What Is Predictive Modeling?

In short, predictive modeling is a statistical technique using machine learning

and data mining to predict and forecast likely future outcomes with the aid of
historical and existing data. It works by analyzing current and historical data
and projecting what it learns on a model generated to forecast likely
outcomes. Predictive modeling can be used to predict just about anything,
from TV ratings and a customer’s next purchase to credit risks and corporate
earnings.

A predictive model is not fixed; it is validated or revised regularly to

incorporate changes in the underlying data. In other words, it’s not a one-and-
done prediction. Predictive models make assumptions based on what has
happened in the past and what is happening now. If incoming, new data
shows changes in what is happening now, the impact on the likely future
outcome must be recalculated, too. For example, a software company could
model historical sales data against marketing expenditures across multiple
regions to create a model for future revenue based on the impact of the
marketing spend.

Most predictive models work fast and often complete their calculations in real
time. That’s why banks and retailers can, for example, calculate the risk of an
online mortgage or credit card application and accept or decline the request
almost instantly based on that prediction.

Some predictive models are more complex, such as those used

in computational biology and quantum computing; the resulting outputs take
longer to compute than a credit card application but are done much more
quickly than was possible in the past thanks to advances in technological
capabilities, including computing power.
Top 5 Types of Predictive Models
Fortunately, predictive models don’t have to be created from scratch for every
application. Predictive analytics tools use a variety of vetted models and
algorithms that can be applied to a wide spread of use cases.

Predictive modeling techniques have been perfected over time. As we add

more data, more muscular computing, AI and machine learning and see
overall advancements in analytics, we’re able to do more with these models.

The top five predictive analytics models are:

1. Classification model: Considered the simplest model, it categorizes

data for simple and direct query response. An example use case would
be to answer the question “Is this a fraudulent transaction?”
2. Clustering model: This model nests data together by common
attributes. It works by grouping things or people with shared
characteristics or behaviors and plans strategies for each group at a
larger scale. An example is in determining credit risk for a loan applicant
based on what other people in the same or a similar situation did in the
past.
3. Forecast model: This is a very popular model, and it works on anything
with a numerical value based on learning from historical data. For
example, in answering how much lettuce a restaurant should order next
week or how many calls a customer support agent should be able to
handle per day or week, the system looks back to historical data.
4. Outliers model: This model works by analyzing abnormal or outlying
data points. For example, a bank might use an outlier model to identify
fraud by asking whether a transaction is outside of the customer’s
normal buying habits or whether an expense in a given category is
normal or not. For example, a $1,000 credit card charge for a washer
and dryer in the cardholder’s preferred big box store would not be
alarming, but $1,000 spent on designer clothing in a location where the
customer has never charged other items might be indicative of a
breached account.
5. Time series model: This model evaluates a sequence of data points
based on time. For example, the number of stroke patients admitted to
the hospital in the last four months is used to predict how many patients
the hospital might expect to admit next week, next month or the rest of
 the year. A single metric measured and compared over time is thus
more meaningful than a simple average.

Common Predictive Algorithms

Predictive algorithms use one of two things: machine learning or deep
learning. Both are subsets of artificial intelligence (AI). Machine learning (ML)
involves structured data, such as spreadsheet or machine data. Deep learning
(DL) deals with unstructured data such as video, audio, text, social media
posts and images—essentially the stuff that humans communicate with that
are not numbers or metric reads.

Some of the more common predictive algorithms are:

1. Random Forest: This algorithm is derived from a combination of

decision trees, none of which are related, and can use both
classification and regression to classify vast amounts of data.
2. Generalized Linear Model (GLM) for Two Values: This algorithm
narrows down the list of variables to find “best fit.” It can work out tipping
points and change data capture and other influences, such
as categorical predictors, to determine the “best fit” outcome, thereby
overcoming drawbacks in other models, such as a regular linear
regression.
3. Gradient Boosted Model: This algorithm also uses several combined
decision trees, but unlike Random Forest, the trees are related. It builds
out one tree at a time, thus enabling the next tree to correct flaws in the
previous tree. It’s often used in rankings, such as on search engine
outputs.
4. K-Means: A popular and fast algorithm, K-Means groups data points by
similarities and so is often used for the clustering model. It can quickly
render things like personalized retail offers to individuals within a huge
group, such as a million or more customers with a similar liking of lined
red wool coats.
5. Prophet: This algorithm is used in time-series or forecast models for
capacity planning, such as for inventory needs, sales quotas and
resource allocations. It is highly flexible and can easily
accommodate heuristics and an array of useful assumptions.
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Predictive Modeling and Data Analytics

Predictive modeling is also known as predictive analytics. Generally, the term
“predictive modeling” is favored in academic settings, while “predictive
analytics” is the preferred term for commercial applications of predictive
modeling.

Successful use of predictive analytics depends heavily on unfettered access

to sufficient volumes of accurate, clean and relevant data. While predictive
models can be extraordinarily complex, such as those using decision trees
and k-means clustering, the most complex part is always the neural network;
that is, the model by which computers are trained to predict outcomes.
Machine learning uses a neural network to find correlations in exceptionally
large data sets and “to learn” and identify patterns within the data.

Benefits of Predictive Modeling

In a nutshell, predictive analytics reduce time, effort and costs in forecasting
business outcomes. Variables such as environmental factors, competitive
intelligence, regulation changes and market conditions can be factored into
the mathematical calculation to render more complete views at relatively low
costs.

Examples of specific types of forecasting that can benefit businesses include

demand forecasting, headcount planning, churn analysis, external factors,
competitive analysis, fleet and IT hardware maintenance and financial risks.

Challenges of Predictive Modeling

It’s essential to keep predictive analytics focused on producing useful
business insights because not everything this technology digs up is useful.
Some mined information is of value only in satisfying a curious mind and has
few or no business implications. Getting side-tracked is a distraction few
businesses can afford.

Also, being able to use more data in predictive modeling is an advantage only
to a point. Too much data can skew the calculation and lead to a meaningless
or an erroneous outcome. For example, more coats are sold as the outside
temperature drops. But only to a point. People do not buy more coats when
it’s -20 degrees Fahrenheit outside than they do when it’s -5 degrees below
freezing. At a certain point, cold is cold enough to spur the purchase of coats
and more frigid temps no longer appreciably change that pattern.

And with the massive volumes of data involved in predictive modeling,

maintaining security and privacy will also be a challenge. Further challenges
rest in machine learning’s limitations.

Limitations of Predictive Modeling

According to a McKinsey report, common limitations and their “best fixes”
include:
 1. Errors in data labeling: These can be overcome with reinforcement
learning or generative adversarial networks (GANs).
2. Shortage of massive data sets needed to train machine
learning: Apossible fix is “one-shot learning,” wherein a machine learns
from a small number of demonstrations rather than on a massive data
set.
3. The machine’s inability to explain what and why it did what it
did: Machines do not “think” or “learn” like humans. Likewise, their
computations can be so exceptionally complex that humans have
trouble finding, let alone following, the logic. All this makes it difficult for
a machine to explain its work, or for humans to do so. Yet model
transparency is necessary for a number of reasons, with human safety
chief among them. Promising potential fixes: local-interpretable-model-
agnostic explanations (LIME) and attention techniques.
4. Generalizability of learning, or rather lack thereof: Unlike humans,
machines have difficulty carrying what they’ve learned forward. In other
words, they have trouble applying what they’ve learned to a new set of
circumstances. Whatever it has learned is applicable to one use case
only. This is largely why we need not worry about the rise of AI
overlords anytime soon. For predictive modeling using machine learning
to be reusable—that is, useful in more than one use case—a possible
fix is transfer learning.
5. Bias in data and algorithms: Non-representation can skew outcomes
and lead to mistreatment of large groups of humans. Further, baked-in
biases are difficult to find and purge later. In other words, biases tend to
self-perpetuate. This is a moving target, and no clear fix has yet been
identified.

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The Future of Predictive Modeling

Predictive modeling, also known as predictive analytics, and machine learning
are still young and developing technologies, meaning there is much more to
come. As techniques, methods, tools and technologies improve, so will the
benefits to businesses and societies.

However, these are not technologies that businesses can afford to adopt later,
after the tech reaches maturity and all the kinks are worked out. The near-
term advantages are simply too strong for a late adopter to overcome and
remain competitive.

Our advice: Understand and deploy the technology now and then grow the
business benefits alongside subsequent advances in the technologies.

Predictive Modeling in Platforms

For all but the largest companies, reaping the benefits of predictive analytics
is most easily achieved by using ERP systems that have the technologies
built-in and contain pretrained machine learning. For example, planning,
forecasting and budgeting features may provide a statistical model engine to
rapidly model multiple scenarios that deal with changing market conditions.

As another example, a supply planning or supply capacity function can

similarly predict potentially late deliveries, purchase or sales orders and other
risks or impacts. Alternate suppliers can also be represented on the
dashboard to enable companies to pivot to meet manufacturing or distribution
requirements.

Financial modeling and planning and budgeting are key areas to reap the
many benefits of using these advanced technologies without overwhelming
your team.

predictive modeling

 




By

 George Lawton
 Joseph M. Carew
 Ed Burns

What is predictive modeling?

Predictive modeling is a mathematical process used to predict future events or
outcomes by analyzing patterns in a given set of input data. It is a crucial
component of predictive analytics, a type of data analytics which uses current
and historical data to forecast activity, behavior and trends.

Examples of predictive modeling include estimating the quality of a sales lead,

the likelihood of spam or the probability someone will click a link or buy a
product. These capabilities are often baked into various business applications,
so it is worth understanding the mechanics of predictive modeling to
troubleshoot and improve performance.

Although predictive modeling implies a focus on forecasting the future, it can

also predict outcomes (e.g., the probability a transaction is fraudulent). In this
case, the event has already happened (fraud committed). The goal here is to
predict whether future analysis will find the transaction is fraudulent. Predictive
modeling can also forecast future requirements or facilitate what-if analysis.

"Predictive modeling is a form of data mining that analyzes historical data with
the goal of identifying trends or patterns and then using those insights to
predict future outcomes," explained Donncha Carroll a partner in the revenue
growth practice of Axiom Consulting Partners. "Essentially, it asks the
question, 'have I seen this before' followed by, 'what typically comes after this
pattern.'"
THIS ARTICLE IS PART OF

What is predictive analytics? An enterprise guide

 Which also includes:

 Predictive analytics vs. machine learning

 7 top predictive analytics use cases: Enterprise examples

 Descriptive vs. prescriptive vs. predictive analytics explained

Top types of predictive models

There are many ways of classifying predictive models and in practice multiple
types of models may be combined for best results. The most salient distinction
is between unsupervised versus supervised models.

 Unsupervised models use traditional statistics to classify the data directly,

using techniques like logistic regression, time series analysis and decision
trees.

 Supervised models use newer machine learning techniques such as neural

networks to identify patterns buried in data that has already been labeled.

The biggest difference between these approaches is that with supervised

models more care must be taken to properly label data sets upfront.

"The application of different types of models tends to be more domain-specific

than industry-specific," said Scott Buchholz, government and public services
CTO and emerging technology research director at Deloitte Consulting.

In certain cases, for example, standard statistical regression analysis may

provide the best predictive power. In other cases, more sophisticated models
are the right approach. For example, in a hospital, classic statistical
techniques may be enough to identify key constraints for scheduling, but
neural networks, a type of deep learning, may be required to optimize patient
assignment to doctors.
Once data scientists gather this sample data, they must select the right model.
Linear regressions are among the simplest types of predictive models. Linear
models take two variables that are correlated -- one independent and the
other dependent -- and plot one on the x-axis and one on the y-axis. The
model applies a best fit line to the resulting data points. Data scientists can
use this to predict future occurrences of the dependent variable.

Some of the most popular methods include the following:

 Decision trees. Decision tree algorithms take data (mined, open source,
internal) and graph it out in branches to display the possible outcomes of
various decisions. Decision trees classify response variables and predict
response variables based on past decisions, can be used with incomplete
data sets and are easily explainable and accessible for novice data
scientists.

 Time series analysis. This is a technique for the prediction of events

through a sequence of time. You can predict future events by analyzing
past trends and extrapolating from there.

 Logistic regression. This method is a statistical analysis method that aids

in data preparation. As more data is brought in, the algorithm's ability to
sort and classify it improves and therefore predictions can be made.

 Neural networks. This technique reviews large volumes of labeled data in

search of correlations between variables in the data. Neural networks form
the basis of many of today's examples of artificial intelligence (AI),
including image recognition, smart assistants and natural language
generation.

The most complex area of predictive modeling is the neural network. This type
of machine learning model independently reviews large volumes of labeled
data in search of correlations between variables in the data. It can detect even
subtle correlations that only emerge after reviewing millions of data points.
The algorithm can then make inferences about unlabeled data files that are
similar in type to the data set it trained on.

Predictiv
e modeling algorithms include logistic regression, time series analysis and decision trees.

Common algorithms for predictive modeling

 Random Forest. This algorithm combines unrelated decision trees and
uses classification and regression to organize and label vast amounts of
data.

 Gradient boosted model. Similar to Random Forest, this algorithm uses

several decision trees, but in this method, each tree corrects the flaws of
the previous one and builds a more accurate picture.

 K-Means. This algorithm groups data points in a similar fashion as

clustering models and is popular in devising personalized retail offers. It
create personalized offers by seeking out similarities among large groups
of customers.

 Prophet. A forecasting procedure, this algorithm is especially effective

when dealing with capacity planning. This algorithm deals with time series
data and is relatively flexible.
 A neural
network is a type of predictive model that independently reviews large volumes of labeled
data in search of correlations between variables in the data.
What are the uses of predictive modeling?
Predictive modeling is often associated with meteorology and weather
forecasting, but predictive models have many applications in business.
Today's predictive analytics techniques can discover patterns in the data to
identify upcoming risks and opportunities for an organization.

"Almost anywhere a smart human is regularly making a prediction in a

historically data rich environment is a good use case for predicative analytics,"
Buchholz said. "After all, the model has no ego and won't get bored."

One of the most common uses of predictive modeling is in online advertising

and marketing. Modelers use web surfers' historical data, to determine what
kinds of products users might be interested in and what they are likely to click
on.

Bayesian spam filters use predictive modeling to identify the probability that a
given message is spam.
In fraud detection, predictive modeling is used to identify outliers in a data set
that point toward fraudulent activity. In customer relationship management,
predictive modeling is used to target messaging to customers who are most
likely to make a purchase.

Carroll said that predictive modeling is widely used in predictive maintenance,

which has become a huge industry generating billions of dollars in revenue.
One of the more notable examples can be found in the airline industry where
engineers use IoT devices to remotely monitor performance of aircraft
components like fuel pumps or jet engines.

These tools enable preemptive deployment of maintenance resources to

increase equipment utilization and limit unexpected downtime. "These actions
can meaningfully improve operational efficiency in a world that runs just in
time where surprises can be very expensive," Caroll said.

Other areas where predictive models are used include the following:

 capacity planning

 change management

 disaster recovery

 engineering

 physical and digital security management

 city planning
How to build a predictive model
Building a predictive model starts with identifying historical data that's
representative of the outcome you are trying to predict.

"The model can infer outcomes from historical data but cannot predict what it
has never seen before," Carroll said. Therefore, the volume and breadth of
information used to train the model is critical to securing an accurate
prediction for the future.

The next step is to identify ways to clean, transform and combine the raw data
that leads to better predictions.

Skill is required in not only finding the appropriate set of raw data but also
transforming it into data features that are most appropriate for a given model.
For example, calculations of time-boxed weekly averages may be more useful
and lead to better algorithms than real-time levels.

It is also important to weed out data that is coincidental or not relevant to a

model. At best, the additional data will slow the model down, and at worst, it
will lead to less accurate models.

This is both an art and a science. The art lies in cultivating a gut feeling for the
meaning of things and intuiting the underlying causes. The science lies in
methodically applying algorithms to consistently achieve reliable results, and
then evaluating these algorithms over time. Just because a spam filter works
on day one does not mean marketers will not tune their messages, making the
filter less effective.

Analyzing representative portions of the available information -- sampling --

can help speed development time on models and enable them to be deployed
more quickly.

Benefits of predictive modeling

Phil Cooper, group VP of products at Clari, a RevOps software startup, said
some of the top benefits of predictive modeling in business include the
following:
 Prioritizing resources. Predictive modeling is used to identify sales lead
conversion and send the best leads to inside sales teams; predict whether
a customer service case will be escalated and triage and route it
appropriately; and predict whether a customer will pay their invoice on time
and optimize accounts receivable workflows.

 Improving profit margins. Predictive modeling is used to forecast

inventory, create pricing strategies, predict the number of customers and
configure store layouts to maximize sales.

 Optimizing marketing campaigns. Predictive modeling is used to unearth

new customer insights and predict behaviors based on inputs, allowing
organizations to tailor marketing strategies, retain valuable customers and
take advantage of cross-sell opportunities.

 Reducing risk. Predictive analytics can detect activities that are out of the
ordinary such as fraudulent transactions, corporate spying or cyber attacks
to reduce reaction time and negative consequences.

The techniques used in predictive modeling are probabilistic as opposed to

deterministic. This means models generate probabilities of an outcome and
include some uncertainty.

"This is a fundamental and inherent difference between data modeling of

historical facts versus predicting future events [based on historical data] and
has implications for how this information is communicated to users," Cooper
said. Understanding this difference is a critical necessity for transparency and
explainability in how a prediction or recommendation was generated.

Challenges of predictive modeling

Here are some of the challenges related to predictive modeling.

Data preparation. One of the most frequently overlooked challenges of

predictive modeling is acquiring the correct amount of data and sorting out the
right data to use when developing algorithms. By some estimates, data
scientists spend about 80% of their time on this step. Data collection is
important but limited in usefulness if this data is not properly managed and
cleaned.

Once the data has been sorted, organizations must be careful to avoid
overfitting. Over-testing on training data can result in a model that appears
very accurate but has memorized the key points in the data set rather than
learned how to generalize.

Technical and cultural barriers. While predictive modeling is often

considered to be primarily a mathematical problem, users must plan for the
technical and organizational barriers that might prevent them from getting the
data they need. Often, systems that store useful data are not connected
directly to centralized data warehouses. Also, some lines of business may feel
that the data they manage is their asset, and they may not share it freely with
data science teams.

Choosing the right business case. Another potential obstacle for predictive
modeling initiatives is making sure projects address significant business
challenges. Sometimes, data scientists discover correlations that seem
interesting at the time and build algorithms to investigate the correlation
further. However, just because they find something that is statistically
significant does not mean it presents an insight the business can use.
Predictive modeling initiatives need to have a solid foundation of business
relevance.

Bias. "One of the more pressing problems everyone is talking about, but few
have addressed effectively, is the challenge of bias," Carroll said. Bias is
naturally introduced into the system through historical data since past
outcomes reflect existing bias.
Nate Nichols, distinguished principal at Narrative Science, a natural language
generation tools provider, is excited about the role that new explainable
machine learning methods such as LIME or SHAP could play in addressing
concerns about bias and promoting trust.

"People trust models more when they have some understanding of what the
models are doing, and trust is paramount for predictive analytic capabilities,"
Nichols said. Being able to provide explanations for the predictions, he said, is
a huge positive differentiator in the increasingly crowded field of predictive
analytic products.

Predictive modeling versus predictive analytics

Predictive modeling is but one aspect in the larger predictive analytics process
cycle. This includes collecting, transforming, cleaning and modeling data
using independent variables, and then reiterating if the model does not quite
fit the problem to be addressed.

"Once data has been gathered, transformed and cleansed, then predictive
modeling is performed on the data," said Terri Sage, chief technology officer
at 1010data, an analytics consultancy.

Collecting data, transforming and cleaning are processes used for other types
of analytic development.

"The difference with predictive analytics is the inclusion and discarding of

variables during the iterative modeling process," Sage explained.

This will differ across various industries and use cases, as there will be
diverse data used and different variables discovered during the modeling
iterations.
For example, in healthcare, predictive models may ingest a tremendous
amount of data pertaining to a patient and forecast a patient's response to
certain treatments and prognosis. Data may include the patient's specific
medical history, environment, social risk factors, genetics -- all which vary
from person to person. The use of predictive modeling in healthcare marks a
shift from treating patients based on averages to treating patients as
individuals.

Similarly, with marketing analytics, predictive models might use data sets
based on a consumer's salary, spending habits and demographics. Different
data and modeling will be used for banking and insurance to help determine
credit ratings and identify fraudulent activities.

Predictive modeling tools

Before deploying a predictive model tool, it is crucial for your organization to
ask questions and sort out the following: Clarify who will be running the
software, what the use case will be for these tools, what other tools will your
predictive analytics be interacting with, as well as the budget.

Different tools have different data literacy requirements, are effective in

different use cases, are best used with similar software and can be expensive.
Once your organization has clarity on these issues, comparing tools becomes
easier.

 Sisense. A business intelligence software aimed at a variety of companies

that offers a range of business analytics features. This requires minimal IT
background.

 Oracle Crystal Ball. A spreadsheet-based application focused on

engineers, strategic planners and scientists across industries that can be
used for predictive modeling, forecasting as well as simulation and
optimization.
 IBM SPSS Predictive Analytics Enterprise. A business intelligence
platform that supports open source integration and features descriptive and
predictive analysis as well as data preparation.

 SAS Advanced Analytics. A program that offers algorithms that identify

the likelihood of future outcomes and can be used for data mining,
forecasting and econometrics.
The future of predictive modeling
There are three key trends that will drive the future of data modeling.

1. First, data modeling capabilities are being baked into more business
applications and citizen data science tools. These capabilities can provide
the appropriate guardrails and templates for business users to work with
predictive modeling.

2. Second, the tools and frameworks for low-code predictive modeling are
making it easier for data science experts to quickly cleanse data, create
models and vet the results.

3. Third, better tools are coming to automate many of the data engineering
tasks required to push predictive models into production. Carroll predicts
this will allow more organizations to shift from simply building models to
deploying them in ways that deliver on their potential value.

This was last updated in January 2022

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