
customer satisfaction, as satisfaction generally includes other elements
of service besides food).
Models in Business Analytics

Model - an abstraction or representation of a real

system, idea, or object.
Captures the most important features
Can be a written or verbal description, a visual
representation, a mathematical formula, or a
spreadsheet.
 Example 1.4: Three Forms of a Model
The sales of a new product, such as a first-generation iPad or
3D television, often follow a common pattern.

1. Verbal description: The rate of sales starts small as early

adopters begin to evaluate a new product and then begins
to grow at an increasing rate over time as positive
customer feedback spreads. Eventually, the market
begins to become saturated and the rate of sales begins
to decrease.
Example 1.4 (continued)
2. Visual model: A sketch of sales as an S-shaped curve
over time
Example 1.4 (continued)

3. Mathematical model: S = aebect

where S is sales, t is time, e is the base of natural
logarithms, and a, b and c are constants.
Influence Diagrams
Influence diagram - a visual representation of a
descriptive model that shows how the elements of
the model influence, or relate to, others.
An influence diagram is a useful approach for
conceptualizing the structure of a model and can assist in
building a mathematical or spreadsheet model.
Example 1.5: An Influence Diagram for Total
Cost

Basic Expanded
Example 1.6: Building a Mathematical
Model
total cost = fixed cost + variable cost (1.1)
variable cost = unit variable cost × quantity produced (1.2)
total cost = fixed cost + variable cost
= fixed cost + unit variable cost × quantity produced (1.3)

Mathematical model:
TC = Total Cost
F = Fixed cost
V = Variable unit cost
Q = Quantity produced
TC = F +VQ (1.4)
Decision Models
Decision model - a logical or mathematical
representation of a problem or business situation that
can be used to understand, analyze, or facilitate making
a decision.
Inputs:
◦ Data, which are assumed to be constant for purposes of the
model.
◦ Uncontrollable variables, which are quantities that can change but
cannot be directly controlled by the decision maker.
◦ Decision variables, which are controllable and can be selected at
the discretion of the decision maker.
Nature of Decision Models
Example 1.7 A Break-Even Decision
Model
TC(manufacturing) = $50,000 + $125*Q
TC(outsourcing) = $175*Q
Breakeven Point: TC(manufacturing) = TC(outsourcing)

$50,000 + $125 × Q = $175 × Q

$50,000 = 50 × Q
Q = 1,000

General Formula
F + VQ = CQ
Q = F/(C - V) (1.5)
Example 1.8: A Sales-Promotion Decision
Model
In the grocery industry, managers typically need to know
how best to use pricing, coupons and advertising
strategies to influence sales. Grocers often study the
relationship of sales volume to these strategies by
conducting controlled experiments to identify the
relationship between them and sales volumes. That is,
they implement different combinations of pricing, coupons,
and advertising, observe the sales that result, and use
analytics to develop a predictive model of sales as a
function of these decision strategies.
Example
Model

Sales = 500 – 0.05(price) + 30(coupons) + 0.08(advertising) +

0.25(price)(advertising)

If the price is $6.99, no coupons are offered, and no advertising is done

(the experiment corresponding to week 1), the model estimates sales as

Sales = 500 - 0.05 × $6.99 + 30 × 0 + 0.08 × 0 + 0.25 × $6.99 × 0 = 500

units
Model Assumptions
Assumptions are made to
◦ simplify a model and make it more tractable; that is, able to be
easily analyzed or solved.
◦ better characterize historical data or past observations.
The task of the modeler is to select or build an
appropriate model that best represents the behavior of
the real situation.
Example: economic theory tells us that demand for a
product is negatively related to its price. Thus, as prices
increase, demand falls, and vice versa (modeled by
price elasticity — the ratio of the percentage change in
demand to the percentage change in price).
Example 1.9: A Linear Demand
Prediction Model
As price increases, demand falls.
Example 1.10 A Nonlinear Demand
Prediction Model
Assumes price elasticity is constant (constant ratio of
% change in demand to % change in price)
Uncertainty and Risk
Uncertainty is imperfect knowledge of what will happen
in the future.
Risk is associated with the consequences of what
actually happens.
“To try to eliminate risk in business enterprise is futile.
Risk is inherent in the commitment of present resources
to future expectations. Indeed, economic progress can
be defined as the ability to take greater risks. The
attempt to eliminate risks, even the attempt to minimize
them, can only make them irrational and unbearable. It
can only result in the greatest risk of all: rigidity.”
– Peter Drucker
Prescriptive Decision Models

Prescriptive decision models help decision

makers identify the best solution.
Optimization - finding values of decision variables
that minimize (or maximize) something such as
cost (or profit).
Objective function - the equation that minimizes (or
maximizes) the quantity of interest.
Constraints - limitations or restrictions.
Optimal solution - values of the decision variables at the
minimum (or maximum) point.
Example 1.11: A Prescriptive Pricing
Model
A firm wishes to determine the best pricing for one
of its products in order to maximize revenue.
Analysts determined the following model:
Sales = -2.9485(price) + 3240.9
Total revenue = (price)(sales)
= price × (-2.9485 × price + 3240.9)
= 22.9485 × price2 + 3240.9 × price

Identify the price that maximizes total revenue,

subject to any constraints that might exist.
Types of Prescriptive Models
Deterministic model – all model input information
is known with certainty.
Stochastic model – some model input
information is uncertain.
◦ For instance, suppose that customer demand is an
important element of some model. We can make the
assumption that the demand is known with certainty; say,
5,000 units per month (deterministic). On the other hand,
suppose we have evidence to indicate that demand is
uncertain, with an average value of 5,000 units per
month, but which typically varies between 3,200 and
6,800 units (stochastic).
Problem Solving With Analytics

1. Recognizing a problem
2. Defining the problem
3. Structuring the problem
4. Analyzing the problem
5. Interpreting results and making a decision
6. Implementing the solution
Recognizing a Problem

Problems exist when there is a gap between what is

happening and what we think should be happening.
For example, costs are too high compared with
competitors.
Defining the Problem

Clearly defining the problem is not a trivial task.

Complexity increases when the following occur:
- large number of courses of action
- the problem belongs to a group and not an
individual
- competing objectives
- external groups are affected
- problem owner and problem solver are not the
same person
- time limitations exist
Structuring the Problem

Stating goals and objectives

Characterizing the possible decisions
Identifying any constraints or restrictions
Analyzing the Problem

Analytics plays a major role.

Analysis involves some sort of experimentation or
solution process, such as evaluating different
scenarios, analyzing risks associated with various
decision alternatives, finding a solution that meets
certain goals, or determining an optimal solution.
Interpreting Results and Making a
Decision
Models cannot capture every detail of the real
problem
Managers must understand the limitations of
models and their underlying assumptions and
often incorporate judgment into making a decision.
Implementing the Solution

Translate the results of the model back to the real

world.
Requires providing adequate resources,
motivating employees, eliminating resistance to
change, modifying organizational policies, and
developing trust.