TABLE OF CONTENTS

TABLE OF CONTENTS
TABLE OF MODELS
TABLE OF FIGURES
INTRODUCTION
1. ABOUT THIS BOOK
2. SUPERFORECASTING
STRATEGIC ANALYSIS
3. INTRODUCTION
4. ENVIRONMENTAL ANALYSIS (PEST)
5. COMPETITIVE MAP
6. BLUE OCEAN MODEL
7. IMPORTANCE–PERFORMANCE MATRIX
8. VMOST
9. RESOURCE AUDIT
10. BOSTON MATRIX
11. PORTER’S FIVE FORCES
12. PRODUCT LIFE CYCLE ANALYSIS
13. DIVERSIFICATION MATRIX (G.E. MATRIX)
14. INTERNATIONALIZATION MATRIX
15. BUSINESS MODEL CANVAS
16. SWOT ANALYSIS
17. ANSOFF’S MATRIX
PRICING AND DEMAND
18. INTRODUCTION
19. PRICE ELASTICITY OF DEMAND
20. GABOR–GRANGER PRICING METHOD
21. VAN WESTENDORP PRICE SENSITIVITY METER
 22. MONADIC PRICE TESTING
23. CONJOINT ANALYSIS
24. CHOICE-BASED CONJOINT ANALYSIS
CUSTOMER ANALYTICS
25. INTRODUCTION
26. RFM MODEL
27. CUSTOMER LIFETIME VALUE 1
28. CUSTOMER LIFETIME VALUE 2
29. NET PROMOTER SCORE® (NPS®)
30. CUSTOMER VALUE MATRIX
31. CUSTOMER PROBABILITY MODEL
32. SURVIVAL ANALYSIS
33. SCORING MODELS
STATISTICAL ANALYSIS
34. INTRODUCTION
35. DESCRIPTIVE STATISTICS
36. INTRODUCTION TO REGRESSIONS
37. PEARSON CORRELATION
38. LINEAR REGRESSION
39. OTHER REGRESSIONS
40. PATH ANALYSIS
41. INTRODUCTION TO HYPOTHESIS TESTING
42. BAYESIAN APPROACH TO HYPOTHESIS TESTING
43. t-TEST
44. TEST OF PROPORTIONS
45. A/B TESTING
46. ANOVA
47. INTRODUCTION TO NON-PARAMETRIC MODELS
48. CHI-SQUARE
49. SPEARMAN’S RANK CORRELATION
 50. PHI CORRELATION
51. MANN–WHITNEY U TEST
52. WILCOXON SIGNED-RANK TEST
53. KRUSKAL–WALLIS TEST
54. FRIEDMAN TEST
55. SCHEIRER–RAY–HARE TEST
56. MCNEMAR TEST
57. COCHRAN’S Q TEST
58. INTRODUCTION TO CLASSIFICATION MODELS
59. BINARY CLASSIFICATION
60. LOGISTIC REGRESSION
61. CLUSTER ANALYSIS
62. PROFILE ANALYSIS
63. PRINCIPAL COMPONENT ANALYSIS
64. EXPLORATORY FACTOR ANALYSIS
65. CONFIRMATORY FACTOR ANALYSIS
FORECASTING
66. INTRODUCTION
67. S-CURVE LIFE CYCLE ANALYSIS
68. MOVING AVERAGE
69. EXPONENTIAL SMOOTHING
70. TIME SERIES ANALYSIS
71. PICKUP MODELS
72. REGRESSIONS
WHAT-IF ANALYSIS AND OPTIMIZATION MODELS
73. INTRODUCTION
74. SCENARIO ANALYSIS
75. SIMPLE DECISION TREES
76. GAME THEORY MODELS
77. MONTE CARLO SIMULATIONS
 78. MARKOV CHAIN MODEL
79. SALES FUNNEL ANALYSIS
80. OPTIMIZATION
BIBLIOGRAPHY


TABLE OF MODELS

A/B Testing              93
Additive Pickup              134
ANOVA with Repeated Measures              96
Ansoff's Matrix              35
Bayesian Hypothesis Testing              86
Best-Worst-Average Scenario Analysis              138
Binary Classification              111
Blue Ocean Model              21
Bootstrapping              85
Boston Matrix              26
Business Model Canvas              32
Chi-Square Goodness of Fit              100
Chi-Square Test of Independence              99
Chi-Square Test of Proportions              100
Choice-Based Conjoint Analysis              49
Cluster Analysis              114
Cochran’s Q Test              109
Competitive Map              20
Confirmatory Factor Analysis              122
Conjoint Analysis              46
Contingency Table              102
Cramer’s V Coefficient              102
Customer Lifetime Value 1              55
Customer Lifetime Value 2              57
Customer Probability Model              62
Customer Value Matrix              60
Descriptive Statistics              70
Diversification Matrix              30
Environmental Analysis (PEST/PESTEL)              18
Exploratory Factor Analysis              120
Exponential Smoothing              130
Forecast Performance Analysis              126
Friedman Test              106
Gabor Granger Pricing Method              42
Game Theory Models              142
Importance-Performance Matrix              22
Internationalization Matrix              31
Kruskal-Wallis Test              105
Linear Regression              75
Logistic Regression              113
Mann-Whitney U Test              103
MANOVA              97
Markov Chain Model              146
McNemar Test              108
Monadic Price Testing              45
Monte Carlo Simulations              144
Moving Average              129
Multiplicative Pickup              134
Multivariate Regression              77
Multivariate Scenario Analysis              139
Net Promoter Score              59
Non-Linear Regressions              78
One-Sample Test of Proportions              91
One-Sample t-Test              88
One-Way ANOVA              95
Optimization              151
Paired t-Test              90
Path Analysis              79
Pearson Correlation              74
Phi Correlation              102
Pickup Regression Model              135
Porter's 5 Forces              28
Principal Component Analysis              118
Product Life Cycle Analysis              29
Profile Analysis              116
Resource Audit              25
RFM Model              54
Sales Funnel Analysis              148
Sceirer-Ray-Hare Test              107
Scoring Models              65
S-Curve Life-Cycle Analysis              127
Shuffling              85
Simple Decision Trees              140
Spearman's Rank Correlation              101
Superforecasting              13
SWOT Analysis              34
Time Series Analysis              132
Two-Sample Test of Proportions              92
Two-Sample t-Test              89
Two-Way ANOVA              95
Van Westendorp Price Sensitivity Meter              43
VMOST              23
Wilcoxon Signed Rank Test              104


TABLE OF FIGURES
Figure 1: PEST Model (Political Trends)
Figure 2: Competitive Map
Figure 3: Four-Action Framework for the Implementation of a Blue Ocean
Strategy
Figure 4: Importance–Performance Matrix
Figure 5: VMOST Analysis
Figure 6: Resource Audit Example
Figure 7: Boston Matrix
Figure 8: Porter’s Five Forces Framework
Figure 9: Competitive Life Cycle
Figure 10: Diversification Matrix
Figure 11: Internationalization Matrix
Figure 12: Business Model Canvas
Figure 13: SWOT Analysis
Figure 14: Ansoff’s Matix
Figure 15: Classification of Methods for WTP Estimation
Figure 16: Price Elasticity of Demand
Figure 17: Gabor–Granger Pricing Method
Figure 18: Van Westendorp’s Price Sensitivity Meter
Figure 19: Van Westendorp’s PMS Extension with Demand and Revenue
Estimation
Figure 20: Demand Curve Derived from Monadic Price Testing
Figure 21: Combinations and Stated Preferences of Conjoint Analysis
Figure 22: Price–Utility Linear Relation
Figure 23: Customers’ Value Calculated by an RFM Model
Figure 24: Customer Lifetime Value of Different Customers
Figure 25: Transition Matrix of Customers’ Segments
Figure 26: Customer Value Matrix
Figure 27: Survival Curve
Figure 28: Coefficients of the Logistic and Linear Regressions
Figure 29: Result Table with the Purchase Probability, Estimated Amount,
and Final Score
Figure 30: Histogram and Box Plot
Figure 32: Normal Probability Plot
Figure 33: Best-Fit Line Scatter Plot
Figure 34: Standardized Residuals Plot with an Outlier
Figure 35: Correlation Matrix
Figure 36: Output of Linear Regression Analysis
Figure 37: Output of Multivariate Regression Analysis
Figure 38: Exponential Regression
Figure 39: Path Analysis Diagram
Figure 40: Direct and Indirect Effects within Variables
Figure 41: Summary of Parametric and Non-parametric Tests
Figure 42: Possible Outcomes of Hypothesis Testing
Figure 43: Matrix of the Bayesian Inference Method
Figure 44: Input Data of a One-Sample t-Test
Figure 45: Results of a One-Sample t-Test
Figure 46: Output of a Two-Sample t-test Assuming Unequal Variances
Figure 47: Output of a Paired t-Test
Figure 48: Results of a One-Sample Test of Proportions
Figure 49: Output of Conversion Rate A/B Testing
Figure 50: Output of a One-way ANOVA Analysis
Figure 51: Output of a Two-Way ANOVA Analysis
Figure 52: Results of a Single-Factor ANOVA with Repeated Measures
Figure 53: Results of a Two-Factor ANOVA with Repeated Measures
Figure 54: Summary of Non-parametric Tests
Figure 55: Observed Values vs Expected Values in a Chi-Square Test
Figure 56: Data and Results of a Goodness of-Fit Chi-Square Test
Figure 57: Spearman’s Rank Correlation
Figure 58: Contingency Table
Figure 59: Interpretation of Phi and Cramer’s V coefficients
Figure 60: Mann–Whitney U Test
Figure 61: Wilcoxon Signed-Ranks Test
Figure 62: Kruskal–Wallis test
Figure 63: Friedman’s Test
Figure 64: Data for the Scheirer–Ray–Hare Test
Figure 65: Scheirer–Ray–Hare Test
Figure 66: Data and Results of a McNemar Test
Figure 67: Data and Results of a Cochran’s Q Test
Figure 68: Table for the Calculation of the ROC Curve
Figure 69: ROC Curve
Figure 70: Logistic Regression
Figure 71: Simple Cluster Analysis Using a Scatter Chart
Figure 72: Example of Equal Levels in Profile Analysis (on Average Levels
Are Equal Even If There Is No Parallelism)
Figure 73: Example of Parallelism in Profile Analysis
Figure 74: Example of Flatness in Profile Analysis
Figure 75: Results of a PCA
Figure 76: Scree Plot
Figure 77: Loading Factors and Communalities
Figure 78: Path Diagram of Confirmatory Factor Analysis
Figure 79: Sales Data and Forecast Using Log Transformation
Figure 80: Log Transformed Data and Linear Trend Line (on the Left); Real
Sales Data and Forecasted Sales (on the Right)
Figure 81: Example of Three- and Five-Period Moving Averages
Figure 82: Exponential Smoothing with a Smaller (0.2) and Larger (0.8)
Alpha
Figure 83: Time Series Analysis
Figure 84: Scenario Summary
Figure 85: Probability Tree
Figure 86: Prisoner’s Dilemma
Figure 87: Decision Tree with Players’ Payoff
Figure 88: Monte Carlo Simulation Output
Figure 89: Probability Transition Matrix
Figure 90: Markov Chain Output
Figure 91: Sales Funnel
Figure 92: Sales Funnel of the Starting Situation (Scenario 0)
Figure 93: Model Definition (Optimization)
Figure 94: Results of the Optimization Using Solver
Figure 95: Sales Funnel after the Optimization (Scenario 1)


INTRODUCTION


1. ABOUT THIS BOOK

Life is really simple, but we insist on making it complicated.
(Confucius)
 
Why is analytics so important? Making analytics part of the competitive
strategy of a company nowadays offers an extremely powerful competitive
advantage,[1] since a good analysis allows companies to make better
decisions, which mean reducing costs, increasing margins, making
customers more loyal, or gaining more customers. Moreover, there seems to
be a shortage of human resources in data analysis (from more technical to
more business-oriented roles) that will last for several years.
What is Business Analytics? The BABOK® Guide[2] defines business
analysis as “the set of tasks and techniques used to work as liaison among
stakeholders in order to understand the structure, policies, and operations of
an organization, and to recommend solutions that enable the organization to
achieve its goals.” According to the guide, business analysts should be
competent in several knowledge areas, such as planning, monitoring,
elicitation, management, requirement analysis, and so on. Besides, they must
have robust underlying competencies to find solutions and facilitate the
decision-making processes necessary to attain the company’s goals. To find
these solutions, business analysts perform a series of tasks using several
“techniques”: here, at least for me, is where the most exciting part of
business analytics begins.
What the BABOK® Guide calls “techniques” is a set of models, techniques,
templates, and best practices that business analysts use more or less
creatively to solve a problem. After reading several books, articles, and
posts, taking years of university and business courses, and applying several
techniques as a business analyst, what I was lacking was an organized and
simple toolbox containing all the models, techniques, and templates that I
had used and learned so far. However, what I found in my search was either
too limited or too extensive and technical; in other words, I could not find a
complete and balanced toolkit that is not too complex but has enough details
to implement the models. An addition problem was that information was
usually spread across several sources, and the more complete ones only
contained models concerning a specific topic (e.g. statistical models,
business models, or pricing models).
Checking for references among books and websites, I found several options;
for example, Business Analysis Techniques: 99 Essential Tools for
Success[3] is a good reference book that organizes and explains several
techniques. In addition, www.real-statistics.com and
www.excelmasterseries.com are two notable websites that I have used for
many of the statistical models proposed in this book. I suggest visiting them
for more in-depth information on statistical analysis in Excel.
However, what I was looking for was a reference with practical models for
fast decision making, so this book focuses on those models and techniques
that helped me to make the predictions, forecasts, and estimates that I needed
to make business decisions. Since I decided to concentrate on analytical
models, this book omits those models that are more focused on other aspects,
for example project management.
This is why a year ago I started this project that you can read now and that
aims to create a toolkit that is as complete as possible, with ready-to-use
templates for descriptive, predictive, and prescriptive analysis.
I tried to make the toolkit as simple as possible, so almost all the tools that I
propose do not need specific technical skills or the use of specialized
software. In fact, for each tool presented in this book, it is possible to
download a ready-to-use template in Excel. I have to admit that I also
included some more complex models that require the use of specific
software, but for the rest of the models the template includes all the formulas
and instructions required to execute them.
I greatly appreciate simplicity, and I think that experts (and non-experts!)
often tend to complicate simple things, maybe to show their knowledge or
maybe just because we think that complex problems need complex solutions.
However, I strongly believe that, to solve a problem efficiently and
effectively, it is usually better to simplify it as much as possible, starting by
formulating a simple question that reflects the objective of the research or
analysis: Do we have to increase or decrease prices? How much? For which
product? For which customers? When?
The second step is to identify the scope of the analysis:
-          What happened? (Descriptive analysis)
-          Why did it happen? (Diagnostic analysis)
-          What will happen? (Predictive analysis)
-          What are we going to do? (Prescriptive analysis)
The third step is to select the model or technique that is most suitable for the
situation. The fourth step is to check for available data and/or determine how
to gather additional data from both internal and external sources. It may
happen that it is not possible to collect all the data needed for a specific
model; in this case we can either 1) try to use proxy data as a substitute for
the unavailable data or 2) change to the second-best model. The fifth step
concerns the proper analysis and validation of the results, and the final step
is to communicate the results properly.
An excellent book, which I highly recommend to all analysts, is
Superforecasters,[4] which summarizes an extensive study concerning the
patterns behind the most accurate forecasts and the best practices to achieve
a good prediction of future events. Among several best practices, one that I
admire is the “Fermi estimate.” This method, attributed to the physicist
Enrico Fermi, consists of breaking down a complex estimate into several
simpler estimates (see 2. SUPERFORECASTING).
Before leaving you to the tools of this book, I would just like to suggest that,
whenever you perform an analysis, try to be flexible, be creative, and enjoy
the process. Happy analyzing!


2. SUPERFORECASTING
The only true wisdom is in knowing you know nothing.
(Socrates)
 
Even though this is not a technique, I decided to start this toolbox with
superforecasting, inspired by the book by Philip E. Tetlock and Dan Gardner,
[5] which I consider a must for any analyst. The authors try to explain why
some experts are good at making predictions and others are not based on
several forecasting experiments.
The first reason for poor forecasting is overconfidence in our knowledge
(“illusion of knowledge”); the example is given of how medicine improved
when experimentation was introduced. Our brain works using two systems, 1
and 2.[6] System 1 is good for fast, effortless reasoning that happens
unconsciously and is useful in pattern recognition (for example, when
driving on a route that we follow often, we use System 1). However, System
1 can create biases or illusions, since the reasoning behind it is based on
simplifications to make fast and effortless responses. In the case of dealing
with problems with possible biases, we have to use System 2, the system that
uses reasoning and logic and, despite requiring more time and effort, allows
us to overcome the “illusion of knowledge.” Usually, for complex problems
we need to use System 2, but sometimes, when there are many patterns or
much information, intuition can be a better solution, since it can simplify all
the information and analyze unconsciously a quantity of patterns that we are
not able to analyze logically.
Another reason for unfortunate forecasts is the lack of precision and/or
measurement. Vague forecasts cannot be measured, and therefore we cannot
improve our forecasting methods. A good prediction has to include:
-          A measurable outcome: “the USSR will dissolve”;
-                  A more precise forecast with a possible date frame: “within one
year from now”;
-          Probability: “80% probability that it will happen.”
Probability should not be a measure of our confidence in the results but the
result of our reasoning (based on several pieces of information) about the
probability of an event occurring. To measure the results of our forecasts
with probabilities, it is necessary to make several similar predictions to
calculate their accuracy and calibration.
The author also proves that average group predictions are better than
individual predictions, because they use different perspectives, knowledge,
and information. If we have to perform forecasts individually, we can behave
like a group by aggregating different sources of information, asking for other
people’s perspectives and opinions, and always questioning the results. We
should also remember to update our results based on any new, relevant
information that we obtain.
Finally, a wonderful technique that will help in making complex forecasts is
“Fermi estimation.” It consists of breaking down a problem into several
probability questions to make more accurate guesses and then adding up
those questions that will produce a more realistic final outcome. This
technique usually starts by taking into consideration an outer perspective.
For example, we are presented with a picture of a family and we have to
predict whether they have a pet or not. Instinctively we may start by
focusing on the family’s characteristics that we can identify. However, we
should start with a broader perspective, for example the number of families
in a certain geographical space (country, state, city, etc.) who own pets,
namely 30%. This is our starting point, so we know without any other
additional information that our best guess would be that there is a 30%
probability that this family owns a pet. We can then adjust our prediction
with an inside view focusing on the family’s characteristics, for example
age, ethnicity, children, and so on. A famous example is the estimation of the
number of piano tuners in Chicago. Instead of guessing the number directly,
the problem is broken down into several questions, starting with defining the
total population of the city, then determining the number of households,
guessing the number of households with a piano, gauging how often a piano
needs to be tuned, and so on.[7]


STRATEGIC ANALYSIS


3. INTRODUCTION
Strategic analysis includes all those models and techniques that study the
environment in which an organization operates. This environment ranges
from external trends (economy, policies, technological innovations, etc.) to
the organization (mission, strategy, goals, value chain, etc.) and its business
environment (competitors, substitute products, customers, suppliers, etc.).
The objective of a strategic analysis is to investigate ideas and problems
either to evaluate the strategic direction of the organization or to identify
possible future strategies. I will focus only on the descriptive, predictive, and
prescriptive analytical models of strategic analysis, excluding any strategy
implementation and follow-up techniques.


4. ENVIRONMENTAL ANALYSIS
(PEST)
OBJECTIVE
Identify external key trends and their impacts on an organization, company,
or department.
DESCRIPTION
PEST analysis and all its variations (PESTEL, PESTLIED, STEEPLE, etc.)
are used to analyze the key trends that affect the surrounding environment of
an organization but on which the organization has no influence. The key idea
is to identify the trends that can most affect the company, organization, or
department in several areas:
-          POLITICAL
-          ENVIRONMENTAL
-          ECONOMIC
-          SOCIO-CULTURAL
-          TECHNOLOGICAL
-          …
Examples of key trends are an increase in interest rates, a new law, and the
increasing use of mobile devices. Many more examples can be found quite
easily, but the main idea that I want to transmit is that the division by area is
just a way to facilitate the identification of the key trends, as the decision on
whether to include a trend in one area or another has little or no effect on the
model. This model is commonly used with other tools that complement the
analysis of the business environment (competitive analysis, Porter’s five
forces analysis, etc.), and it is usually used for SWOT analysis (strengths,
weaknesses, opportunities, threats), in which it represents the external
factors, namely opportunities and threats.
 Figure 1: PEST Model (Political Trends)

To avoid using this model as a mere theoretical tool, once the key trends
have been identified, it is necessary to define the impacts of each one using
cause–effect reasoning and to try to quantify the positive or negative effect
that each trend can have on the organization in terms of revenues or costs.
Some trends could have an almost direct impact, but others require several
hypotheses, estimations, and calculations. Often it is necessary to determine
the impact on intermediary indicators before calculating the monetary
impact. For example, the growing sensibility for recycling can influence the
company’s packaging. In this case we can estimate the loss of reputation
first, then the decrease in demand, and finally the impact on revenues.
Another important element to be identified is the timing of the impact, since
it will affect the actions that will be taken and when they will be
implemented.
There are two main methods for gathering data for this model. The first one
is to exploit experts’ knowledge of several sectors and areas to identify the
key trends affecting the future of the organization. Several techniques can be
applied, such as the Delphi method, brainstorming, and think tanks. The
second method is more “DIY” and it concerns gathering published forecasts
of experts, futurists, organizations, governments, and so on. A common error
with both methods is that people tend to jump directly to possible solutions,
but doing so worsens the performance of the model. In this phase the focus
just needs to be on the trends and on quantifying the impact that they will
have on the organization.
TEMPLATE
http://analyticsmodels.blogspot.com.es/p/strategic-analysis-templates.html
 


5. COMPETITIVE MAP
OBJECTIVE
Analyze the positioning of a company or a product in comparison with other
companies or products by evaluating several attributes.
DESCRIPTION
A competitive map is a tool that compares a company or products with
several competitors according to the most important attributes. We can also
add to the map the relative importance of each attribute. From this map we
can understand how a company is positioned in relation to several attributes
and define the key issues for strategic decisions. For example, we can decide
to focus on the communication and promotion about the quality of our
product if we are well positioned and it is important for customers.

Figure 2: Competitive Map

The data for this map are usually gathered through surveys. If the selection
of attributes is not clear or the number of attributes is large, we can ask a
preselection question whereby interviewees rank the most important
attributes. Then they will be asked about the importance and performance of
the selected attributes for each company or product. I suggest dividing the
question into two parts:
-          Importance: give a score from 1 to 5 for each attribute;
-                  Performance: give a score from 1 to 5 for each combination of
attribute and company (or product).
TEMPLATE
http://analyticsmodels.blogspot.com.es/p/strategic-analysis-
templates.html
 


6. BLUE OCEAN MODEL

OBJECTIVE
Identify possible disruptive business ideas.
DESCRIPTION
This method is described in the book Blue Ocean Strategy written by W.
Chan Kim and Renée Mauborgne in 2005.[8] The idea behind it is that
companies should not focus on beating competitors (red oceans) but on
creating “blue oceans,” meaning new uncontested markets. Accordingly, the
competition will be irrelevant and new value will be created for both the
company and its customers.
The book offers several tools and approaches to apply a blue ocean strategy
systematically (these tools are available on the official website[9]). One of
the proposed tools is an action framework that suggests implementing a blue
ocean strategy by modifying, creating, or eliminating factors concerning the
product or service offered, for example a significant reduction of prices
thanks to a different production methodology or the creation of touchscreens
in the mobile industry.

Figure 3: Four-Action Framework for the Implementation of a Blue Ocean Strategy

TEMPLATE
http://analyticsmodels.blogspot.com.es/p/strategic-analysis-templates.html


7. IMPORTANCE–PERFORMANCE
MATRIX
OBJECTIVE
Decide whether to improve, maintain, or reduce specific company success
factors or product attributes.
DESCRIPTION
This model is used to assess the performance of a company on several
success factors or the performance of a product on several attributes. It can
be a part of the competitive map model presented in this book.

Figure 4: Importance–Performance Matrix

The data for this map are usually gathered through surveys. If the selection
of attributes is not clear or the number of attributes is large, we can ask a
preselection question whereby interviewees rank the most important
attributes. Then the interviewees will be asked to give a score from 1 to 5 for
each attribute.
TEMPLATE
http://analyticsmodels.blogspot.com.es/p/strategic-analysis-templates.html


8. VMOST
OBJECTIVE
To describe what the company wants to achieve and how it intends to
achieve it.
DESCRIPTION
It is a descriptive analysis tool that enables the reflection or communication
of the strategic intent of a company, since it includes:
-                  What the company wants to achieve: vision, mission, and
objectives
-          How to achieve them: strategies and tactics
In more detail, the components of these tools are:
-          Vision: aspiration for future market-oriented results;
-                  Mission: the fundamental purpose of the company: why the
company exists;
-          Objectives: the goals that the company intends to reach; all these
objectives are aligned with both the mission and the vision;
-                  Strategies: long- and medium-term actions to achieve the
objectives;
-          Tactics: short-term actions to achieve the objectives.
Usually the vision and mission are not clearly understood, but put simply the
vision is “what we want to become,” for example “to be in the top three tech
companies in the world,” while the vision is “what we want to do,” that is,
why we exist, for example “to create innovative products ….” The vision
and mission are often accompanied by a description of the company’s core
values, meaning the company’s principals that reflect its culture (e.g.
integrity, transparency, and environmental friendliness).
 Figure 5: VMOST Analysis

From this analysis we can obtain some of the strengths and weaknesses to
include in the SWOT analysis. If the VMOST is well defined and
communicated and people are committed to achieving what it states, it is a
strength in the SWOT; otherwise, it is a weakness.
The information for the VMOST can already be defined and documented in
a company or it can be built through brainstorming, workshops, or
interviews with high-level managers and directors.
TEMPLATE
http://analyticsmodels.blogspot.com.es/p/strategic-analysis-templates.html
 


9. RESOURCE AUDIT
OBJECTIVE
Identify the weaknesses and strengths within an organization.
DESCRIPTION
This model identifies the resources available to an organization, which can
be divided into:
-          Financial resources (funds, loans, credit …)
-          Physical resources (plants, buildings, machinery …)
-          Intangible resources (reputation, know-how …)
-          Human resources
To define the strengths and weaknesses (which can be used afterwards in a
SWOT analysis), we should ask several questions, such as:
-                  Are the available resources enough for the current competitive
situation?
-          Will they be able to support future developments?
-                  How difficult is it to obtain more of these resources for the
company? And for its competitors?
-                  How difficult is it for a competitor to imitate these resources or
core competencies?
-          How important are they for the core business?
Simplifying, we can state that it is a strength for the organization when it
possesses unique resources or when it has more or easier access to imitable
resources than its competitors.
 Figure 6: Resource Audit Example

The identification of strengths and weaknesses is based on qualitative

reasoning, but this can be supported by both quantitative data (financial
ratios, reputation indexes, employee turnover rate, etc.) and qualitative data
(workshops, interviews, brainstorming, etc.).
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10. BOSTON MATRIX

OBJECTIVE
Decide the best allocation of resources among different products, product
lines, or business units.
DESCRIPTION
Created by the Boston Consulting Group, this method aims to decide how to
allocate resources depending on the market positioning of different products
or services. The market positioning depends on two variables:
-                  Market share: more than the simple percentage of the market
share, the relative importance depends on the number of competitors,
the position according to the market share, and how the company
compares to its largest competitor. There is also a big assumption that
limits this model: the market share is positively related to earnings and
profitability.
-          Market growth: this is the growth rate of a product or service, and
it represents not only the prospective growth of earnings but also the
attractiveness of a market.
 Figure 7: Boston Matrix

This matrix aids in decision making and is based on the following four
categories:
-          Stars: these products maintain the level of investment and strategy
and will be cash cows when the market growth declines;
-          Cash cows: these are products with a high market share and low
growth; the investment needed is limited;
-                  Question marks: it is important to improve the strategy by
investing in the right levers to increase the market positioning and
sales. The goal is to move these products to the “stars” box;
-                  Dogs: here there are two options, either not to invest in these
products or to redefine them.
The Boston matrix is considered a useful tool to define strengths and
weaknesses in SWOT analysis, but it can also reveal future opportunities for
the organization.
The data can usually be gathered from published information concerning
industries, sectors, products, or services. If the data are not available, it is
possible to estimate the market share by surveying a representative sample
of customers.
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11. PORTER’S FIVE FORCES

OBJECTIVE
Analyze the competitive environment in which the company operates.
DESCRIPTION
This tool is part of the external strategic analysis, and it is useful for
completing the SWOT analysis concerning opportunities and threats. While
the PESTEL analysis concerns the external environment and macro trends,
Porter’s technique focuses on the industry domain.
It is very important before undertaking this analysis to establish the company
domain of competition, since this can change the results significantly. The
analysis of the competitive environment is undertaken through five
categories:
-          Competitors: how strong is the rivalry among competitors?
-          New entrants: how easy is it for new entrants to start competing?
-          Substitutes: how many and how significant are they?
-                  Buyers: how many are there and how easily can they change
supplier?
-                  Suppliers: how many are there and how high are the switching
costs for buyers?
The answers to these questions reveal several opportunities or threats for the
company; for example, if customers (buyers) have few options and their
switching costs are high, this is an opportunity for the company.
 Figure 8: Porter’s Five Forces Framework

The data can be gathered from extensive market research and from industry
experts through interviews, workshops, and brainstorming.
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12. PRODUCT LIFE CYCLE

ANALYSIS
OBJECTIVE
Define the maturity of the industry in which a company is competing or the
maturity of a product that it is selling.
DESCRIPTION
Several studies have been carried out on industries’ life cycles. Industries
and products usually start from an emergent phase, pass through a growth
phase, and finally reach a mature phase. At this point either they start the
cycle again thanks to innovations or they decline.
This is a tool made for reasoning about the maturity of the industry and the
maturity of the kind of products being manufactured. To define the phase in
which the company is positioned, consider the following:
-          Emergent phase: this is characterized by a small number of firms,
low revenues, and usually zero or negative margins;
-          Growth phase: the margins are increasing rapidly (for a while, but
less in the last part of the growth phase), as well as the number of
firms;
-                  Mature phase: the global revenues are increasing at a far slower
rate; both the margins and the number of firms are decreasing.

Figure 9: Competitive Life Cycle

Usually, after the emergent phase, the dominant standards are defined and
the rise of one or a few companies is experienced (annealing). Due to rapidly
increasing margins, many companies imitate those successful pioneers, and,
consequently, the margins start to decrease and a few companies start to
leave the market (shakeout). Only the most efficient firms remain in the
market during the mature phase, at the end of which we have either decline
or disruption thanks to innovation or a demand shift. Finally, the process
starts again.
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13. DIVERSIFICATION MATRIX

(G.E. MATRIX)
OBJECTIVE
Make decisions on diversification strategies.
DESCRIPTION
A firm’s scope can be to broaden by diversifying its products or services,
which can be either related or unrelated to the core business. To decide
whether to maintain, create, or close specific business units, we must start
with a detailed analysis of advantages and disadvantages. A simple matrix is
used to explore the main opportunities concerning diversification, which
depends on one side on the industry attractiveness of business units (which
can be measured by Porter’s five forces analysis) and on the other side on
the competitive advantage of the business units.

Figure 10: Diversification Matrix

For business units in the upper-right box, the decision should be to invest
more, while for the boxes in which there is either good industry
attractiveness or a good competitive advantage, it should be to maintain the
current course. Companies should consider closing business units that fall
into the lower-left box.
The data are mainly qualitative and usually derived from other analytical
tools, for example Porter’s five forces or the industry competitive life cycle
for the Y axis (industry attractiveness) and competitive maps or resource
audits for the X axis (business unit competitive advantage).
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14. INTERNATIONALIZATION
MATRIX
OBJECTIVE
Make decisions on internationalization strategies.
DESCRIPTION
An internationalization strategy implies several preliminary analyses to
respond to the two main questions: where and how? However, the main
trade-off when internationalizing is between the advantages of global
integration and the disadvantages of local responsiveness (the need for
adaptation).
The matrix with these two indicators can be filled either with different
industries (in the case that we want to decide which business unit to
internationalize) or with different competitors to identify business
opportunities.

Figure 11: Internationalization Matrix

With this matrix (in the example of analyzing competitors), it is possible to
find opportunities in which competitors are not exploiting the upper-left
corner, implement strategies with lower adaptation costs, and obtain better
global integration advantages. In addition, opportunities can be found for
which the conditions are not optimal for other firms (lower-right corner) and
hence there are no competitors there, so it is possible to be profitable. The
data for this model are gathered through published articles or studies,
industry public data, and experts’ opinions (brainstorming, workshops, etc.).
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15. BUSINESS MODEL CANVAS

OBJECTIVE
Analyze our own business model or competitors’ business models.[10]
DESCRIPTION
This tool, invented by Alexander Osterwalder et al.,[11] can be used to
analyze how an organization is creating and delivering value to its
customers. Even though its original purpose was to help in creating a new
product or business, in this book the business model canvas is presented as
an analytical tool, since those kinds of models are not covered. This model
can also be useful for understanding whether a company is a competitor or
not, since it analyzes the value proposition, which responds to customers’
needs. In fact, companies compete not on products but on the needs that they
satisfy or the problems that they solve for their customers.

Figure 12: Business Model Canvas

The study includes the analysis of nine building blocks of the business and
how they are related to each other. First we define our customer segments
and then the value propositions that we are offering to them. The value
proposition is a need that we satisfy or a problem that we solve for a specific
customer segment. It is possible that we are offering different value
propositions to different customers; for example, a search engine is
providing search results to web users and advertising spaces to companies.
Then we identify how to deliver this value to our customers (channels) and
how we manage our relationships with them (customer relationships). At
this point we are able to describe our revenue model (revenue streams).
However, to understand how to create our value propositions, we need to
identify our key activities, key resources, and key partners. These three
blocks allow us to identify our cost structure. For more information about
this model, visit the official website[12] or sign up for the free online course
“How to Build a Startup.”[13]
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16. SWOT ANALYSIS

OBJECTIVE
Concerning a company, identify the main strengths to maintain,
opportunities to exploit, threats to reduce, and weaknesses to manage.
DESCRIPTION
The SWOT analysis is the consolidation of internal and external analyses,
and it is used for strategy definition, usually in its first stage, to establish the
bases of several strategic actions:
-                  External analysis: analysis of the external opportunities and
threats resulting from the external environment (PEST, PESTEL); for
example, the increasing use of mobile devices can be an opportunity to
exploit or the increasing cost of energy can be a potential threat.
-          Internal analysis: internal strengths and weaknesses resulting from
the internal analysis (MOST, resource audit, etc.) and from
competitive analysis (competitive map, importance–performance
matrix). For example, a well-known brand is a strength and a poor
company strategy definition is a weakness.

Figure 13: SWOT Analysis

From this matrix the analyst can define strategic actions that exploit existing
opportunities, using the company’s strengths as critical success factors and
reducing the risks that can be provoked by potential threats and the
company’s weaknesses. Since this is a consolidation of several other
analyses, the sources of data depend on previous analyses and on several
gathering techniques, such as brainstorming, the Delphi method, and
surveys. The consolidation process can be performed directly by the analyst,
but it is usually a good practice to consolidate the results or submit the
analysis to other company members, for example through workshops or
think tanks.
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17. ANSOFF’S MATRIX

OBJECTIVE
Define the most appropriate business strategy based on the existence of
markets and products.
DESCRIPTION
Ansoff’s matrix is usually performed after a SWOT analysis, in which
strengths, weaknesses, opportunities, and threats can be transformed into
business strategies:
-                  Market penetration: the organization decides to use existing
products in the existing market by improving tactics and strategies to
push sales, for example through advertising, promotion, and pricing;
-                  Product development: the organization decides to develop new
products for an existing market or to add new features;
-                  Market development: the organization decides to sell existing
products to new markets, for example exporting to new countries;
-                  Diversification: the organization decides to take a more radical
approach by creating a new product for a new market. This can be the
result of an opportunity caused by a new trend, identified in the SWOT
analysis.

Figure 14: Ansoff’s Matix

Once the strategy has been defined using Ansoff’s matrix, the objectives,
strategies, and tactics can be revised in the VMOST model. The information
needed for this matrix can usually be found in previous internal analysis,
external analysis, and SWOT analysis.
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PRICING AND DEMAND



18. INTRODUCTION
Setting the right price is one of the most complicated decisions to take but
also one of the most rewarding. To choose the price that maximizes revenues
and benefits, it is necessary to determine the willingness to pay (WTP) of
customers. Ideally, we should define the WTP of each customer, but in most
cases it is only possible to establish the WTP for several customer segments.
We can define the WTP as the highest price that a person will accept to buy
a product or service. However, it is useful to differentiate between two
concepts: the maximum price and the reference price.[14] The maximum
price is the value of a reference product plus the differentiation value of the
product of interest; for example, the WTP of brand B is the value of brand A
plus the differentiation value between the two brands. The reference price is
the highest price that a person would pay for a product or service assuming
that she has no alternative. In conclusion, we can say that the WTP is either
the maximum price or the reference price depending on which is the lowest.
Several methods can be used for the estimation of the WTP, which can be
divided into two main groups: observations and surveys.
 
Figure 15: Classification of Methods for WTP Estimation14


MARKET DATA
The advantage of market data is that they are easily accessible and imply no
cost other than the time dedicated to the analysis. However, there are several
drawbacks:
-          Usually there is not enough price variation in the data to test the
necessary range of WTP;
-                  We are only analyzing our customers and not the market as a
whole;
-          We can just define whether an individual has a higher WTP than
the selling price, and we lose information about customers who
decided not to purchase the product;
-          Usually demand curves are estimated through regressions, and in
this case several conditions have to be met (see 36. INTRODUCTION
TO REGRESSIONS).
EXPERIMENTS
There are two main kinds of experiments:
-                  Laboratory experiments: purchase behavior is simulated in
scenarios in which prices and products are changed (a main drawback
is that the purchase intention can be biased, since the participants are
aware of the experiment and because they are not spending their
money or real money);
-                  Field experiments: these are tests in which different prices and
products are offered to customers for real purchase.
A general drawback of experiments is that they are quite costly.
DIRECT SURVEYS
Surveys are a faster and less expensive method for determining the WTP.
Either experts or customers directly can be interviewed. In the first case,
sales and marketing experts are asked to predict the WTP of customers. This
method usually performs better in situations in which the number of
customers is small, while it performs poorly when the customer base is large
and heterogeneous. In this case it is preferable to conduct customer surveys
to ask customers their WTP directly. A widely used technique is the one
proposed by Van Westendorp. Although this method is easy and direct, it has
several drawbacks:
-                  Customers can have incentives to underestimate their WTP (to
influence real product prices) or to overestimate their WTP (to show a
better social status in front of researchers);
-          Even if customers try to reveal their true WTP, this is a difficult
and complicated task and the response can be biased unconsciously by
several factors;
-                  If buyers have no market reference, they can overestimate their
WTP.


INDIRECT SURVEYS
With indirect surveys a situation more similar to the purchase process is
presented, since the respondents are asked to indicate whether they would
purchase a specific product with a specific price or not. For this reason the
performance tends to be better than that of direct surveys. There are two
main techniques: conjoint analysis and discrete choice analysis.
Conjoint Analysis
Different products with varying attributes and price are presented to the
respondents, who are asked to rank them. Since it is not possible to
determine whether the respondents would buy the product at the presented
price, usually they are also asked to identify a limit below which they will
not buy the product. A disadvantage of this method is that the usual market
prices are shown; therefore, if the respondents’ WTP is not included in these
prices, the estimated WTP can be quite different from the true one.
Discrete Choice Analysis
As in conjoint analysis, products are decomposed into attributes for which
the utility is calculated. However, in discrete choice analysis, the
respondents have to choose a product from a set of several alternatives. The
main methodological difference is that attributes’ utility is estimated at an
aggregated level (the population), while in conjoint analysis it is calculated
for each individual. To estimate the utility at the individual level, the results
of discrete choice analysis can be processed using a hierarchical Bayes
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19. PRICE ELASTICITY OF

DEMAND
OBJECTIVE
Determine the price sensitivity of demand.
DESCRIPTION
The price elasticity of demand is a measure that represents how much the
demand will change due to a change in the price. With a price elasticity of
“1,” a 5% increase in the price means that the demand will increase by 5%.
However, the price elasticity of demand is usually negative, since an
increase in the price is likely to produce a decrease in the demand.
Elasticities of -1 or 1 are considered to be “unit elasticities,” since a variation
in the price provokes a proportional variation in the demand (positive or
negative). Elasticities with an absolute value less than 1 (for example 0.4 or
-0.6) are considered to be inelastic, since a variation in the price results in a
less than proportional variation in the demand, while elasticities larger than 1
are considered to be elastic. To simplify, if at a specific point the demand is
price inelastic, an increase in the price would increase the revenues; if it is
elastic, a decrease in the price would have a positive effect on the revenues.
To calculate the price elasticity, this formula can be applied:

where the percentage change in the demand is divided by the percentage

change in the price. We can either take the two nearest offered prices or
calculate the elasticity by taking more distant prices. We can also calculate
the elasticity using midpoints between offered prices. With a PED of -0.4, if
we increase the price by 20%, we can expect the demand to increase by 8%
(-0.4 * 0.2 = -0.8). However, this calculation is less precise for large price
variations. It is usually better to calculate “arch elasticities,” in which the
change in the demand is calculated incrementally at each 1% price variation
(in our case 20 times). With this calculation our reduction in the demand is
estimated to be 7%: 1 - (1.2 ^ (-0.4)).
In addition, when calculating the PED, it is important to consider timing and
inflation:
-                  Timing: if our data are spread across a large period of time (i.e.
several years), we must consider that the demand could be different
due to a change in consumer tests, new substitutes, and so on. The
supply could also have changed, and this has an important effect on the
price equilibrium with demand.
-          Inflation: we should use real prices, since for example if our price
has increased by 3% but inflation is about 3%, then in practice our
price has not changed.
 

Figure 16: Price Elasticity of Demand

The data can be analyzed in more detail using a regression (see 38. LINEAR
REGRESSION). For example, in Figure 16 the price elasticity changes
drastically at a certain price level. In other cases the data can be too
scattered. In either case we should consider segmenting the data, since this
can be caused by the heterogeneity of the respondents (e.g. seniors are less
price sensitive while young people are far more price sensitive).
The data used for a PED calculation can be either real data from transactions
or survey data. If we use transaction data, we must be able to exclude
demand variations due to different factors from the price (we can for
example include other predictor variables in the regression – see
“Multivariate Regression” in chapter 39. OTHER REGRESSIONS). If we
use survey data, the pricing models described in the following chapters can
be considered.
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20. GABOR–GRANGER PRICING

METHOD
OBJECTIVE
Define the optimal price range for a product or service.
DESCRIPTION
This method is useful in taking general pricing decisions. Data are collected
through surveys in which each respondent is asked about his intention to
purchase and shown several prices that move up or down depending on the
previous answers. Alternatively, prices can be shown randomly or in a fixed
series. The highest price at which a respondent reports that he would buy is
considered to be his WTP. Once we have a specific price limit (WTP) for
each interviewee, we can draw an accumulated demand curve.

Figure 17: Gabor–Granger Pricing Method

Since we have the information about demand and WTP available, we can
calculate the revenue curve in the graph and establish the optimal price at
which revenues are maximized (Figure 17).
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21. VAN WESTENDORP PRICE

SENSITIVITY METER
OBJECTIVE
Determine consumer price preferences.
DESCRIPTION
People are asked to define prices for a product at four levels: too cheap,
cheap, expensive, and too expensive. The questions usually asked are:
-          At what price would you consider the product to be so expensive
that you would not buy it? (Too expensive)
-                  At what price would you consider the product to be so
inexpensive that you would doubt its quality? (Too cheap)
-                  At what price would you consider the product to start to be
expensive enough that you could start to reconsider buying it?
(Expensive)
-          At what price would you consider the product to be good value for
money? (Cheap)
The results are organized by price level, with the accumulated demand for
each question. The demand is usually accumulated inversely for the
categories “cheap” and “too cheap” to define crossing points with the other
two variables (Figure 18).
 Figure 18: Van Westendorp’s Price Sensitivity Meter

From the four intersections, we have the boundaries between which the price
should be settled (lower bound and upper bound). Although the other two
price points are sometimes used, I prefer to use this model to define the lead
prices and upper prices for a product, while the middle prices should not be
static but should change based on several factors (period of purchase, place,
conditions, etc.).
With this model we can define price boundaries, but we cannot estimate the
purchase likelihood or demand. For the estimation of the demand (and
revenues), we ask an additional question regarding the likelihood of buying
the product at a specific price with a five-point Likert scale (5 = strongly
agree, 1 = strongly disagree). The price to be tested can be the average of the
“cheap” price and the “expensive” price for each respondent. A more
comprehensive approach would be to ask the question for both the “cheap”
and the “expensive” price. Then the results must be transformed into
purchase probabilities, for example strongly agree = 70%, agree = 50%, and
so on. With these results we can build a cumulative demand curve and a
revenue curve (Figure 19). The optimal price is the one at which the
revenues are maximized (be aware that this approach aims to maximize
revenues and does not take into account any variable costs).
 Figure 19: Van Westendorp’s PMS Extension with Demand and Revenue Estimation

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22. MONADIC PRICE TESTING

OBJECTIVE
Analyze people’s purchase intention at different price points and for
alternative products.
DESCRIPTION
In monadic price testing, purchase behavior is tested for several price points,
but each respondent is shown just a single price. Due to this method, a large
base of respondents is necessary. A variation that needs a smaller sample is
sequential monadic testing, in which the respondents are shown different
price points, one at a time (usually no more than three price points are
presented to each respondent). It is important to bear in mind that sequential
monadic testing implies some biases and usually shows a higher purchase
intention at the lower prices than monadic testing.
This is probably the best method for analyzing purchase behavior at a given
price; however, it is only useful if we have an idea of the appropriate price
points for a particular market. If this is not the case, we would need to obtain
this information prior to the analysis, either through direct or indirect survey
methods (see 18. INTRODUCTION).

Figure 20: Demand Curve Derived from Monadic Price Testing

Once the data have been collected, we can summarize the purchase behavior
for the different price points (e.g. 11% of the market would purchase the
product at €30, €32% at 20, etc.), and we can estimate a demand curve. The
data are usually collected through surveys but can also be obtained from
controlled experiments.
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23. CONJOINT ANALYSIS

OBJECTIVE
Identify customers and potential customers’ preferences for specific
attributes of a product. It can also be used to define the willingness to pay
and the market share of different products.
DESCRIPTION
Conjoint analysis is a surveying technique used to identify the preferences of
customers or prospective customers. The respondents are shown several
products with varying levels of different attributes (e.g. color, performance)
and are asked to rank the products. This ranking is then used to calculate the
utility of each attribute and product at the individual level. The results can be
used to define the best combination of attributes and price or to simulate
market share variations with competitors (if competitors’ products are
presented).
First of all it is very important to spend enough time designing the analysis,
starting with the selection of the most important attributes and attributes’
levels.
There are three kinds of methods:
-                  Decompositional methods: the respondents are presented with
different product versions, they rank them, and then the utilities are
calculated at the attribute level by decomposing the observations;
-                  Compositional methods: the respondents are asked to rate the
different attributes’ levels directly;
-                  Hybrid methods: compositional methods are used in the first
phase to present a limited number of product versions in the second
phase (they are useful when we have a large combination of attributes
and levels).
In addition to the methods described above, several kinds of adaptive
conjoint analysis are used to increase the efficiency of conjoint analysis,
especially when the number of attributes is large.
In conjoint analyses the price is usually included as an attribute and the price
utility is calculated. However, this creates several problems:
-          By definition the price has no utility but is used in exchange for
the sum of attributes’ utilities of the product;
-                  The price ranges, number of levels, and perception of the
respondents can bias the answers;
-                  The purchase intention is not included, so we do not know
whether the respondent would actually buy the product at the
presented price (to avoid this problem partially, the respondents are
usually asked to define a limit in the ranking below which products are
not purchased).
The willingness to pay is calculated as the exchange rate between price
utility and attribute utility. However, to avoid the abovementioned problems,
we should consider a different approach, for example dividing the analysis
into two phases:
1-        Perform a classic conjoint analysis for non-price attributes to
define utilities;
2-     Ask for the purchase intention of full product profiles with varying
prices to define the lower and upper boundaries between which the
respondent would agree to purchase the product.
With this information a linear function can be estimated in which the price is
the dependent variable and the utility is the independent variable.
In the example we present a classic conjoint analysis that includes the price
as an additional attribute. It includes one three-level attribute, one two-level
attribute (color), and three levels of price. Full-profile products are presented
to the respondents (compositional method), and they are asked to give a
preference on a scale from 0 to 10 (10 being the most preferred product)
instead of ranking the products.
 Figure 21: Combinations and Stated Preferences of Conjoint Analysis

The utility of a respondent is calculated by removing one level for each

attribute to perform a multiple linear regression with dummy variables. The
removed variables will have a utility of “0,” while the attributes included in
the regression will have the utility corresponding to the regression
coefficients. After verifying the significance of each attribute (p-value <
0.05; see 38. LINEAR REGRESSION), the coefficients can be summed to
build the utility equation.
The utility equation at the individual level can be used to define the most
profitable combination of attributes and price. It also allows the building of
scenarios in which shifts in the market share are calculated due to changes in
the price or products’ attributes compared with the products offered by
competitors. Especially for the market share scenarios, it is important to
define the purchase intention by asking the respondents to state a “limit”
beyond which they will not purchase the product.
In the template a second sheet is presented in which the price is not included
as an additional attribute but the respondents are asked about it separately,
either directly or by showing them different price–product combinations and
asking for their purchase intention. The last example usually performs better,
but if we have numerous combinations, we cannot show all of them.
 Figure 22: Price–Utility Linear Relation

There are two main approaches when creating surveys for conjoint analysis:
-          Classic conjoint: the respondents are shown all the combinations
of attributes’ levels and are asked either to rank them or to define their
preferences on a certain scale (e.g. 0 to 10). If the number of
combinations is too large, we should either split the combinations and
present them several times to the respondents or present only a certain
percentage of all the possible combinations (randomly selected). We
should also ask for a “limit,” that is, the ranking position or preference
level at which the respondent would change his purchase intention.
-          Conjoint in which the price is not an attribute: the process is the
same as the classic conjoint analysis, but the price is not included as an
attribute. After asking the respondents to rank or set their preferences
concerning several combinations of attributes’ levels, they are asked
whether they would purchase a specific combination at a specific
price. Depending on the response, either the utility or the price is
modified to identify the WTP. If the number of combinations is
limited, each one can be tested; if the number is large, not all
combinations can be tested and the WTP must be calculated for
 different levels of utility and can then be estimated for all the
combinations.
TEMPLATE
http://analyticsmodels.blogspot.com.es/p/pricing-and-demand-
templates.html


24. CHOICE-BASED CONJOINT

ANALYSIS
OBJECTIVE
Identify customers and potential customers’ preferences for specific
attributes of a product. It can also be used to define the willingness to pay
and market share of different products.
DESCRIPTION
This method is preferred to conjoint analysis because it represents a more
realistic purchase situation and, in the case of having a large number of
possible combinations, because it is sufficient to show only a certain number
of combinations to each respondent. Then the responses are analyzed
together and the utility is defined at the aggregated level (not at the
individual level as in conjoint analysis).
For this method it is also very important to choose carefully the attributes (as
a rule of thumb, no more than seven including the price) and the product
profiles to present, that is, the combinations of attributes. Once the attributes
and product profiles have been defined, choice scenarios are designed. A
scenario is a combination of several products that is presented to the
respondents. When defining scenarios, these recommendations should be
followed:
-          A “none” choice should be included among the products presented
in each purchase scenario;
-          Each scenario should not have more than 5 products;
-                  Between 12 and 18 scenarios are usually presented to each
respondent.
Usually, all the combinations cannot be presented in the same scenario, and a
good practice is to show from two to five products in each scenario. When
choosing the combination of products for each scenario, it is important that
all the products are shown an equal number of times and that each product is
compared equally with other alternatives.
Once the data have been collected, utilities are estimated at the aggregate
level. The market share of each product can be calculated using the “share of
preferences”:
-                  Products’ utilities are calculated by summing all the attributes’
utilities;
-          Products’ utilities are exponentiated;
-                  The market share is calculated as the product’s exponentiated
utility divided by the sum of all the exponentiated utilities.
To obtain utilities at the individual level, a method called “hierarchical
Bayes” is used. This method enables us to calculate a more reliable market
share based on the choice of each respondent using three main techniques:
-          First choice: each respondent chooses the product that maximizes
her utility (this technique is suggested for expensive products that
imply a careful evaluation, such as houses and cars);
-                  Share of preference: each respondent purchases a share of each
product based on the share of utilities (suggested when a product is
purchased several times during a certain period);
-                  Randomized first choice: each respondent chooses one product
with a probability proportional to its utility.
This method is also useful for predicting variations in the market share
compared with competitors by creating simulations in which prices or other
products’ attributes are changed. For example, we can analyze whether a
discount can attract a big enough market share to compensate for the
reduction in price. In this kind of simulation, we assume that competitors are
not modifying both attributes and price, but in reality this could not be the
case. This is why we should at least simulate several scenarios including
possible competitors’ reactions. A more complex approach would be to
include a game theory model (see 76. GAME THEORY MODELS).
TEMPLATE
Due to the complexity of choice-based conjoint analysis, I suggest using
specific tools (several of these can be found by searching on the net) or using
Excel complements, such as the one offered by XLSTAT,[15] from which an
example can be downloaded in Excel with the results of a choice-based
conjoint analysis
(https://help.xlstat.com/customer/en/portal/articles/2062347-running-a-
choice-based-conjoint-analysis-cbc-with-xlstat)


CUSTOMER ANALYTICS


25. INTRODUCTION
Unlike the other models described in this book, customer analytics analyzes,
predicts, and prescribes at the very individual level. The main idea is that a
company has at its disposal “customer equity,” which is the sum of the
values of each customer. This value is determined by several clients’
behavior, such as the amount spent, purchase frequency, level of
recommendation, and so on.
Customer analytics allows companies to segment their customer base
properly and personalize products and services for each group of clients or
even each individual client. Personalization enables them to retain their most
valuable customers and increase customers’ value by properly implementing
commercial techniques, such as upselling, cross-selling, recommendation
programs, and so on.
Data at the individual level are more complicated to obtain and more
complex to analyze than aggregated data. The majority of this information
comes from historical market data (a company’s data concerning purchases,
customers’ actions, and profiling data), but they are usually complemented
with survey data.


26. RFM MODEL

OBJECTIVE
Estimate the lifetime value of a customer or group of customers.
DESCRIPTION
This is probably the simplest model for the estimation of customers’ value.
In spite of its simplicity, it is also famous for its reliability, which is based on
three variables:
-                  Recency: the more recent the purchase or interaction, the more
inclined the client is to accept another interaction;
-                  Frequency: the more times a customer purchases, the more
valuable he or she is to the company;
-          Monetary value: the total value of a customer also depends on the
amount spent in a given period.

Figure 23: Customers’ Value Calculated by an RFM Model

Usually, these three variables are transformed into comparable indicators

(for example into a “0 to 1” indicator) and summed up to obtain a total value
indicator. We can also define different weights for each indicator.
TEMPLATE
http://analyticsmodels.blogspot.com.es/p/customer-analytics-templates.html


27. CUSTOMER LIFETIME VALUE

1
OBJECTIVE
Estimate the lifetime value of a customer or group of customers.
DESCRIPTION
Customer lifetime value is an indicator that represents the net present value
of a customer based on the estimated future revenues and costs. The main
components of this calculation are:
-          Average purchase margin (revenue – costs);
-          Frequency of purchase;
-          Marketing costs;
-          Discount rate or cost of capital.
There are several ways to calculate it, and different formulas have been
proposed. The most difficult part is to estimate customers’ retention (in
contractual settings) or repetition and to estimate the monetary amount that a
customer will spend in the future. It is important to remember that CLV is
about the future and not the past, which is why using past data of a customer
is not the best method for calculating CLV. A good practice is to segment
customers and estimate the retention and spending patterns based on similar
customers. Then, the following formula can be applied:

CLV = customer lifetime value

MC = yearly marginal contribution, that is to say the total purchase revenue
in a year minus the unit costs of production and marketing
R = retention rate (yearly)
D = discount rate
CA = cost of acquisition (one-time cost spent by the company to reach a new
customer)
 Figure 24: Customer Lifetime Value of Different Customers

The discount rate can be the average cost of capital for the company or the
related industry, and it is used to depreciate the value of future benefits to
estimate what they are worth today.
With this formula we can estimate the CLV of a single customer or a
segment of customers. In the case of estimating it at the individual level, we
should use the retention rate (r) of similar customers, for example customers
who buy similar products, or more sophisticated techniques, for example
cluster analysis.
When we define the value of a customer or a group of customers, we can
make decisions concerning the level of attention, the investment in
marketing and retention costs, or the amount that we can spend (cost of
acquisition) to attract customers with a similar CLV.
Even though it is quite difficult to estimate, we have to consider that the
CLV formula does not take into account the value generated by referrals.
Although some formulas have been proposed,[16] this calculation is seldom
used due to the lack of information. In fact, to calculate the customer referral
value, we need information about the advocates and the referred customers,
and for the latter we should be able to distinguish those who would have
made the purchase anyway (without the referral). As a proxy we can use the
NPS (see 29. NET PROMOTER SCORE® (NPS®)) combined with other
information from surveys, such as asking whether a customer has been
referred and how much the referral has affected the purchase.
The market’s historical data is the main source of information (at the
individual level, usually from CRM systems), but it can be enriched with
survey data, for example concerning the likelihood of repeating the purchase
or recommending the product.
TEMPLATE
http://analyticsmodels.blogspot.com.es/p/customer-analytics-templates.html


28. CUSTOMER LIFETIME VALUE

2
OBJECTIVE
Estimate the retention and future spending amount of customers.
DESCRIPTION
In the previous chapter I explained the principles of CLV and its calculation.
However, one of the problems was the estimation of the retention rate (for
which the simplification was to apply the average retention rate of similar
customers) and future spending amounts (we assumed that the average
spending amount of each customer will not change in the future). Despite the
facility of the implementation of this approach, it can be much too simplistic
and fail to estimate CLV reliably.
There are several methods for estimating retention and spending amounts,
but some of them can be far too complex. The method that I will propose has
a good balance between accuracy and implementation simplicity and is
based on customer segmentation and probability.
The first step is to take the customer data of year -2 and segment them based
on their value and their activeness. For the value we can use the amount
spent in a specific year (which is a mix of the average amount spent per
purchase and the frequency of purchases), and for activeness we can use the
recency of the last purchase (for example the number of days between the
last purchase and the end of the analyzed year). For activeness we can also
use a mix of recency and frequency. In the second step, we have to define a
certain number of customer segments. The segmentation technique can be
either a simple double-entry matrix or a statistical clustering technique. We
can for example end up with six clusters:
-          Active high value
-          Active low value
-          Warm
-          Cold
-          Inactive
 -          New customers
The idea behind this technique is to estimate the retention and spending
amount using the probability of a customer remaining in the same segment
or changing segment and by applying to this customer the average spending
amount of the new segment. To calculate the probability of moving from one
segment to another, it is necessary to segment the customers into year -1 and
create a transition matrix (transition among different segments from year -2
to year -1) in which probabilities are calculated for each combination of
segment groups.

Figure 25: Transition Matrix of Customers’ Segments

With the probability transition matrix we can simulate how the segments will
change in the future (see ¡Error! No se encuentra el origen de la
referencia.) and maybe realize that we are dangerously reducing active
customers in favor of inactive ones and that we need to acquire a slightly
bigger number of each kind of customer to avoid a decrease in profits. In any
case with this matrix we can simulate several years ahead and estimate how
many customers will still be active. We can also estimate their value by
multiplying the average value of each segment by the number of customers
of the same segment in a specific year (year 0, year +1, year +2, etc.).
In the proposed template, I have added an estimation of new customers
acquired each year to simulate the total number of customers and their value
a few years ahead. However, to calculate the CLV of the current customers,
this value should be set to 0 and then the total value of each year discounted
by the discount rate.
TEMPLATE
http://analyticsmodels.blogspot.com.es/p/customer-analytics-templates.html
 


29. NET PROMOTER SCORE®

(NPS®)
OBJECTIVE
Identify customers’ likelihood of making recommendations.
DESCRIPTION
Usually the value of customers is calculated using only the variables amount
spent and frequency of purchases. However, customers can create value in
several other ways, one of which is by recommending the service to other
potential buyers. The so-called “word-of-mouth” phenomenon is nowadays
empowered by social networks, metasearch websites, or portals that provide
customer feedback on products.
Positive recommendations can not only increase sales but also allow
companies to save money on advertising. The Net Promoter Score® is an
indicator that estimates the probability of recommendation of a group of
customers based on the recommendation intention of single customers. It
was developed and registered as a trademark by Fred Reichheld, Bain &
Company, and Satmetrix.
The data are collected through surveys, and the respondents are asked to
score from 0 to 10 the likelihood of recommending the product or service.
Those who respond 9 or 10 are the real promoters, while those who respond
6 or lower are the detractors. The respondents whose score is from 7 to 8 are
considered passive, since, even if they say that they would recommend the
product or service, in reality they do not recommend it. The NPS® is the
percentage of promoters minus the percentage of detractors.
TEMPLATE
http://analyticsmodels.blogspot.com.es/p/customer-analytics-templates.html


30. CUSTOMER VALUE MATRIX

OBJECTIVE
Identify customer segments according to the value that they provide to the
organization.
DESCRIPTION
A particularly interesting article published in the Harvard Business
Review[17] states that the customers who buy the most are not necessarily
the most valuable customers, since, according to the authors, the most
valuable customers are those who are able to bring in new valuable clients
through recommendations. The referral value of customers includes not only
the value generated by the new customers but also the savings on the
acquisition costs (advertising, discounts, etc.). In this article both customer
lifetime value and customer referral value are calculated properly, but
usually these data are hardly available, mainly due to the fact that identifying
those customers who made recommendations and the new customers
obtained thanks to the recommendations is a complex task.
However, we can take the customer value matrix based on their conclusions
and apply it to our customer data in a simpler way. For this simplification we
assume that “repetition” is correlated with “lifetime value” and that the
intention to recommend a product is correlated with new customers gained
through advocacy. These data can be gathered through a survey in which we
ask about repetition (actual or intended) and whether the customer would
recommend the product. With the results of these two variables, we create a
four-block matrix:
-          Champions: they are high buyers and good advocates;
-                  Affluents: they are high-spending customers but do not tend to
make recommendations;
-                  Advocates: they are the customers who make the most
recommendations but do not buy a lot;
-                  Misers: they are low-value customers in both purchasing and
recommending.
 Figure 26: Customer Value Matrix

To assign customers to the right box, we can take the median of the two
indicators. The purpose of this model is to differentiate our marketing
techniques:
-                  Affluents: offer them incentives in exchange for recommending
products to a few friends;
 
-                  Advocates: focus on upselling or cross-selling, for example by
offering bundled products or discounts for products that they are not
buying;
-                  Misers: try the two abovementioned techniques to move them
either to the affluents or to the advocates (or maybe to the champions).
We can also improve the model by adding a value component besides the
repetition, for example the money spent on average for each purchase.
A drawback of using this simplification is that we must be able to relate the
survey to a real customer to differentiate our marketing techniques. Hotels,
for example, use check-out surveys and ask their customers about repetition
and recommendation.
The data are gathered through online or offline surveys in such a way that
the survey can be related to a customer (through email, transaction
identification number, etc.).
TEMPLATE
http://analyticsmodels.blogspot.com.es/p/customer-analytics-templates.html
 


31. CUSTOMER PROBABILITY

MODEL
OBJECTIVE
Predict the long-term future behavior of customers.
DESCRIPTION
Customer behavior can be predicted by regressions or willingness-to-pay
methods; however, while these methods are good at predicting actions for
“period 2,” the more we try to predict further into the future, the more these
methods are inaccurate. A customer probability model can help in refining
the customer lifetime value calculation.
To move beyond “period 2,” we should use a probabilistic model based on
pattern recognition. Quite a simple model that can be implemented in Excel
is the “Buy Till You Die” model,[18] which needs three inputs: recency,
frequency, and the number of customers for each combination of the
previous two variables.
This model can be applied in discrete-time settings, which means that it can
be applied either to cases in which the customer can buy a product on
specific purchase occasions (for example when participating in an annual
conference) or to cases in which a discrete purchase interval is created (time
can be “discretized” by a recording process, for example whether or not a
customer went on a cruise or stayed at a specific hotel during a year).
The model proposed by Peter S. Fader and Bruce G.S. Hardie18 uses a log-
likelihood function estimated using the Excel plug-in Solver. They explain
how to build the model from scratch and provide an Excel template (see the
template link below) in which in the last sheet they preset the DERTs
(discounted expected residual transactions), which are “the expected future
transaction stream for a customer with purchase history.”
This model uses historical transactional data of the company at the
individual level. These data are usually stored in CRM systems.
TEMPLATE
http://www.brucehardie.com/notes/010/
 


32. SURVIVAL ANALYSIS

OBJECTIVE
Estimate the expected time for an event to occur.
DESCRIPTION
Survival analysis is used for example in medicine (the survival of patients),
in engineering (the time before a component breaks), or in marketing (the
customer churn rate) to estimate when an outcome will occur. When
undertaking this kind of analysis, it is important to consider the concept of
“censoring,” that is, the issue that values are only partially known. This is
due to the fact that, at the moment of the measurement, for some individuals
(or objects) the event has already occurred but for others it has not.
Two of the most-used techniques are the “Kaplan–Meier” method and the
Cox regression. The first one is a non-parametric statistical technique that is
used when we have categorical variables or the number of observations is
small. The example developed in the template uses this technique to estimate
the probability of a mechanical component surviving (not breaking) after a
certain number of years. Figure 27 shows the survival curve chart, which
depicts the survival function.

Figure 27: Survival Curve

In addition to the survival curve chart, a life table can be used to analyze the
results. This table contains the number of years, number of events, survival
proportion, standard error, and confidence intervals. In the case in which we
need to compare the survival function of two groups, we can use the log-
rank test to verify whether the two curves are significantly different.
If the number of observations is large and we want to include additional
explanatory variables, then we should use a Cox regression.
Survival analysis can be very useful when we need to prioritize efforts. For
example, we can estimate when employees are about to leave the company
using a Cox regression with several explanatory variables (years in the
company, number of projects, satisfaction, performance, etc.). We can then
create a matrix using the survival function on one side and performance on
the other side and focus our efforts on those who present both a high
performance level and a high probability of leaving.
For this kind of analysis we need a specific tracking of the “survival time” of
the concerned object. We can also obtain this data in a CRM, for example
concerning subscriptions and unsubscriptions of customers to a certain
service.
TEMPLATE
http://analyticsmodels.blogspot.com.es/p/customer-analytics-templates.html


33. SCORING MODELS

OBJECTIVE
Define the priority of action concerning customers, employees, products, and
so on.
DESCRIPTION
Scoring models help to decide which elements to act on as a priority based
on the score that they obtain. For example, we can create a scoring model to
prevent employees leaving the company in which the score depends on both
the probability of leaving and the performance (we will act first on those
employees who have a higher probability of leaving and are important to the
company). Scoring models are also quite useful in marketing; for example,
we can score customers based on their probability of responding positively
to a telemarketing call and, based on our resources, call just the first “X”
customers.
The model that I will propose concerns a scoring model of customers’ value
based on the probability of purchasing a product and on the amount that they
are likely to spend. This model is the result of two sub-models:
-          Purchase probability: We will use a logistic regression to estimate
the purchase probability of a customer in the next period (see 26. RFM
MODEL and 60. LOGISTIC REGRESSION);
-                  Amount: We will use a linear regression to estimate the amount
that each customer is likely to spend on his or her next purchase (see
38. LINEAR REGRESSION).
The first step is to choose the predictor variables. In our case I suggest using
recency, first purchase, frequency, average amount, and maximum amount of
year -2, but we could try additional or different variables. The target variable
will be a binary variable that represents whether the client made a purchase
during the following period (year -1). A logistic regression is run with the
eventual transformation of variables and after verifying that all the necessary
assumptions are met (see 36. INTRODUCTION TO REGRESSIONS and
60. LOGISTIC REGRESSION).
 Figure 28: Coefficients of the Logistic and Linear Regressions

In the second part of the model, we can use for example only the average
amount and the maximum amount of year -2, and the total amount spent in
year -1 is used as the target variable. We run a multivariate linear regression
with the eventual transformation of the variables, after verifying that all the
necessary assumptions are met (see 36. INTRODUCTION TO
REGRESSIONS, 38. LINEAR REGRESSION, and 39. OTHER
REGRESSIONS). It is important to note that in this regression we will not
use the whole customer database but select only those customers who
realized a purchase in year -1.
The last step is to put together the two regressions to score customers based
on both their purchase probability and the likely amount that they will spend.
We use the regression coefficients for the estimates of each customer. In the
linear regression, we directly sum the intercept and multiply the variables’
coefficients (Figure 28) by the actual values of each customer to estimate the
amount.[19] However, in the logistic regression we should use the
exponential function to calculate the real odds of purchasing:
Probability = 1 / (1 + exp(- (intercept coefficient + variable 1 coefficient *
variable 1 + variable n coefficient * variable n)))

Figure 29: Result Table with the Purchase Probability, Estimated Amount, and Final Score
Now that we have two more columns in our database, we just need to add a
third one for the final score, which will be the purchase probability times the
estimated amount (Figure 29). With this indicator we can either rank our
customers (to prioritize marketing and resource allocation for some
customers) or use this indicator to estimate next-period revenues.
TEMPLATE
http://analyticsmodels.blogspot.com.es/p/customer-analytics-templates.html


STATISTICAL ANALYSIS


34. INTRODUCTION
Several statistical analyses can be applied to data to answer different
business questions. It is important to know when to apply which model and
what the limitations are, but there are two important principles when
performing statistical analysis:
-          Context: this means understanding the data, the goal of the model,
the exactitude needed for the results, whether or not we need to use all
the data set or just a portion of it, etc.
-          Segmentation: this refers to segmenting the data to fit the model
better.
In the following chapters I will start by explaining how to perform a
descriptive statistics analysis of a variable and then I will explain several
analysis techniques, which can be grouped into three main categories:
-                  Regressions: the analysis of the relationship between different
variables and the creation of models in which unknown values of an
outcome variable are estimated using one or more predictor variables;
-                  Hypothesis testing: the analysis of the differences between
groups based on one or more variables of interest;
-                  Classification models: models of which the outcome is
membership of a group.
Sometimes several models can be used for the same business issue, and the
choice will depend on the kind of variables that we are using (categorical,
ordinal, or quantitative) and their distribution.
Once the model has been chosen, the next steps are to check the conditions,
carry out the analysis, check the significance and fit, validate, and refine.
An important part of statistical analysis consists of manipulating data to
prepare it for the model implementation:
-          Outliers can significantly bias results, so we have three options:
Maintain the outlier: in the case that we verify that the value is
correct;
Elimination: in the case that the outlier is an error;
 Transformation: in the case that we can correct the error and
replace it with the correct value;
-                  Registers with missing data cannot be used in some statistical
methods, such as regressions:
Leave missing values if we are using a model that is not affected
by them, if the number of affected registers is small, or if we
cannot replace them with appropriate values;
Replace missing values using a prediction method (we can use a
simple average or a more complex method).
-          Data binning is necessary when a variable has too many categories
and we need to group them, for example to analyze their distribution;
-                  Variable transformation can be necessary either to meet the
requirements for the implementation of a specific model or to improve
the model outcome.
There is a useful website that shows step by step how to create statistical
analysis models in Excel: http://blog.excelmasterseries.com/.


35. DESCRIPTIVE STATISTICS

OBJECTIVE
Analyze the distribution of one or several variables in a data set.
DESCRIPTION
In statistical analysis the first step is to analyze the available data. This step
is also useful to check for outliers or for the assumption of normality to use
these data for a particular statistical model or test (see 36. INTRODUCTION
TO REGRESSIONS). Since the analysis of these assumptions is included in
the chapter introducing regressions, here I will focus on the descriptive
statistics that are useful for describing numeric variables:
Statistic Description
Mean Arithmetic mean of the data
Standard Represents the difference between the expected value and the
Error actual value
Median Central value (the value that divides the data in two – in the
case of an even number of values, the median is the mean of
the two central values)
Mode Most frequent value
Standard A measure of how values are spread out. Mathematically, it is
Deviation the square root of the variance
Sample Average of the squared differences between each value and
Variance the mean (it is also a measure of how values are spread out)
Kurtosis A measure of the “peakedness” and flatness of the
distribution. “0” means that the shape is that of a normal
distribution, a flatter distribution has negative kurtosis, and a
more peaked distribution has positive kurtosis
Skewness A measure of the symmetry of the distribution. “0” means
that the distribution is symmetrical. If the value is negative,
the distribution has a long tail on the left, and if it is positive,
it has a long tail on the right. As a rule of thumb, a
 distribution is considered to be symmetrical if the kurtosis is
between 1 and -1
Range The difference between the largest and the smallest value
Minimum The smallest value
Maximum The largest value
Sum The sum of values
Count The number of values
 
As shown in the template, these statistics can be calculated either using the
Excel complement “Data Analysis” or using the Excel functions. The same
is valid for creating a histogram, with which we can analyze the frequency of
values and gain an idea of the type of distribution. In Figure 30 a sample
including age data is represented in a histogram. On the right a box plot
provides more information, dividing our data into quartiles (grouping the
values into 4 groups containing 25% of the values). The plot shows that 50%
of people are aged approximately between 33 and 46 years, while the rest are
spread across a bigger range of ages (25% from 46 to 64 and 25% from 18 to
33).

Figure 30: Histogram and Box Plot

In the template we can see how the two graphs have been created. For the
histogram we need to decide which age groups we want to use and fill a
table with them. Then we can use the formula “=FREQUENCY” by
selecting all the cells on the right of the age groups and pressing “SHIFT +
CONTROL + ENTER,” and the formula will provide the frequencies. For
the box plot we have to make some calculations and perform some tricks
using a normal column chart if we have an older version than Excel 2016.
The template and several tutorials can be consulted on the Internet.
Finally, we may have to identify which kind of distribution our data
approximate the most (for example to conduct a Monte Carlo simulation).
There is no specific method, but we can start by using a histogram and
comparing the shape of our data with the shapes of theoretical distributions.
The following URL provides 22 Excel templates with graphs and data of
different distributions:
http://www.quantitativeskills.com/sisa/rojo/distribs.htm.
If our variables are categorical, we can analyze them using a frequency
table (count and percentage frequencies). We can also analyze the
distribution of frequencies. In the case that our variables are ordinal, we
should use the same method for categorical variables (for example if the
categories are the answer to a satisfaction question with ordinal answers like
“very bad,” “bad,” etc.). However, in some cases we may want to analyze
ordinal variables with statistics used for numerical ones (for example, if we
are analyzing answers to a question about the quality of services on a scale
from 1 to 10, it can be interesting to calculate the average score, range, etc.).
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36. INTRODUCTION TO
REGRESSIONS
Regressions are parametric models that predict a quantitative outcome
(dependent variable) from one or more quantitative predictor variables
(independent variable). The model to be applied depends on the kind of
relationship that the variables exhibit.
Regressions take the form of equations in which “y” is the response
variables that represent the outcome and “x” is the input variable, that is to
say the explanatory variable. Before undertaking the analysis, it is important
that several conditions are met:
-                  Y values must have a normal distribution: this can be analyzed
with a standardized residual plot, in which most of the values should
be close to 0 (in samples larger than 50, this is less important), or a
probability residual plot, in which there should be an approximate
straight line (Figure 31);
-                  Y values must have a similar variance around each x value: we
can use a best-fit line in a scatter plot (Figure 32);
-                  Residuals must be independent; specifically, in the residual plot
(Figure 33), the points must be equally distributed around the 0 line
and not show any pattern (randomly distributed).

Figure 31: Normal Probability Plot

 Figure 32: Best-Fit Line Scatter Plot

If the conditions are not met, we can either transform the variables[20] or
perform a non-parametric analysis (see 47. INTRODUCTION TO NON-
PARAMETRIC MODELS).
In addition, regressions are sensitive to outliers, so it is important to deal
with them properly. We can detect outliers using a standardized residual plot,
in which data that fall outside +3 and -3 (standard deviations) are usually
considered to be outliers. In this case we should first check whether it was a
mistake in collecting the data (for example a 200-year-old person is a
mistake) and eliminate the outlier from the data set or replace it (see below
how to deal with missing data). If it is not a mistake, a common practice is to
carry out the regression with and without the outliers and present both results
or to transform the data. For example, we may apply a log transformation or
a rank transformation. In any case we should be aware of the implications of
these transformations.
 Figure 33: Standardized Residuals Plot with an Outlier

Another problem with regressions is that records with missing data are
excluded from the analysis. First of all we should understand the meaning of
a missing piece of information: does it mean 0 or does it mean that the
interviewee preferred not to respond? In the second case, if it is important to
include this information, we can substitute the missing data with a value:
-                  With central tendency measures, if we think that the responses
have a normal distribution, meaning that there is no specific reason for
not responding to this question, we can use the mean or median of the
existing data;
-                  Predict the missing values using other variables; for example, if
we have some missing data for the variable “income,” maybe we can
use age and profession to for the prediction.
Check the linear regression template (see 38. LINEAR REGRESSION),
which provides an example of how to generate the standardized residuals
plot.


37. PEARSON CORRELATION

OBJECTIVE
Find out which quantitative variables are related to each other and define the
degree of correlation between pairs of variables.
DESCRIPTION
This method estimates the Pearson correlation coefficient, which quantifies
the strength and direction of the linear association of two variables. It is
useful when we have several variables that may be correlated with each
other and we want to select the ones with the strongest relationship.
Correlation can be performed to choose the variables for a predictive linear
regression.

Figure 34: Correlation Matrix

With the Excel Data Analysis complement, we can perform a correlation

analysis resulting in a double-entry table with correlation coefficients
(Pearson’s coefficients). We can also calculate correlations using the Excel
formula “=CORREL().” The sign of the coefficient (Pearson correlation
coefficient) represents the direction (if x increases then y increases =
positive correlation; if x increases then y decreases = negative correlation),
while the absolute value from 0 to 1 represents the strength of the
correlation. Usually above 0.8 it is very strong, from 0.6 to 0.8 it is strong,
and when it is lower than 0.4 there is no correlation (or it is very weak).
Figure 34 shows that there is a very strong positive correlation between X1
and Y and a strong positive correlation between X1–X3 and X3–Y. X3 and
X4 have a weak negative correlation.
TEMPLATE
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38. LINEAR REGRESSION

OBJECTIVE
Define the linear relationship between an input variable (x) and an outcome
variable (y) to create a linear regression predictive model.
DESCRIPTION
The equation for a linear regression is:
Y = α + βx
where is the outcome variable, α is the intercept, β is the coefficient, and
is the predictor variable. This model is used to predict values of for
values that are not in the data set or, in general, how the outcome is affected
when the input variable changes. For example, such a model can predict how
much sales would increase due to an increase in advertising spending.
In a linear regression we can only use numerical variables, which are either
discrete or continuous. We can include categorical variables by transforming
them into dummy variables (a categorical variable with four categories is
transformed into three variables of two values, 0 and 1).
After checking the conditions (see 36. INTRODUCTION TO
REGRESSIONS), the linear regression can be carried out using the Data
Analysis Excel complement (Figure 35) or by using Excel statistical
formulas such as “=CORREL()” for R, “=INTERCEPT()” for the intercept
coefficient, and “=LINEST()” for the X coefficient (and other statistics). If a
scatter plot containing both variables seems to indicate that the relationship
is not linear, we can either transform the independent variable (log, power,
etc.) or try using a non-linear regression (39. OTHER REGRESSIONS).
Figure 35: Output of Linear Regression Analysis


There are three main outputs from this analysis:

-          P-value: the model is valid if the p-value of both the intercept and
the X variable are below 0.5 (or another chosen alpha value). In the
case that the intercept has a higher p-value, we can set the intercept to
0 before carrying out the regression;
-          R2: this is a measure of how much the variability of y is explained
by x; the closer to 1, the more x explains variations in y;
-          Coefficient of X: this defines the direction and the strength of the
relationship (see 37. PEARSON ).
It is important to bear in mind that, even if all the conditions are met, we find
a strong correlation, and the regression is significant (p-value < 0.5), it does
not mean that there is causality. A good example is that we may find a
correlation between the number of ice creams consumed and the number of
people drowning in swimming pools, but that does not mean that one is
caused by the other. It is important to discard the hypothesis of a third
common variable that is causing the variations in x and y (in our example
this variable would be “temperature”).
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39. OTHER REGRESSIONS

OBJECTIVE
Define the relationship between one or more input variables (x) and an
outcome variable (y) to create a regression predictive model.
Each of the following regressions needs to meet the same conditions as those
mentioned in 36. INTRODUCTION TO REGRESSIONS. In addition, we
need to perform the same analysis of outliers and missing data.
MULTIVARIATE REGRESSION
This linear regression is used when we have several predictor variables. In
this case we need to check the p-values of all the predictor variables. We
may need to exclude variables with a high p-value (> 0.5). It is apparent that
the more the number of predictor variables increases, the higher the R2, but it
does not mean exclusively that the model is better. With multivariate
regressions we should check the adjusted R2, which takes into account the
increasing number of variables. As a general rule, comparing two models
with equal or very close adjusted R2s, the one with fewer predictor variables
should be chosen.

Figure 36: Output of Multivariate Regression Analysis

An important issue when using multiple predictor variables is the problem of
collinearity. Predictor variables cannot be correlated with one another, so we
should perform a correlation analysis and eliminate correlated variables.
In a multivariate regression, we can only use numerical predictor variables;
however, there is a transformation that can be used to include categorical
variables: dummy coding. Supposing that a categorical variable has k levels,
we would create k-1 dummy variables, each with two levels (0 and 1).
In the case of using ordinal input variables, we may choose either to treat
them as numerical variables (including them directly in the regression) or to
transform them into dummy variables. In the former case, we assume that
the distances among the levels are meaningful (e.g. the difference in value
from 1 to 2 is the same as the one from 2 to 3). In the case of treating it as a
categorical variable, we do not make the previous assumption but lose
information about the ordering.
NON-LINEAR REGRESSIONS
The mathematics behind non-linear models is more complex, as is their
interpretation and validation. Whenever possible, it is better to use a simple
linear regression, and if the pattern in the data changes, we can segment the
data to explain the variation with two or more linear regressions. However, if
we really think that a non-linear model is necessary to fit the data well:
-          We can use more complete software than Excel (in Excel we can
draw a scatter plot with non-linear trend lines, with the equation and
R2, but for a proper interpretation and validation we should use more
professional tools);
-          As a general rule, if we are testing several non-linear models and
they are both significant and have a similar R squared, we should
choose the less complex one (for example a quadratic one over a cubic
one).
 Figure 37: Exponential Regression

Examples of non-linear regressions are exponential, logarithmic,

polynomial, quadratic, cubic, and power. For two-dimension analyses, we
can plot our data in a graph such as the one shown in Figure 37 and add a
trend line to the graph (in Excel we can try several trend lines and check the
R2 for the goodness of fit of the line to the data). For regressions with more
dimensions or for more robust analyses (including other statistics besides the
regression function and R2), we should use statistical software.
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40. PATH ANALYSIS

OBJECTIVE
Define the direct and indirect effects of input variables.
DESCRIPTION
Path analysis is part of a broader group called SEM (structural equation
modeling). SEM uses several models to define the relationships within and
between variables. Besides path analysis, this group includes confirmatory
factor analysis, partial least squares path analysis, LISREL, and so on.
Path analysis is based on multiple regressions, but it extends further since it
allows the interpretation of the relationships within the predictor variables
and the dependent variable to be defined. For example, in a multiple
regression, we can find that gender, child abuse, and drug use are good
predictor variables for suicidal tendencies. However, we suspect that the use
of drugs is affected by child abuse. With a path analysis we can define a
model (represented by a path diagram) in which we define both direct and
indirect effects of the predictor variables on the dependent variable.
Consequently, we can better interpret the relationships within and between
variables.
STEP 1: MODEL DEFINITION
Even if we can calculate all the relations among variables and then work
according to the regression coefficients and correlation coefficients, the
recommended approach is first to define a structural model based on our
knowledge and to create a path diagram with the hypothesis of relationships
between and within predictor and outcome variables.
Figure 38: Path Analysis Diagram


The diagram includes several elements:

-                  Observed variables: those variables that are measured and are
represented by rectangles;
-                  Latent variables: those variables that cannot be measured, for
example “errors”[21] (variances that are not explained by the model),
which are represented by circles or ellipses;
-                  Regression coefficients: causal relationships between two
variables represented by straight arrows (also called path coefficients
or direct effects);
-                  Correlation coefficients: non-causal relationships between two
variables represented by curved arrows.
An important limitation is that the number of free parameters (relations
established in the path diagram) has to be lower than the number of distinct
values. Distinct values are calculated by the formula p*(p + 1) / 2, where p is
the number of variables. The number of free parameters is the sum of all the
relations established in the model (put simply, the number of arrows in the
path diagram).
To learn more about path analysis and SEM, I suggest referring to the book
A Beginner’s Guide to Structural Equation Modeling.[22]
STEP 2: DATA ANALYSIS
This model requires the same conditions as regressions to be met (see 36.
INTRODUCTION TO REGRESSIONS) and uses a multiple regression and
a correlation matrix to find all the parameters of the model. For this step I
suggest consulting the paper of Akinnola Akintunde[23] entitled “Path
Analysis Step by Step Using Excel.” To obtain the parameters:
-                  Standardize all the variables using the Excel function
“=STANDARDIZE” (using the x value, the mean of the variable, and
its standard deviation);
-                  Run a multivariate regression from which the regression
coefficients (considered the direct effects of a certain predictor
variable on the dependent variable) will be used;
 -          Run a correlation matrix among all the variables (the correlation
coefficients will be used for calculating the indirect effects);
-                  Errors can be calculated by the formula “1 - R2”; however, they
are just descriptive parameters and are not used in the actual
calculation of relationships.
Now we have all the parameters of the path diagram. We know the direct
effects (the correlation coefficients of the multivariate analysis and the
correlation between predictor variables) and the non-causal correlation
between independent variables. We can also calculate the indirect effects.
For example (Figure 39), the indirect effect of X1 on Y is “c * b,” while the
total effect is “a + c * b.”

Figure 39: Direct and Indirect Effects within Variables

STEP 3: MODEL TESTING AND MODIFICATION

The model can be tested using for example the chi-square test for the
“badness of fit” (see 48. CHI-SQUARE) or other methods (RMSEA or GFI).
The recommended values for the model to have a good fit are:
-          Chi-square p-value > 0.05;
-          RMSEA < 0.05;
-          GFI > 0.95.
This Excel template can help in calculating the goodness of fit of SEM
models: http://www.watoowatoo.net/sem/sem.html. If the model fitting is
not satisfactory, it is necessary to modify the path diagram to seek a better fit
by:
-          Eliminating non-significant parameters by checking the t-statistics
of parameters (i.e. if they are larger than 1.96);
-          Adding new parameters using two techniques:
 Modification index: a large value indicates potentially useful
parameters;
Expected parameter change: approximate value of the new
parameter if added;
-                  Analyzing the standardized residual matrix and checking for
values higher than 1.96 or 2.58 (for example), which identify values
that are not well accounted for in the model.
 
RECOMMENDATIONS
Even though it is possible to create simple path analysis models in Excel, my
suggestion is to use a proper statistical tool to help to build and calculate the
model. The most important part is to understand the reasoning behind this
kind of model so that the calculation part can be carried out more quickly
and precisely using a proper tool. The associated template will not include
the calculation of the model but simply the path diagram presented in this
chapter.
 
TEMPLATE
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41. INTRODUCTION TO
HYPOTHESIS TESTING
OBJECTIVE
Verify whether two (or more) groups are significantly different from each
other, usually by comparing their means or medians.
DESCRIPTION
Generally speaking, statistical hypothesis testing concerns all the techniques
that test a null hypothesis versus an alternative hypothesis. Although it also
includes regressions, I will only focus on the testing performed on samples.
There are three main steps in hypothesis testing:
-                  Definition: identify the problem, study it, and formulate
hypotheses;
-          Experiment: choose and define the data collection technique and
sampling method;
-                  Results and conclusion: check the data, choose the most
appropriate test, analyze the results, and make conclusions.
DEFINITION
The first step in hypothesis testing is to identify the problem and analyze it.
The three main categories of hypothesis testing are:
-                  to test whether two samples are significantly different; for
example, after conducting a survey in two hotels of the same hotel
chain, we want to check whether the difference in average satisfaction
is significant or not;
-          to test whether a change in a factor has a significant impact on the
sample by conducting an experiment (for example to check whether a
new therapy has better results than the traditional one);
-          to test whether a sample taken from a population truly represents
it (if the population’s parameters, i.e. the mean, are known); for
example, if a production line is  expected to produce objects with a
specific weight, it can be checked by taking random samples and
weighting them. If the average weight difference from the expected
 weight is statistically significant, it means that the machines should be
revised.
After defining and studying the problem, we need to define the null
hypothesis (H0) and alternative hypothesis (Ha), which are mutually
exclusive and represent the whole range of possibilities. We usually compare
the means of the two samples or the sample mean with the expected
population mean. There are three possible hypothesis settings:
-          To test any kind of difference (positive or negative), the H0 is that
there is no difference in the means (H0: μ = μ0 and Ha: μ ≠ μ0);
-          To test just one kind of difference:
positive (H0: μ ≤ μ0 and Ha: μ > μ0);
negative (H0: μ ≥ μ0 and Ha: μ < μ0).


EXPERIMENT
The sampling technique is extremely important; it must be certain that the
sample is randomly chosen (in general) and, in the case of an experiment,
the participants must not know in which group they are placed. Depending
on the problem to be testing and the test to be performed, different
techniques are used to calculate the required sample size (check
www.powerandsamplesize.com, which allows the calculation of the sample
size for different kinds of tests).
RESULTS AND CONCLUSIONS
Once the data have been collected, it is necessary to check for outliers and
missing data (see 36. INTRODUCTION TO REGRESSIONS) and choose
the most appropriate test depending on the problem studied, the kind of
variables, and their distribution. There are two main approaches to testing
hypotheses:
-                  The frequentist approach: this makes assumptions on the
population distribution and uses a null hypothesis and p-value to make
conclusions (almost all the methods presented here are frequentist);
-                  The Bayesian approach: this approach needs prior knowledge
about the population or the sample, and the result is the probability for
a hypothesis (see 42. BAYESIAN APPROACH TO HYPOTHESIS
TESTING).
Figure 40: Summary of Parametric and Non-parametric Tests


Tests usually analyze the difference in means, and the result is whether or
not the difference is significant. When we make these conclusions, we have
two types of possible errors:
-          α: the null hypothesis is true (there is no difference) but we reject
it (false positive);
-          β: the null hypothesis is false (there is a difference) but we do not
reject it (false negative).
 
Possible outcomes of NOT REJECT NULL REJECT NULL
hypothesis testing HYPOTHESIS HYPOTHESIS
THE NULL
HYPOTHESIS IS 1-α Type I error: α
TRUE
THE NULL
HYPOTHESIS IS Type II error: β 1-β
FALSE
Figure 41: Possible Outcomes of Hypothesis Testing

 
The significance of the test depends on the size of α, that is, the possibility of
rejecting the null hypothesis when it is true. Usually we use 0.05 or 0.01 as a
critical value and reject the null hypothesis when α is smaller than the p-
value (the critical value representing the probability, assuming that the null
hypothesis is true, of observing a result at least as extreme as the one that we
have (i.e. the actual mean difference).
It is important to remember that, if we are running several tests, the
likelihood of committing a type I error (false positive) increases. For this
reason we should use a corrected α, for example by applying the Bonferroni
correction (divide α by the number of experiments).[24]
In addition, it is necessary to remember that, with an equal sample size, the
smaller the α chosen, the larger the β will be (false negative).
If the test is significant, we should also compute the effect size. It is
important not only whether the difference is significant but also how large
the difference is. The effect size can be calculated by dividing the difference
between the means by the standard deviation of the control group (to be
precise, we should use a pooled standard deviation, but it requires some
calculation). As a rule of thumb, an effect size of 0.2 is considered to be
small, 0.5 medium, and above 0.8 large. However, in order contexts the
effect size can be given by other statistics, such as the odds ratio or
correlation coefficient.
Confidence intervals are also usually calculated to have a probable range of
values to derive a conclusion in which there is, for example, 95% confidence
that the true value of the parameter is within the confidence interval X‒Y.
The confidence interval reflects a specific interval level; for example, a 95%
interval reflects a significance level of 5% (or 0.05). When comparing the
difference between two means, if 0 is within the confidence interval, it
means that the test is not significant.


ALTERNATIVE METHODS
In the following chapters I will present several methods for hypothesis
testing, some of which have specific requirements or assumptions (type of
variables, distribution, variance, etc.). However, there is also an alternative
that we can use when we have numerical variables but are not sure about the
population distribution or variance. This alternative method uses two
simulations:
-          Shuffling (an alternative to the significance test): we randomize
the groups’ elements (we mix the elements of the two groups
randomly, each time creating a new pair of groups) and compute the
mean difference in each simulation. After several iterations we
calculate the percentage of trials in which the difference in the means
is higher than the one calculated between the two original groups. This
can be compared with the significance test; for example, if fewer than
5% of the iterations indicate a larger difference, the test is significant
with α < 0.05.
-                  Bootstrapping (an alternative to confidence intervals): we
resample each of our groups by drawing randomly with replacement
from the groups’ elements. In other words, with the members of a
group, we recreate new groups that can contain an element multiple
times and not contain another one at all. An alternative resampling
method would be to resample the original groups in smaller subgroups
(jackknifing). After calculating the difference in means of the new
pairs of samples, we have a distribution of means and can compute our
confidence interval (i.e. 95% of the computed mean differences are
between X and Y).


42. BAYESIAN APPROACH TO

HYPOTHESIS TESTING
OBJECTIVE
Identify the probability of a hypothesis using the probability of related
events.
DESCRIPTION
This probabilistic approach is often used in logic tests, which may require a
statement such as the following to be solved:
0.5% of the population suffers a certain disease and those with
this disease that take a clinical test are diagnosed correctly in
90% of cases. You also know that you have on average 10% of
false positive tests on people who do not have the disease. A
person has been diagnosed as positive; what is the probability
that he actually has the disease?
This problem is solved by finding the percentage of true positives (the test is
positive and the person has the disease) in the total number of positive tests,
and it can be approached by drawing the following matrix and calculating
the missing percentages (Figure 42):

Figure 42: Matrix of the Bayesian Inference Method

The answer is given by dividing 0.45% by 10.45%, giving a 4.31%
possibility of that person being sick. More formally, the problem is resolved
by the following equation:

where P is the probability, A is having the disease, and B is when the test is
positive; therefore, P(A|B) is the probability of having the disease when the
test is positive and P(B|A) is the probability of obtaining a positive test when
the patient has the disease. The template shows how the values have been
calculated starting from the proposed problem.
TEMPLATE
http://analyticsmodels.blogspot.com.es/p/statistical-analysis-
templates_2.html


43. t-TEST
OBJECTIVE
Verify whether two groups are significantly different.
DESCRIPTION
There are three main applications of the t-test:
-                  One-sample t-test: compare a sample mean with the mean of its
population;
-          Two-sample t-test: compare two sample means;
-          Paired t-test: compare two means of the same sample in different
situations (i.e. before and after a treatment).[25]
To perform a t-test, it is necessary to check the normality assumption (see
36. INTRODUCTION TO REGRESSIONS); however, the t-test tolerates
deviations from normality as long as the sample size is large and the two
samples have a similar number of elements. In the case of important
normality deviations, we can either transform the data or use a non-
parametric test (see Figure 40 in chapter 41. INTRODUCTION TO
HYPOTHESIS TESTING).
An alternative to the t-test is the z-test; however, besides the normality
assumption, it needs a larger sample size (usually > 30) and the standard
deviation of the population.
Each of the three kinds of t-tests described above has two variations
depending on the kind of hypothesis to be tested. If the alternative
hypothesis is that the two means are different, then a two-tailed test is
necessary. If the hypothesis is that one mean is higher or lower than the other
one, then a one-tailed test is required. It is also possible to specify in the
hypothesis that the difference will be larger than a certain number (in two-
sample and paired t-tests).
After performing the test, we can reject the null hypothesis (there are no
differences) if the p-value is lower than the alpha (α) chosen (usually 0.05)
and if the t-stat value is not between the negative and the positive t-critical
value (see the template). The critical value of t for a two-tailed test (t-critical
two-tail) is used to calculate the confidence interval that will be at the 1
minus the α chosen (if we choose 0.05 we will have a 95% confidence
interval).


ONE-SAMPLE T-TEST
With this test we compare a sample mean with the mean of the population.
For example, we have a shampoo factory and we know that each bottle has
to be filled with 300 ml of shampoo. To control the quality of the final
product, we take random samples from the production line and measure the
amount of shampoo.

Figure 43: Input Data of a One-Sample t-Test

Since we want to stop and fix the production line if the amount of shampoo
is smaller or larger than the expected quantity (300 ml), we have to run a
two-tailed test. Figure 43 shows the input data as well as the calculated
standard deviation and sample mean, which is 295. A confidence level of
0.05 is chosen. We then calculate the t-critical value and p-value (the
formulas can be checked in the template).

Figure 44: Results of a One-Sample t-Test

Since the p-value is lower than the alpha (0.05), we conclude that the
difference in the means is significant and that we should fix our production
line. The results also include the confidence interval of 95%, which means
that we are 95% confident that the bottles are filled with a minimum of 292
ml and a maximum of 298 ml.


TWO-SAMPLE T-TEST
A practical example would be to determine whether male clients buy more
or less than female ones.
First of all, we should define our hypothesis. In our example our hypothesis
is that male and female clients do not buy the same amount of goods, so we
should use a two-tailed test; that is, we do not infer that one group buys more
than the other one. On the other hand, if we would like to test whether males
buy more, in this case we would use a one-tailed test.
In the Excel complement “Data Analysis,” we choose the option “t-Test:
Two-Sample Assuming Unequal Variances” by default, since, even if the
variances are equal, the results will not be different, but if we assume equal
variances, than we will have a problem in the results if finally the variances
are not equal. We select the two-sample data and specify our confidence
level (alpha, by default 0.05).

Figure 45: Output of a Two-Sample t-test Assuming Unequal Variances

Since we are testing the difference, either positive or negative, in the output,
we have to use the two-tailed p-value and two-tailed t-critical value. In this
example the difference is significant, since the p-value is smaller than the
chosen alpha (0.05).
Confidence intervals are also calculated in the template, concluding that we
are 95% confident that women buy between 8 and 37 more products than
men.


PAIRED T-TEST
We want to test two different products on several potential consumers to
decide which one is better by asking participants to try each one and rate
them on a scale from 1 to 10. Since we have decided to use the same group
to test both products, we are going to run a paired two-tailed t-test. The alpha
chosen is 0.05.

Figure 46: Output of a Paired t-Test

The results of the example show that there is no significant difference in the
rating of the two products, since the p-value (two-tail) is larger than the
alpha (0.05). The template  also contains the confidence interval of the mean
difference, which in this case includes 0 since there is no significant
difference.
 
TEMPLATE
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44. TEST OF PROPORTIONS

OBJECTIVE
Verify whether two proportions are significantly different.
DESCRIPTION
This test has the same purpose as a t-test but is applied to compare
proportions, that is, when elements can take the value of 0 or 1. For example,
we can compare the conversion rate of two advertising campaigns (two-
sample test of proportions) or compare the improvement in patients who
received a new drug compared with the average improvement of these
patients.
As in the t-test, we need to specify our hypothesis and, based on that, run
either a two-tailed t-test or a one-tailed t-test (see 43. t-TEST); the only
difference is that instead of using means we use proportions. We then need
to specify the required significance level (α) and the hypothesized difference
between the proportions.
Other differences from the t-test is that we resolve the test by calculating the
z-critical value instead of the t-critical value and that the calculation is
slightly different because we use proportions instead of means, variances,
and standard deviations. In addition, we have to check that the number of
events (conversions) and the number of “no events” (users who did not buy)
are at least 10.
ONE-SAMPLE
The boss of a company claims that 80% of people are very satisfied with
their working conditions. Our null hypothesis is that the satisfaction is equal
to 80%, and our alternative hypothesis is that the satisfaction rate is different
from 80%. The HR department decides to survey 100 employees, with a
result of 73%. At the 0.05 level of significance, we fail to reject the null
hypothesis, so we cannot state that the satisfaction of our survey is
significantly different from 80%. In Figure 47 we can see that the confidence
interval (95%) includes 80%.
Figure 47: Results of a One-Sample Test of Proportions


TWO-SAMPLE
A company has started a new online marketing campaign and wants to
compare it with a standard online marketing campaign. The goal is to
increase the conversion rate of online users, and the conversion rates of the
two campaigns are compared using a proportion test. The results are not
presented here, since this test is explained in more detail in chapter 45. A/B
TESTING.
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45. A/B TESTING

OBJECTIVE
Test two or more items/objects and identify the one with the best
performance.
DESCRIPTION
A/B testing is part of a broader group of methods used for statistical
hypothesis testing in which two data sets are compared. Having defined a
probability threshold (significance level), we can determine statistically
whether to reject the null hypothesis or not. Usually, the null hypothesis is
that there is no significant difference between the two data sets.
A/B testing is a randomized experiment with two variants (two-sample
hypothesis testing), but we can also add more samples. The difference from
multivariate testing is that in A/B testing only one element varies, while in
the other test different elements vary and we should test several
combinations of elements. These tests are used in several sectors and for
different business issues, but nowadays they are quite popular in online
marketing and website design.

Figure 48: Output of Conversion Rate A/B Testing

Usually the steps to follow are:

-          Identify the goals: for example “improving the conversion rate of
our website”;
-                  Generate hypotheses: for example “a bigger BUY button will
convert more”;
-          Create variables: in our example the element to be modified is the
BUY button and the variation website can be created with a double-
 size BUY button;
-          Run the experiment:
Establish a sample size: depending on the expected conversion
rate, the margin of error that is acceptable, the confidence level,
and the population, the minimum sample size can be calculated
(see the template);
The two versions must be shown to visitors during the same
period, and the visitors must be chosen randomly (we are
interested in testing the effect of a larger button; if we do not
choose visitors randomly or show the two versions during
different periods, the results will probably be biased);
-          Analyze the results:
Significance: depending on the significance level chosen for the
test (usually 90%, 95%, or 99%), we can be X% confident that
the two versions convert differently;
Confidence intervals: depending on the confidence level chosen,
there will be a probable range of conversion rates (we will be
X% confident that the conversion rate ranges from X to Y);
Effect size: the effect size represents the difference between the
two versions.
The proposed template provides a simple calculator for the necessary sample
size and for testing the significance of conversion rate A/B testing. However,
a considerable amount of information about A/B testing is available online.
[26] The template of chapter 44. TEST OF PROPORTIONS shows the same
test with more statistical detail as well as the calculation of the mean
difference confidence interval, while the A/B testing template presents
confidence intervals for each mean of the two samples.
In the proposed example, the data are obtained using a web analytics tool
(for example Google Analytics), but they can come from any experiment
that we decide to run.
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46. ANOVA
OBJECTIVE
Verify whether two or more groups are significantly different.
DESCRIPTION
While with a t-test we can only test two groups, with ANOVA we can test
several groups and decide whether the means of these samples are
significantly different. The simplest analysis is one-way ANOVA, in which
the variance depends on one factor. Suppose that we want to know whether
the age of people buying three different products is significantly different to
focus the promotional campaigns better. In this case we have just one factor
(type of product); therefore, we run a one-way ANOVA after checking the
normality assumption (see 36. INTRODUCTION TO REGRESSIONS).

Figure 49: Output of a One-way ANOVA Analysis

Once the test is concluded, we check the p-value (< 0.05) and F-value (larger
than the F-critical value) to reject the null hypothesis and infer that the
populations are not equal. In the proposed example, there is a significant age
difference among products. However, we should perform a t-test of each pair
of groups to determine where the difference lies.
In a two-way ANOVA we have two factors to be tested. For example, we
are selling products A, B, and C in three countries (1, 2, and 3). In the
proposed example, we use a two-way ANOVA “without replication,” since
only one observation is recorded for each factor’s combination (we will use
an ANOVA “with replication” if there are more observations recorded for
each combination). In a two-way ANOVA, there are two null hypotheses to
be tested, one for each factor, and it is possible that the hypothesis will be
rejected for one factor but not for the other one.
In our example we reject the null hypothesis for the factor “type of product”
(rows), since its p-value is smaller than 0.05, but we cannot reject the null
hypothesis for the factor “country” (columns).

Figure 50: Output of a Two-Way ANOVA Analysis

We can also perform an ANOVA with repeated measures when we have

repeated measures within the same group. In our example a company
decided to start a four-week training program for five employees to diminish
the number of errors made at work. In this case the repeated measures are
the errors of each employee in the same week of training.
 Figure 51: Results of a Single-Factor ANOVA with Repeated Measures

The template contains the calculations for a single-factor repeated-measures

ANOVA. In our example, since the p-value is lower than 0.05 (our chosen
alpha), we reject the null hypothesis of no difference among the week’s
means and infer that the training has had an impact on the number of errors
(Figure 51).
We can use the Excel Data Analysis complement to perform a two-factor
repeated-measures ANOVA, choosing the test “Anova: Two-Factor With
Replication.” In the proposed example, we are selling different product
versions in different markets, and we want to test whether either the product
or the market (or both) have an impact on the number of products sold. The
results show that, while the kind of product (rows) affects the sales (p-value
< 0.05), the market (columns) does not (Figure 52).

Figure 52: Results of a Two-Factor ANOVA with Repeated Measures

An extension of ANOVA is MANOVA, which allows the test to be run with
more than one dependent variable. For example, it is possible to run a
MANOVA using “level of education” as the categorical independent
variable and “test score” and “yearly income” as the continuous independent
variables.
 
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47. INTRODUCTION TO NON-

PARAMETRIC MODELS
Non-parametric models are used as counterparts of parametric models that
analyze the correlation or dependence between variables when parametric
models’ assumptions are not met: normal distribution, homogeneous
variance, ratio or interval variables, and independent data sets.
If the sample size is large enough (i.e. larger than 100), we can use
parametric tests even if we are not sure of the normality of the population
distribution. If the sample is small and we are not certain of the population
distribution, we should use non-parametric tests.
In addition, with ordinal and nominal variables, we cannot conduct
parametric tests. In the case of numerical variables that can be ranked (e.g.
the satisfaction of clients measured on a 0–10 scale), we usually cannot use
them as interval variables, since the distance between the values is not equal
along the scale. For example, someone who chose “6” is not necessarily
twice as satisfied as someone who chose “3.”
Figure 53 presents a list of the non-parametric tests presented in this book.

Figure 53: Summary of Non-parametric Tests



48. CHI-SQUARE
OBJECTIVE
Verify whether the difference between the observed frequencies and the
expected frequencies is significant or not.
DESCRIPTION
A chi-square test is used to test the frequencies of independent observations
(not suitable for paired testing) with two main purposes:
-                  Test of independence: to determine the association between two
categorical variables, for example if the kind of civil status does not
affect the kind of service that customers buy;
-                  Test of goodness of fit: to determine the difference between the
observed values and the expected values (for example whether a
sample taken from a population follows the expected population
distribution or a theoretical distribution).
In either case the method used is the same; specifically, we apply a chi-
square test using the observed values and the expected values. When using a
chi-square test, it is important to bear in mind that this test is sensitive to the
sample size (with fewer than 50 this test is not appropriate) and needs to
have a minimum frequency in each bin or class (at least 5). If these
conditions are not met, we should consider using Fisher’s exact test.
TEST OF INDEPENDENCE
In the example we are testing the independence of the variables “civil status”
and “service level” chosen by customers.

Figure 54: Observed Values vs Expected Values in a Chi-Square Test

For this test we assume that the probability of having a specific service level
and the probability of being married, single, or divorced are independent
events. With these assumptions, we compare the actual distribution of the
products sold in each country and the expected distribution based on the
independent probabilities of the two events (see the template). In other
words, the test compares the expected frequencies with the actual
frequencies. The Excel formula “=CHITEST” is then applied, and if the
resulting p-value is smaller than 0.05 (or a different alpha), we reject the null
hypothesis (the two variables are independent) and we can infer that the two
variables are associated. In other words, we can say that civil status affects
the level of service purchased.


GOODNESS OF FIT
Goodness of fit can be calculated in Excel using the same formula
(=CHITEST), which is applied to a column (or row) with observed values
and a column with expected values. For example, if we throw a die, we
expect that each number has the same probability of appearing (1/6) but
suspect the die to have been loaded. In our example we throw the die 60
times and expect to produce each number 10 times. If the p-value is lower
than 0.05, we reject the null hypothesis, which is that the variables are
independent (as in the chi-square independence test). Since the p-value is
larger than 0.05, we conclude that the die is not loaded.

Figure 55: Data and Results of a Goodness of-Fit Chi-Square Test

We can also compare our observed values with a theoretical distribution.

TEST OF PROPORTIONS
The chi-square test can also be used instead of the z-test in the test of
proportions (see 44. TEST OF PROPORTIONS) when the assumptions for
using the parametric test are not met. In this case we will compare the
observed proportion with the expected proportion with a double-entry
contingency table (the same table used in the independence test but with
only two categories per row and two categories per column).
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49. SPEARMAN’S RANK

CORRELATION
OBJECTIVE
Verify whether two variables are correlated (in the case that the assumptions
for parametric tests are not met).
DESCRIPTION
It defines the statistical dependence of two variables that can be discrete,
continuous, or ordinal. Spearman’s correlation should be used instead of
Pearson’s correlation (see 37. PEARSON CORRELATION) when there is a
non-linear monotonic relation between the two variables, there are
significant outliers, or at least one of the variables is ordinal.
In practice, Spearman’s correlation is Pearson’s correlation of the ranking of
the two variables. First we should analyze the data in a scatter plot and then
calculate the ranking of the two variables. In the case that we have variables
with the same value, we need to calculate an average ranking (this can be
performed with a specific function in Excel – see the template).

Figure 56: Spearman’s Rank Correlation

If the number of observations is larger than 10, we can use the p-value to
verify whether the correlation coefficient is significant or not. If it is smaller
than 10, we should use a table with critical values (see the template), and, in
the case that the absolute value of the correlation coefficient (r) is larger than
the critical value (rho-crit), then it is significant.
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50. PHI CORRELATION

OBJECTIVE
Identify the association or correlation between two nominal variables.
DESCRIPTION
When we have categorical dependent variables, this method is used as the
counterpart of the Pearson correlation with numeric variables or the
Spearman correlation with rank variables. It can also be defined as the
measure of the effect size of a chi-square test (which is used when we have
categorical dependent and independent variables). The first step is to create a
contingency table, that is, a double-entry table with the cross-frequencies of
the selected variables. In our example we want to check the association
between a specific therapy and the end of an illness in several patients. The
dependent variable is represented in the rows (cured and not cured) and the
independent variable in the columns (therapy 1 and therapy 2).

Figure 57: Contingency Table

Then we have to run a chi-square test comparing the observed frequencies

with the expected frequencies (for the expected frequencies we create a copy
of the table and calculate them in the same way as for the chi-square test; see
48. CHI-SQUARE). With this value we can calculate two coefficients of
correlation:
-          Phi coefficient: this is the simplest coefficient used as a measure
of the association of two categories in two variables;
-          Cramer’s V coefficient: this is an adjusted phi coefficient and the
two variables can have more than two categories; it can also compare a
categorical variable with an ordinal one.
 Figure 58: Interpretation of Phi and Cramer’s V coefficients

Figure 58 presents some guidelines that will help to interpret the results of
the two tests: in other words the degree of association between the two
variables (small, medium, or large). The interpretation of the Cramer’s V
coefficient will depend on the number of categories being compared; in the
case of having just two, the results and interpretation will be the same as the
phi correlation coefficient.
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51. MANN–WHITNEY U TEST

OBJECTIVE
Verify whether the difference in two groups is significantly different (in the
case that the assumptions for parametric tests are not met).
DESCRIPTION
It defines whether two samples are significantly different, and it is used
instead of the two-sample t-test when normality assumptions are not met,
data are ordinal, or there are significant outliers.
This test requires some assumptions: the data are at least ordinal, the sum of
observations in the two samples is at least 20, the observations are
independent (we can use this test as a substitute for the t-test of independent
samples but not a paired t-test), and the two samples have similar
distribution shapes.
For the test we need to combine all the data and rank each value (in the case
of tied values, an average ranking is calculated as in Spearman’s test).

Figure 59: Mann–Whitney U Test

In the example a one-tailed test is performed to verify whether men on

average are more satisfied than women. Since the p-value is smaller than the
alpha (0.05), we reject the null hypothesis and can assume that men are more
satisfied than women.
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52. WILCOXON SIGNED-RANK

TEST
OBJECTIVE
Verify whether the difference in two groups is significantly different (in the
case that the assumptions for parametric tests are not met).
DESCRIPTION
It is a non-parametric substitute of the t-test in the case that normality cannot
be verified or the sample is too small (smaller than 30), but, differing from
the Mann–Whitney test, it is used for paired samples (the groups are not
independent). The example presented here is a “signed-rank Wilcoxon test”
(for paired samples and as a counterpart of the parametric paired t-test).
The assumptions for this test are: the samples are from the same population,
the pairs are chosen independently, the data are measured at least on an
ordinal scale (continuous, discrete, or ordinal), and the distribution is not
especially skewed (that is to say it is approximately symmetrical).

Figure 60: Wilcoxon Signed-Ranks Test

To perform the test, the difference between observations is calculated and

ranked. When we have samples with fewer than 25 observations, we use a
table with a t-critical value to verify the significance; specifically, we reject
the null hypothesis (there is no difference in the samples) if T is lower than
T-critical. If we have a larger sample, we can use the p-value for the
assessment of the significance.
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53. KRUSKAL–WALLIS TEST

OBJECTIVE
Verify whether the difference in two groups is significantly different (in the
case that the assumptions for parametric tests are not met).
DESCRIPTION
This test is an extension of the Wilcoxon signed-rank test to more than two
independent samples. It can also be seen as the non-parametric counterpart
of the one-way ANOVA, used when the samples do not have a normal
distribution (above all when the sample is small) or when the variances are
very different. However, this test requires the samples to have similar
distribution shapes (which can be assessed using a histogram), to be of equal
size, and to have more than five observations.

Figure 61: Kruskal–Wallis test

The example presented in the template concerns the launching of a new pill.
In the experiment the respondents are given one of the three pills (old, new,
and placebo), and they have to report the number of days for which the
effect of the pills remained. The results are ranked, and the test is performed.
If the p-value is lower than the alpha (0.05), we reject the null hypothesis
and can say that there is a significant difference among the three groups; to
put it another way, the pills have different effects. In the case of significance,
we can perform a pairwise comparison using the Mann–Whitney U test.
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54. FRIEDMAN TEST

OBJECTIVE
Verify whether the difference between two groups is significantly different
(in the case that the assumptions for parametric tests are not met).
DESCRIPTION
This test is the non-parametric counterpart to the one-way ANOVA with
repeated measures.

Figure 62: Friedman’s Test

The example in the template concerns an experiment in which we ask fifteen

potential customers to try three versions of a product and to give an
evaluation from 1 to 10. The results for each person are then ranked and the
test is performed. If the p-value is smaller than the alpha (0.05), we reject the
null hypothesis and infer that there is a significant difference in the
preference of at least two out of the three products.
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55. SCHEIRER–RAY–HARE TEST

OBJECTIVE
Verify whether the difference between two groups is significantly different
(in the case that the assumptions for parametric tests are not met).
DESCRIPTION
This test is the non-parametric counterpart of the two-way ANOVA with
repeated measures or, if we compare it with other non-parametric tests, it is
the two-factor version of the Kruskal–Wallis test. The same conditions as the
Kruskal–Wallis test have to be met; in particular, the samples must have the
same size and at least five observations each.

Figure 63: Data for the Scheirer–Ray–Hare Test

In the template example, we have three types of advertisement (rows) and

three different products (columns). For each intersection we register the
number of products sold. The data are registered five times for each
intersection advertisement/product. The data are then ranked, the ANOVA
test is performed on the ranked data, and the H values are calculated using
the output of the ANOVA test.

Figure 64: Scheirer–Ray–Hare Test

In the example only the “rows” parameter is significant, meaning that the
type of advertisement affects the number of products sold. However, the
kind of product is not a determinant variable.
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56. MCNEMAR TEST

OBJECTIVE
Verify whether there is a significant change before and after an event
(nominal variables).
DESCRIPTION
This non-parametric test is the counterpart of the parametric paired t-test or
the non-parametric Wilcoxon signed-rank test when the repeated measures
are dichotomous (yes/no, 1/0, cured/not cured, etc.). In the example a
company decides to launch a specific campaign to increase the
recommendation of its products. After the campaign the number of
customers who changed from detractors to advocates is recorded as well as
the number of customers who changed in the opposite direction.

Figure 65: Data and Results of a McNemar Test

As a rule of thumb, when the sum of the two subjects that changed group (in
our example the number of customers who changed their recommendation
attitude) is lower than 25, we should use a binomial distribution or a chi-
square distribution. In the template a formula calculates this condition
automatically, and, if the highlighted cell reports that the test is significant,
then we reject the null hypothesis and infer that there is a significant
difference in the change of attitude. To put it another way, we can say that
the campaign increased the recommendation of customers.
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57. COCHRAN’S Q TEST

OBJECTIVE
Verify whether there is a significant change before and after an event
(nominal variables) when we have more than two groups.
DESCRIPTION
The Cochran’s Q test is the counterpart of the parametric ANOVA with
repeated measures and the non-parametric Scheirer–Ray–Hare test when the
repeated measures are dichotomous. The template shows the example of a
company that wants to discover whether the satisfaction of clients differs
significantly according to the season. The dichotomous measure is
satisfaction (1 = satisfied, 0 = not satisfied), and for a sample of twenty
customers we have their responses in three seasons: high, intermediate, and
low.
 Figure 66: Data and Results of a Cochran’s Q Test

After running the test, if the p-value is lower than 0.05, we reject the null
hypothesis and therefore there is a significant difference in satisfaction
depending on the season. Once we have rejected the null hypothesis, we
should run a pairwise Cochran’s Q test (simply by repeating the test and
using the two seasons each time) or we can perform a McNemar test.
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58. INTRODUCTION TO
CLASSIFICATION MODELS
In the following chapters, I group several methods of which the purpose is to
classify either variables or elements of data sets.
The first two methods, binary classification and logistic regression, define an
element’s membership of one of the two outcome groups based on one or
more input variables. Cluster analysis is an exploratory technique that
classifies elements into groups by similarities in several input variables.
Profile analysis is performed to analyze the similarities and dissimilarities of
different groups to define the profiles. Principal component analysis and
exploratory factor analysis are used to group different variables into latent
variables, while confirmatory factor analysis first defines the latent variables
in a model and then validates the model.


59. BINARY CLASSIFICATION

OBJECTIVE
Classify the elements of a data set into two groups.
DESCRIPTION
In binary classification the goal is to classify the elements of a data set into
two groups according to a more or less complex classification rule. The
example proposed in the template concerns a company that wants to promote
a very exclusive perfume by giving a free sample to some of its customers.
The cost of providing a free sample is €50, but in the case of reaching the
right customer, the expected return is worth €950 (€1000 minus the cost of
the sample). To classify the clients, the company decides to use a score that
is calculated from the number of purchases and the average amount spent by
each customer (see 33. SCORING MODELS for more information about the
creation of score indicators). Our classification rule is “the higher the score,
the more likely it is that the free sample will work.”
The first step is to check whether the chosen classification rule is valid, that
is to say how efficiently it allows us to classify the elements (customers).
The ROC curve measures the efficiency of the classification, and it is the
combination of:
-          Sensitivity: TRUE POSITIVE RATIO = TP / (TP+FN)[27]
-          1-specificity: FALSE POSITIVE RATIO = 1 - TN / (TN + FP)
The curve is obtained by ordering our sample of 20 clients from the highest
to the lowest score and reporting the results of the experiment (1 = the client
bought the product, 0 = the client did not buy the product; see Figure 67).
 Figure 67: Table for the Calculation of the ROC Curve

The ROC curve is the continuous line in the following graph (Figure 68),
while the dashed line is the theoretical ROC curve in a model in which the
classification is random. Graphically, we understand that our model is more
efficient than a random classification method, since the continuous line is
above the dashed line. The area under the curve (AUC) is the measure of
classification efficiency and represents the probability of a positive event
being classified as positive. A random model (red line) has an AUC of 0.5,
while a good model has an AUC higher than 0.7. Our model has an AUC of
approximately 0.82, so we can conclude that our classification rule classifies
customers efficiently.
 Figure 68: ROC Curve

The next step is to find the optimal threshold, which is the minimum score
that a client should have to receive a free sample. For that we have to assign
the costs and gains of the four possible results of the classification:
-          True positive: if we give a free sample to the right customer, we
have a cost of €50 for the sample and a return of €1000, so we assign
to the TP a revenue of €950;
-                  False positive: if we give the sample to the wrong customer, we
have a cost of €50;
-                  True negative: we correctly establish that this customer will not
buy in spite of the free sample, so we have neither costs nor revenues;
-                  False negative: we fail to identify a customer who would have
bought the product, but still we have neither costs nor revenues.
When we define this matrix, we do not have to include either opportunity
costs (the potential revenues lost in a false negative) or opportunity gains
(the money saved from not sending a free sample to the wrong customer in a
true negative). If we included them, we would double the costs and
revenues. In our example the optimal threshold is a score of 65, which
means that the company has to send a free sample to customers with at least
this score.
This cost/revenue matrix can be used to establish the probability threshold in
a logistic regression (see 60. LOGISTIC REGRESSION). Using the same
example, we can perform a logistic regression with several predictor
variables (number of purchases, amount spent, location, marital status, etc.)
and calculate the probability of individual customers buying a product. On
the basis of the cost of incentives and the gains from reaching the right
customers, the probability threshold may be higher or lower than 0.5.
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60. LOGISTIC REGRESSION

OBJECTIVE
Predict a binary outcome from one or more quantitative predictor variables.
DESCRIPTION
This regression is used to answer yes/no questions, such as to buy or not to
buy a product based on one or more predictor variables, meaning that it
calculates the probability of the event occurring (buying the product). When
we have a binary outcome, we cannot perform a linear regression, since the
assumptions of normality of distribution and equal variance are not met for
the target variable. If the variables are categorical, we need to transform
them into dummy variables (see 38. LINEAR REGRESSION).

Figure 69: Logistic Regression

In the template I use the log-likelihood function and the Excel complement
“Solver” to estimate the regression parameters. Once we have obtained the
results of the regression, we have to apply an exponential function to obtain
the odds of an event, since we cannot use the parameters directly.
The proposed template includes a logistic regression with one predictor
variable, but more variables can be added. In addition, we can use a target
variable with more than two values and perform a multinomial logistic
regression.
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templates_2.html


61. CLUSTER ANALYSIS

OBJECTIVE
Identify groups of customers or products (or other objects).
DESCRIPTION
Cluster analysis is an exploratory technique that groups a series of objects
into homogeneous clusters using one or more input variables. The goal is to
find the right balance between the similarity of the objects within each
cluster and the dissimilarity among clusters. The ability to identify groups of
customers or products can be used to leverage synergies or to allocate
resources better.
The simplest clustering technique is the one that uses a two-variable matrix
and visually identifies possible groups. The example shown in the template
concerns a stock problem. Suppose that a company wants to optimize the
stock of different products, knowing that having a large stock of each
product is very expensive but that running out of products when requested
implies economic and image damage. To solve this problem, the company
needs to decide which products will have a large stock and which will be
more “on demand.” The variables used are the average daily sales volume
and volatility of sales (the standard deviation of daily sales divided by the
daily average sales of each product).
 Figure 70: Simple Cluster Analysis Using a Scatter Chart

We can identify three main groups of products:

-          In the top-left corner, we have products with strong sales and low
variability for which the company will maintain a large stock;
-                  In the top-right corner, we have products with strong sales but
with high variability and therefore the company will decide on a case-
to-case basis;
-          The third group (lower part) has a low volume of sales and a high
level of variability and the company will produce these items on
demand.
This is a simple and visually effective technique; however, if we want to
define the clusters with a more robust technique or to include more than two
variables, we should use statistical software. Several methods can be used
(hierarchical models, k-means, distribution-based, density-based, etc.), but
they usually follow the same steps:
-          Choose the variables: include relevant explanatory variables (for
example for a product we can choose the average volume of sales, the
average price, etc.) and exclude variables that are exogenous or merely
descriptive (color, size, etc.);
-          Identify and eventually eliminate outliers;
 -                  Define the number of groups: the number of groups can be
decided using statistical methods (dendrograms) or business criteria
(common sense, constraints of the organization, etc.); we can also start
with a larger number of groups and then reduce it until we find the
optimal number;
-                  Normalize the variables: variables can be on different scales, so
we have to normalize them to obtain comparable distances;
-          Choose the clustering method depending on the business issue, the
variables used (quantitative or qualitative), and whether the number of
groups is known;
-          Run the test and analyze the results; we can also use ANOVA;
-          Use explanatory and descriptive variables to describe the groups.
 
TEMPLATE
http://analyticsmodels.blogspot.com.es/p/statistical-analysis-
templates_2.html


62. PROFILE ANALYSIS

OBJECTIVE
Identify whether two or more groups have significantly different profiles.
DESCRIPTION
This analysis is performed when the aim is to compare the same dependent
variables between groups over several periods or when there are several
measures of the same dependent variable. It is usually performed to analyze
the results of different kinds of tests (psychological, intelligence, etc.).
To compare data between groups, profile analysis uses both graphical
representations (plots) and statistical methods that analyze the variance. The
plots are usually represented with scores or responses on the y axis and time
points (or observations or tests) on the x axis. These representations provide
an idea of the similarity/dissimilarity of the groups. However, using
statistical methods (ANOVA, MANOVA, etc.) we can answer statistically
the three main questions in a profile analysis:
-          Do the groups on average have equal levels of scores across time
points or observations?

Figure 71: Example of Equal Levels in Profile Analysis (on Average Levels Are Equal Even If There Is
No Parallelism)


-                  Are the groups’ performances parallel across time points or

observations?

Figure 72: Example of Parallelism in Profile Analysis

-                  Do the profiles present flatness across time points or

observations? (Flatness is when the score across different points does
not change significantly and the line is approximately flat.)

Figure 73: Example of Flatness in Profile Analysis

The proposed template only offers a graphical representation of equal levels,
parallelism, and flatness. For a proper profile analysis we should use a
statistical tool. The data for a profile analysis usually come from several
kinds of tests (psychological, intelligence, etc.) or from experiments (the
taste of food to potential customers, response to a cure, etc.).
TEMPLATE
http://analyticsmodels.blogspot.com.es/p/statistical-analysis-
templates_2.html


63. PRINCIPAL COMPONENT

ANALYSIS
OBJECTIVE
Analyze the interrelations among several variables and explain them with a
reduced number of variables.
DESCRIPTION
A principal component analysis (PCA) analyzes the interrelations among a
large number of variables to find a small number of variables (components)
that explain the variance of the original variables. This method is usually
performed as the first step in a series of analyses; for example, it can be used
when there are too many predictor variables compared with the number of
observations or to avoid multicollinearity.
Suppose that a company is obtaining responses about many characteristics of
a product, say a new shampoo: color, smell, cleanliness, and shine. After a
PCA it finds out that the four original variables can be reduced to two
components[28]:
-          Component “quality”: color and smell;
-          Component “effect on hair”: cleanliness and shine.
Even though it is possible to run a PCA in Excel with complex calculations
or special complements,[29] I suggest using a proper statistical tool. Here I
will only explain some guidelines when performing a PCA.
First of all, the analysis starts with a covariance or correlation matrix. I
suggest using a correlation matrix, since we cannot use a covariance matrix
if the variables have different scales or the variances are too different. Then,
eigenvectors (the direction of the variance) and eigenvalues (the degree of
variance in a certain direction) are calculated. Now we have a number of
components that is equal to the number of variables, each one with a specific
eigenvalue.
Figure 74: Results of a PCA


The more variance (eigenvalue) that a component explains, the more

important it is. There are several approaches that we can use to choose the
number of components to retain:
-          Defining a threshold before the analysis:
choose all the components with a certain eigenvalue (usually >
1);
choose a priori a specific number of components (then verify the
total variance explained and other validity tests);
choose the first x components that explain at least X% of the
variance, for example 80% if using the results for descriptive
purposes or higher if the results will be used in other statistical
analysis (Figure 74);
-                  Use a scree plot (Figure 75) and “cut” the line at the main
inflexion point or at one of the main inflexion points where there is an
acceptable total variance explained (for example, in Figure 75 the first
four components can be chosen, since there is an important inflexion
point, but they just explain 60% of the variance).

Figure 75: Scree Plot

The next step is to analyze the principal components’ correlation coefficients

in a matrix with variables and components. Ideally we want one variable to
have a high correlation with one component to define each component
conceptually (smell and color = component “quality”). However, even if we
cannot explain the resulting components conceptually, we have to bear in
mind that the main objective of a PCA is to reduce a large number of
variables to a manageable number of components, while interpreting the
component is not strictly necessary. In chapter 64. EXPLORATORY
FACTOR ANALYSIS, PCA analysis will be used as the method for a factor
analysis, and I will introduce optimization methods, factor scoring, and
validity tests.
TEMPLATE
http://analyticsmodels.blogspot.com.es/p/statistical-analysis-
templates_2.html


64. EXPLORATORY FACTOR

ANALYSIS
OBJECTIVE
Explore the underlying latent structure of the data to identify implicit
unobserved variables that are “hidden” behind several observed variables.
DESCRIPTION
An exploratory factor analysis (EFA) analyzes the interrelation among a
large number of variables to find a small number of latent or implicit
variables (called factors) that explain most of the correlation/covariance of
the original variables. There is usually confusion between PCA (principal
component analysis) and EFA. The main goal of PCA is to reduce a large set
of variables to a smaller possible set of variables that still explain most of the
variance.
Unlikely PCA, EFA is used to identify or understand complex concepts that
are not directly measurable: social status, intelligence, psychological profile,
sociability, and so on. For example, in an EFA we can see that there are
similar patterns in responses about income, education, and occupation, so we
can identify them as the latent variable “social status.”
Before starting the analysis, we should check some assumptions:
-          Normality: it is not a compulsory requisite but it can improve the
results;
-                  Sample size: ideally we should have a large ratio between the
number of observations and the number of variables, for example 20:1
(we can still accept lower ratios, but those under 5:1 are not
recommended).
As in the PCA analysis, I will not propose an Excel template, since I highly
recommend performing EFA with a proper statistical tool. However, if we
are really interested in running EFA in Excel, tutorials are available online.
[30] In general, a smaller sample size will require higher correlations for the
analysis to produce valid results (validity tests are explained later in this
chapter).
We start by choosing the method for extracting the factors, which is PCA in
our case, but there are some other methods (principal axis, maximum
likelihood, etc.). Therefore, the first steps are the same as those for PCA (see
63. PRINCIPAL COMPONENT ANALYSIS):
-          Reproduce a correlation matrix;
-                  Choose the threshold for the number of retained factors
(eigenvalue, number of factors, total variance explained, scree plot).
Statistical tools also offer a choice of rotation method. Without entering into
the technical explanation, I think it is enough to know that it maximizes the
differences between the loading factors to have ideally one variable with
high correlation with one factor. The most popular and most-used method is
probably varimax, but the advantages and disadvantages of the other
methods can be investigated.
At this point we will have a correlation matrix, a scree plot, and a table
summarizing the components together with their eigenvalues and the
percentage of variance explained. The next table to be used is a matrix with
factors and variables filled with loading factors. Loading factors are
measures that range from -1 to 1 and represent how much a factor explains a
specific variable. This is the key to understanding the underlying data and
interpreting a factor conceptually. In Figure 76 it is clear that Factor 1
explain mainly variables 5, 6, 7, 8, and 10, while Factor 2 explains variables
1 to 4. Variable 9 has low loading factors with both factors, so it may be
excluded. In addition, as a rule of thumb, each variable should have a
communality of at least 0.5 to be maintained in the model. The communality
of a variable is the proportion of variation explained by the retained factors.
 Figure 76: Loading Factors and Communalities

Having chosen the retained factors and variables, we have to recalculate the
loading factors and communalities. Afterwards, we need to perform a
validity test to check for two possible problems: 1) the correlation among the
variables is too low and 2) the correlation among the variables is too high
and there is a risk of multicollinearity.
For the first problem we should run two MSA (measure of sample adequacy)
tests:
-                  Bartlett’s test: if the p-value is significant (usually < 0.05), the
overall correlation among the variables is acceptable;
-          KMO test: this is a measure from 0 to 1 that verifies whether there
is a variable that does not correlate well (it should be higher than
0.5[31]; otherwise, we should check the “anti-image correlation
matrix,” which provides single KMO values of each variable, and
identify the one that may have to be removed).
To discard the hypothesis of multicollinearity, we should first become
suspicious at the beginning of the test if in the correlation matrix there are
values close to 0.9 or higher. Then, we can look at the “determinant” of the
correlation matrix, which should be near 1, while a near 0 determinant would
signify probable multicollinearity. We can also run a Haitovsky’s
significance test (check the p-value, which should be < 0.05).
TEMPLATE
http://analyticsmodels.blogspot.com.es/p/statistical-analysis-
templates_2.html


65. CONFIRMATORY FACTOR

ANALYSIS
OBJECTIVE
Confirm or reject a structured equation model that identifies one or more
latent (not observed) variable.
DESCRIPTION
Confirmatory factor analysis (CFA) uses almost the same statistical
techniques as exploratory factor analysis (EFA) but is conceptually quite
different. While EFA explores measured variables to discover possible latent
unobserved variables (factors), CFA firstly defines a theoretical model and
then runs a factor analysis either to confirm or to reject the proposed model.
The model definition implies specifying the number of factors, the variables
that relate to each factor, and the strengths of the relationships. The model is
usually represented by a path diagram similar to the one described for path
analysis (see 40. PATH ANALYSIS).
 Figure 77: Path Diagram of Confirmatory Factor Analysis

For example, we hypothesize that there are two latent variables, “social
status” and “influence on other people.” We then design the theoretical
model by defining:
-          Latent variables (factors): social status and influence (represented
by ellipses);
-                  Observed variables (e.g. income and education) represented by
rectangles;
-          Relations between variables and factors (factor loadings) that are
represented by simple arrows (variables can be related to just one
factor or to both of them);
-          Correlation between factors, if we think it exists (curved double-
headed arrows);
-          Errors, represented by ellipses (usually we have errors pointing at
all the observed variables);
-                  Correlation between errors, if we think it exists (curved double-
headed arrows).
An important limitation is that the number of free parameters (relations
established in the path diagram) has to be lower than the number of distinct
values. Distinct values are calculated by the formula p * (p + 1) / 2, where p
is the number of variables. The number of free parameters is the sum of all
the relations established in the model (to put it simply, the number of arrows
in the path diagram).
The model can be tested using for example the chi-square test for the
“badness of fit” (see 48. CHI-SQUARE) or by other methods (RMSEA or
GFI). The recommended values for the model to have a good fit are:
-          Chi-square p-value > 0.05;
-          RMSEA < 0.05;
-          GFI > 0.95.
This Excel template can help in calculating the goodness of fit of SEM
models: http://www.watoowatoo.net/sem/sem.html. If the model fitting is
not satisfactory, the path diagram needs to be modified to seek a better fit by:
 -          Eliminating non-significant parameters by checking the t-statistics
of the parameters (i.e. if they are larger than 1.96);
-          Adding new parameters using two techniques:
Modification index: a large value indicates potentially useful
parameters;
Expected parameter change: the approximate value of the new
parameter if added;
-                  Analyzing the standardized residual matrix and checking for
values higher than 1.96 or 2.58 (for example), which identify values
that are not well accounted for in the model.
 
TEMPLATE
I suggest using a proper analytical tool to run this model, but the paper
below shows how to perform this model in Excel:
https://www.researchgate.net/publication/7151927_Confirmatory_factor_ana
lysis_using_Microsoft_Excel.


FORECASTING


66. INTRODUCTION
The objective of forecasting is to produce predictions and indications
(usually demand or sales) for future periods using historical data and making
several assumptions. For example, we want to forecast the monthly sales of
the year +1 and we take as a reference the monthly sales of the current year.
An assumption could be that the sales will not change next year and our
forecast will be equal to the historical data. Other simple-to-implement
assumptions can be to establish a fixed increase in sales each month or a
proportional increase, for example 10%. Assumptions can become much
more complex when using trend or causal models.
To carry out robust forecasts, it is important to identify the elements that
have an impact on the demand and use the best technique available to
estimate the impact. The answers will not be found for all the elements that
have an impact on the demand, but it is necessary to make the best
assumptions by complementing quantitative techniques with qualitative
techniques and personal business insights.
A regression can be used to define price elasticity and, knowing that the
company will change its prices, this parameter can be included in the
forecast. However, if we just use historical data and apply the price elasticity
effect to a price shift, we are assuming that the other elements affecting the
demand do not change: the demand is stable, customers do not change their
behavior or taste, competitors maintain their actual prices, and so on.
FORECASTING TECHNIQUES AND METHODS
There are several methods[32] available, and choosing among them depends
on five main factors:
-                  The life cycle phase of our product or service (the emergent,
growth, or mature phase);
-          The type of product;
-          The minimum accuracy required and how much we are willing to
invest in time and money;
-                  The data availability (and the cost of obtaining more data if
possible);
-          The scope of the forecast (short, medium, or long term).
We can group the forecasting models into three categories:
-                  Qualitative techniques: the forecast is based on the opinion of
experts (the Delphi method, brainstorming, panel consensus, etc.), the
opinion of customers through surveys, or market research. It is usually
applied when we do not have quantitative data (a product launch) or
for forecasts of several years ahead.
-                  Time series and projections: the forecast is based on pattern
recognition about past data (seasonality, cycles, and trends) and the
projection of these patterns into the future. Its accuracy is greater when
the product has already entered into a steady phase (the mature phase).
These methods can be more stable or more sensitive to changes;
however, they cannot predict turning points based on special events
and can only react more or less rapidly to a change in measured data.
Examples are the moving average, exponential smoothing, and time
series analysis.
-          Causal models: the forecast is based on the relationship between
the outcome (sales) and one or more predictor variables, such as
product characteristics (price, quality, and availability), competitors’
product characteristics, our strategy vs competitors’ strategy
(advertising, promotions, etc.), or external factors (economic or
geopolitical factors). This group includes different kinds of
regressions, pricing models, and customer analytics models for
predicting future behavior.
In the following chapters I will start by explaining how to perform an S-
curve life cycle analysis, which is considered to be a causal model but is in
part also a projection model. I think that this method should not be used
alone but as the base for more accurate forecasting methods. Then I will
focus on the three most-used “time series and projection” methods: moving
average, exponential smoothing, and time series analysis. Finally, I will
include two causal methods used in revenue management (pickup models
and regressions). I will not include pricing models and customer analytics
models, since they have already been included in previous chapters.
FORECAST PERFORMANCE
To choose the best method to use, first of all we should consider the kind of
business and the available data. However, this information is usually not
sufficient and we need to compare different methods based on their
performance.
The performance is calculated by the forecast error, that is to say the
difference between the real data and the forecasted data. If we have enough
data, it is a good practice to use part of it to build the model (training data)
and part of it to test the model (test data).
Two of the commonly used error methods are:
-                  MSE (mean squared error): this is the average of the squared
errors of each period;
-          MAPE (mean absolute percentage error): this is the average of the
absolute percentage error of each period.


67. S-CURVE LIFE CYCLE

ANALYSIS
OBJECTIVE
Identify the maturity of a product or service and forecast the demand for the
next periods.
DESCRIPTION
The assumption behind this model is that usually a product has a life cycle
that follows an S-shaped curve with three main phases (see 12. PRODUCT
LIFE CYCLE):
-          Emergent phase: this is characterized by a low number of firms,
low revenues, and usually zero or negative margins;
-          Growth phase: the margins are increasing rapidly (for a while, but
less in the last part of the growth phase), as well as the number of
firms;
-                  Mature phase: the global revenues are increasing at a far lower
rate; both the margins and the number of firms are decreasing. At this
point the product can enter into a decline phase, for example if a newer
substitute product is introduced or if the demand is decreasing.
As mentioned in chapter 12. PRODUCT LIFE CYCLE, it is important to
identify the phase of the product or service (this analysis also applies to
different product levels – brand, product line, product category, etc.). For
this purpose we should identify the trend in the number of firms, revenues,
and margins. However, we can complement this analysis with a statistical
approach that will help us to forecast the future growth.
If our product is in the emergent phase or just in the development phase, we
do not have enough data to estimate the S-curve, so we should use the data
of products with similar characteristics and analyze their product life cycle
curves. It is important to make good assumptions about the market saturation
level and the differences between our product and the similar product that
can affect the growth rates in the three phases. The more data we obtain after
the launch of our product, the more precisely we can compare it with the S-
curve of similar products and, thus, the more we can adjust our assumptions.
If we estimate that our product is already in the growth phase, besides
comparing it with similar products, we can build our S-curve using for
example a logarithmic linear estimate (see the template) and forecast future
sales. As shown in Figure 78, the sales data for each period (years[33]) are
inserted into the table then transformed to estimate a linear trend. In the last
row of the table, the logarithmic transformation is reversed and the sales are
projected (see the graph on the right in Figure 79).

Figure 78: Sales Data and Forecast Using Log Transformation

If we think that the S-curve does not fit the forecast properly, we can change
our assumptions about the market saturation level (which will change the
log-transformed data and thus our forecast). In the template the R2 is
calculated and we can use it as a measure of how well the forecast curve fits
the actual sales data. However, remember that our assumptions about market
saturation levels are more important than reaching a “perfect” fit of the
forecast curve. For example, we can reach a higher R2 but with an
improbably high market saturation level. In fact, there are different factors
that can affect the shape of the curve: the economic situation, competitors’
strategies, the entry of new substitute products, new fashions, and so on.

Figure 79: Log Transformed Data and Linear Trend Line (on the Left); Real Sales Data and
Forecasted Sales (on the Right)
Finally, in the case that our product is already in the mature phase, this
model will just project a slightly increasing or stable level of sales. However,
it cannot predict or estimate whether or when our product will pass into the
decline phase. This can be realized only when the product has already started
to decline. Anyway, when it becomes apparent that our product is in the
mature phase, our strategic actions will focus on optimization and “life
extension.” On one side we have to optimize what we can obtain with this
product and its market by reaching its full potential (pricing optimization,
loyalty programs, product bundling, advertising, promotions, etc.). However,
sometimes this is not enough either to continue to increase sales or to avoid
declining. In this case we should consider actions that are able to “push
upward” the S-curve, extending the life cycle of the product: product
evolution, innovation, new markets, new use of the product, and so on.
Finally, it is important to remember that this is not a precise forecasting
method, since this is not its main goal. With this method we can project the
medium- and long-term product growth potential, but, for a more accurate
forecast, this method has to be complemented with more precise methods,
especially for the short-term forecast.
TEMPLATE
http://analyticsmodels.blogspot.com.es/p/forecasting-templates.html
 


68. MOVING AVERAGE

OBJECTIVE
Forecast the demand for the next periods.
DESCRIPTION
The assumption behind this model is that the recent demand is a good
predictor of the future demand. The formula is:

The demand forecast (F) for the next period (t + 1) is forecast by averaging
the demand (X) of a number of periods (n) including the present one (t).
Here the election of the number of periods is fundamental. The more periods
that we include in the average, the more we reduce the randomness in the
model, but, on the other side, we lose important information about
seasonality.
A variation of this model is a weighted moving average model in which
different periods have different impacts on the moving average. Usually
more weight is given to more recent periods, but a different approach can be
chosen depending on the kind of business.
The moving average does not perform well in the presence of seasonality or
business cycles, because it smooths the time series being used. However, it is
a valuable method for extracting seasonality, cycles, or irregularity from a
time series to carry out more advanced forecasting methods, such as
regressions or ARIMA (see 70. TIME SERIES ANALYSIS).
 Figure 80: Example of Three- and Five-Period Moving Averages

 
TEMPLATE
http://analyticsmodels.blogspot.com.es/p/forecasting-templates.html


69. EXPONENTIAL SMOOTHING

OBJECTIVE
Forecast the demand for the next periods.
DESCRIPTION
Unlike the moving average, exponential smoothing includes all the time
series data in the forecast and places more weight on the most recent values,
diminishing the weight of old data exponentially over time.

The forecast for the next period (Ft+1) is calculated by a weighted average of
the value of the current period (Xt) and the forecast of the current period (Ft).
The weight of the current period value ( ) is arbitrary, and the goodness of
the forecast should be tested using different weights. A lower (close to 0)
means that more weight is put on earlier observations, giving a smoother
curve (this is usually appropriate when the time series are stable). An
closer to 1 puts more weight on more recent observations and responds faster
to changes in the time series. Since we have no data for the first period
forecast, we can use the real data of the period.

Figure 81: Exponential Smoothing with a Smaller (0.2) and Larger (0.8) Alpha
Like the moving average, single exponential smoothing is not suited to time
series with a significant trend or seasonality; however, we can include the
trend and seasonality components in the formula:

where S is seasonality, y is the seasonality weight, T is the trend, and β is the

trend weight. The greater the weight, the more responsive to changes is the
forecast. The smaller the weight, the more stable is the forecast.
TEMPLATE
http://analyticsmodels.blogspot.com.es/p/forecasting-templates.html


70. TIME SERIES ANALYSIS

OBJECTIVE
Forecast the demand for the next periods.
DESCRIPTION
Time series analysis is useful for forecasting based on the patterns
underlying the past data. There are four main components:
-          Trend: a long-term movement concerning time series that can be
upward, downward, or stationary (an example can be the upward trend
in population growth);
-                  Cyclical: a pattern that is usually observed over two or more
years, and it is caused by circumstances that repeat in cycles (for
example economic cycles, which present four phases: prosperity,
decline, depression, and recovery);
-                  Seasonal: variations within a year that usually depend on the
weather, customers’ habits, and so on;
-                  Irregular components: random events with unpredictable
influences on the time series.
 Figure 82: Time Series Analysis

There are two main types of models depending on how the previous four
components are included:
(1)  Y(t)=T(t) x S(t) x C(t) x I(t)
Multiplicative models: the four components are multiplied, and in this case
we assume that the components can affect each other.
 
(2)  Y(t)=T(t) + S(t) + C(t) + I(t)
Additive models: we make the assumption that the components are
independent.
Another important element of time series is stationarity. A process is
stationary when an event is influenced by a previous event or events. For
example, if today the temperature is quite high, it is more likely that
tomorrow it will be quite high as well.
There are many models for time series analysis, but one of the most used is
ARIMA (autoregressive integrated moving average). There are some
variations of it as well as non-linear models. However, linear models such as
ARIMA are widely used due to their simplicity of implementation and
understanding.
A good time series analysis implies several exploratory analyses and model
validation, which requires statistical knowledge and experience. The
template contains a simplification of a time series model in which
seasonality and trends are isolated to forecast future sales.
The data can be collected at every instance of time (continuous time series),
for example temperature reading, or at discrete points of time (discrete time
series), when they are observed daily, weekly, monthly, and so on.
TEMPLATE
http://analyticsmodels.blogspot.com.es/p/forecasting-templates.html


71. PICKUP MODELS

OBJECTIVE
Forecast the demand for the next periods.
DESCRIPTION
Pickup models are advanced forecasting models used in revenue
management, and they can be applied in businesses that book the service in
advance (airlines, hotels, theaters, etc.). The forecast is calculated using the
current bookings for a certain future period and estimating the incremental
bookings (pickup) from now until this future period (i.e. departure date,
check-in date, etc.).
The pickup is calculated using past data, and it can be the average pickup
with a specific anticipation (x days before) if we are summing it with the
current bookings or it can be an average pickup ratio (total bookings /
bookings x days before) if we are multiplying it by the current bookings:

In the first formula (additive pickup), the bookings on anticipation day 0

(BDB0) are equal to the current bookings (BDBX) plus the average pickup
bookings between anticipation day x and anticipation day 0 (PUDB(X,O)). In
the second formula (multiplicative pickup), the forecast is calculated by
multiplying the current bookings by the average pickup ratio (PURDB(X,0)).
To estimate good forecasts, it is very important to calculate carefully either
the average pickup or the pickup ratio. Take as an example an airline
company. If we are using the average pickup, then we should take into
consideration seasonality at different levels: time of the day, day of the
week, month, holidays, and so on. The amount of incremental bookings
depends heavily on the demand for a specific departure time, so we should
calculate the average using similar days. However, if we are using the
average pickup ratio, we do not have this problem but may discover that the
booking pace is different for different departure periods; for example, more
people are anticipated to book during summer periods. In this case it is
important to calculate the average pickup ratio from similar departure
periods.
We can also take a step further and expect that the booking pace may change
over time, either because the customer behavior has changed or because we
have widened the booking horizon. For example, we can calculate a trend in
the pickup ratio and adjust it for the prediction of future periods.
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72. REGRESSIONS
OBJECTIVE
Forecast the demand for the next periods.
DESCRIPTION
This method is similar to the pickup model since it predicts final bookings
based on the number of bookings in a certain anticipation period:

The bookings on anticipation day 0 (BDB0) are the dependent variable, the
current bookings (BDBX) are the independent variable, β0 is the intercept, and
β1 is the X regression parameter.
The technique used to define the relation between current bookings and final
bookings is a linear regression, but it is also possible to use other types of
regressions (for more information see36. INTRODUCTION TO
REGRESSIONS).
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WHAT-IF ANALYSIS AND

OPTIMIZATION MODELS


73. INTRODUCTION
What-if analysis includes a broad range of techniques used to depict future
possible scenarios based on the possible developments or turning points that
can affect them. For example, we can hypothesize different scenarios with
different states of the economy or with different competitors’ strategies.
Even though with this analysis we can estimate the most probable outcome
(i.e. the most likely scenario or the average of defined scenarios), the fact of
defining less probable outcomes as well gives decision makers additional
information:
-          Assessment of the risk of an investment if the difference between
extreme outcomes is very large;
-          Be prepared in case a less probable scenario unfolds;
-          Minimize risks and maximize opportunities;
-          Conduct stress tests.


74. SCENARIO ANALYSIS

OBJECTIVE
Identify possible future scenarios.
BEST–WORST–AVERAGE CASE SCENARIO ANALYSIS
Simple scenario analysis can be managed in a spreadsheet into which we can
insert data and functions that represent our business model. In the proposed
example, the spreadsheet contains the figures for an investment in a business
intelligence system for a hotel chain and the costs and returns associated
with this investment. In the first sheet, the most likely scenario is presented,
and with a simple what-if analysis we add a worst-case scenario and a best-
case scenario.
First of all we define the main input variables that affect the outcome:
-                  Revenues: we project the expected additional revenues in future
years thanks to the new BI system. The additional revenues are
expected due to the better service personalization, better client service,
and more effective marketing campaigns.
-          Costs: we will incur additional costs associated with the BI system
management.
-          Cost of capital: to calculate the net present value, we discount the
cash flows with the cost of capital for our company.
The second step is to define the number of scenarios. In our case we have
three, but we can also opt for a multiple-scenario analysis including more
intermediate scenarios (bear in mind that, if we increase the number of
scenarios, on one side we will have more realistic results but on the other
side the analysis will become more complicated).
Then we modify our input variables (revenues, costs, and cost of capital) by
reasoning on the underlying factors that can change them. For example, a
worse global economic situation negatively affects revenues, and some
unexpected situations can increase the costs associated with the project or
just our estimations of the positive effects of the BI system. After defining
the main factors and the underlying assumptions, we modify the input
variables with the maximum negative effect for the worst-case scenario and
with the maximum positive effect for the best-case scenario.
We can use the Excel What-If Analysis tool to save different scenarios and
to create a summary of them by clicking on “Data,” “What-If Analysis,” and
“Scenario Manager.” We will see the three scenarios that I saved; if we click
on one scenario and then “Show,” we will see the scenario. We can also add
a new one by clicking “Add” (I suggest first changing the changing cells in
the spreadsheet – green cells – and then adding a new scenario; otherwise,
we will have to change the values in a less intuitive way in the scenario
manager window). Once we have added a new scenario, we can click on
“Summary” and choose the report type and result cells (by default we will
see the cells of NPV of the scenarios that I have saved).

Figure 83: Scenario Summary

Figure 83 presents the result cells of the summary scenario (changing cells
have been deleted). The current values are the same as the most likely
scenario, since they are the value at the moment of running the summary.
With the cumulated net present values in the next five years, we can now
evaluate the risks and opportunities of this project.
OTHER TYPES OF SCENARIO ANALYSIS
We can also opt for a multivariate scenario analysis, by adding more
intermediate scenarios. In this case a common practice is to assign a
probability to each scenario to evaluate the risks and opportunities according
to both the magnitude of the impact and the associated probability.
Another common technique is decision tree analysis, which tries to
represent all the possible events with associated probabilities and impacts
(see 75. SIMPLE DECISION TREES). A more precise but more complex
technique is to perform simulations, which rely on input variable probability
distributions to create a distribution of possible outcomes (or scenarios). The
advantage of simulations is a more accurate analysis, since we can calculate
statistical parameters with accuracy, such as the standard error, confidence
intervals, and so on (see 77. MONTE CARLO SIMULATIONS).
More information concerning probabilistic scenario analysis is available in
the following document:
http://people.stern.nyu.edu/adamodar/pdfiles/papers/probabilistic.pdf
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75. SIMPLE DECISION TREES

OBJECTIVE
Estimate the probability of future events.
DESCRIPTION
A probability tree is a simple way to represent a “probability space” with
independent and/or dependent events (conditional probabilities). Each node
represents the chances of an event occurring after the previous event has
occurred; therefore, the probability of a certain node is the product of its and
all previous nodes’ probabilities. Here the risks and probabilities can be
sequential or discrete, while in scenario analysis they are only discrete.
In a decision tree we have different types of nodes:
-                  Root node: this is the first node and usually represents the
question about whether to invest or not;
-                  Event or chance nodes (represented by circles): these are events
with several probable outcomes (each one with an associated
probability);
-                  Decision nodes (represented by squares): they represent all
possible decisions that can be taken after an event outcome;
-          End nodes: these are the result nodes.

Figure 84: Probability Tree

The steps in building a decision tree are:
-                  Divide the analysis into different risk phases, meaning future
events of which the outcomes are uncertain;
-          For each event define all the possible outcomes (if they are many
or infinite we must simplify them with a manageable small number of
discrete outcomes) and assign a probability to each of them (the
probability must sum 1);
-          Define decision points, that is, decisions that can be made once an
even outcome is known;
-                  Estimate the value (or cash flow) at each node (the costs and
revenues of this node and the previous ones that led to this outcome).
If revenues are projected in future years, we should apply a discount
rate (see 74. SCENARIO ANALYSIS);
-          Fold back the tree:
For each branch of a decision node choose the one with the
higher value;
For each event node calculate the weighted average probability
of all the outcomes.
With this method we “fold back” the tree until reaching the root node, where
in our example investing in the new product is worth €30 and therefore it is
better than abandoning it. We can also analyze the range of possible values (-
€150 to €400) to gain a better idea of the risks associated with the
investment. When we start the project, depending on the outcome of each
event, we make the decision with the highest associated value. This process
is very useful when we have several sequential nodes with several possible
outcomes.
The data usually imply making assumptions and estimating probabilities of
future events. Business acumen and experts’ opinion are extremely
important in building a reliable probability tree.
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76. GAME THEORY MODELS

OBJECTIVE
Anticipate competitors’ strategic decisions.
DESCRIPTION
Demand forecast or pricing models aim to find the optimal solution to
maximize the benefits. However, this optimization usually does not take into
consideration the fact that competitors are not static actors and will probably
react to strategic decisions.
Game theory models take into account other players’ actions, and they offer
theoretically an equilibrium in which no player can be better off from
changing their strategy (Nash equilibrium). There are four main types of
game theory models:
-                  Static games of complete information: movements are
simultaneous and all the players know the payoff functions of the
others;
-                  Dynamic games of complete information: movements are
sequential and all the players know the payoff functions of the others;
-                  Static games of incomplete information: movements are
simultaneous and at least one player does not have complete
information about the payoff of the others;
-                  Dynamic games of incomplete information: movements are
sequential and at least one player does not have complete information
about the payoff of the others.
Another important element of game theory models is the repetition of the
games , due to the fact that the strategy of players can change depending on
the number of games. In this case we can calculate the net present value of
future outcomes, since the nearest payoffs are more valuable than the most
distant ones. There is also a series of assumptions when applying these
models:
-          Players are rational;
-          Players are risk neutral;
-          Each player acts according to his/her own interest;
 -                  When making a decision, each player takes into consideration
other players’ reactions.
Static (simultaneous) games are usually represented by payoff boxes, of
which the most famous example is the prisoner dilemma. In this case the
dominant strategy for both prisoners is to defect, since, in spite of the
decision of the other prisoner, for both the decision to defect is the one with
the higher payoff.

Figure 85: Prisoner’s Dilemma

On the other side, sequential games are usually represented by decision trees
with the payoffs and decisions of the players.

Figure 86: Decision Tree with Players’ Payoff

Some common applications to business are:

-          Market entry decision making
 -          Price modifications
-          Quantity modifications
To find the solutions to these games, we use demand, supply, cost, and utility
functions. Depending on the possible decisions that the players make,
calculating these functions will define the payoff of players to determine the
equilibrium of the game. When information is not known, we can use
assumptions and weight them with a probability percentage, but this requires
the creation of more complex models.
The template that I propose aims at profit maximization based on decisions
about price changes. Profits (or payoffs) are calculated by the difference
between a cost function and a demand function. The demand is a function of
the price elasticity of the market and the cross-price elasticity with other
competitors (this information can be gathered through several pricing
techniques, for example choice-based conjoint analysis or brand–price trade-
off).
More models are available online (Cournot, Bertrand, and Stackelberg
games), and there are several Excel templates (for example
http://econpapers.repec.org/software/uthexclio/). Data about competitors’
market share, costs, production limits, and so on should be estimated using
industry data, published reports, and experts’ opinion (brainstorming,
workshops, etc.). Prices can be collected more easily, since they are usually
public. Data about price elasticity are calculated through surveys that include
questions for price analysis techniques.
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77. MONTE CARLO SIMULATIONS

OBJECTIVE
Determine probable outcomes.
DESCRIPTION
In deterministic models we predict events in a simple linear system and we
assume that the initial conditions do not change. Besides, the same initial
conditions will give the same results. However, the world is more
complicated and events are usually determined by a complex interrelation of
different variables, some of which are difficult or almost impossible to
estimate. Monte Carlo simulations solve this problem by using probability
distributions for each input variable and then running several simulations to
produce probable outcomes. We can say that this model allows the
prediction of an outcome without conducting many expensive experiments.
The steps for performing a Monte Carlo simulation are:
-          Define the mathematical formula for the outcome;
-                  Identify the probability distributions of the input variables and
define their parameters;
-          Run the simulations;
-          Analyze and optimize.

Figure 87: Monte Carlo Simulation Output

Input and Output Variables
The first step in a Monte Carlos simulation is to define the output, that is to
say to identify the variable that we want to predict, for example “profits.”
Then we should identify the input variables on which “profits” depend.
Some of them may be certain; for example, we can have a fixed cost with a
specific value, but usually they are uncertain. For each of the uncertain
variables, we need to identify a specific probability distribution to use for the
simulation. Examples of distribution are:
-          Discrete distribution: we define the probability of a finite number
of values;
-          Uniform distribution: each variable value has similar probabilities
(for example, when throwing a die, each number has a 1/6
probability);
-          Bernoulli distribution: we have only two alternative and exclusive
outcomes (0 or 1);
-          Normal distribution: the central values are the most probable ones
(defined by the mean and standard deviation);
-                  Triangular distribution: we have a most probable value and a
lower and an upper limit;
-          Other distributions: exponential, logarithmic, binomial, beta, etc.
Having identified the distribution, we can use a chi-square test (see 48. CHI-
SQUARE) to check whether the data fit the chosen distribution. An
alternative would be to conduct a Korm–Smirnov test.
In this phase we also write the mathematical formula by which the outcome
is defined, for example:
Profits = (Price – Variable cost) * Units – Fixed Costs
The simulation is then performed repeating the input variables (with each
specific probability distribution) hundreds or thousands of times to obtain a
distribution of probable results.
Analysis and Optimization
Once the range of probable results has been obtained, depending on the
objective, we use indicators such as the minimum value, maximum value,
average, standard deviation, and so on. In general we usually compare:
 -                  Expected value: the mean of all the outputs with its confidence
intervals;
-                  Risk: in the proposed example it is the probability of negative
profits (% of outputs < 0), but we can also choose a specific value.
It is also possible to compare different simulations with different input
variables’ values or distributions. To compare them, we should calculate the
confidence intervals of both expected values and risks. If the range between
the confidence intervals does not overlap, we can infer that one scenario is
better or worse than the other one.
If the objective is to use the results for a business plan or in risk analysis, we
can stop here, but if we want to optimize the outcomes, a sensitivity analysis
is needed. In this kind of analysis, we measure the “importance” of each
input and may decide to act on the most influential ones. Usually the
correlation coefficient between each input and the output is used, but
different techniques can be adopted.
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78. MARKOV CHAIN MODEL

OBJECTIVE
Calculate the probability of future events.
DESCRIPTION
A Markov chain is a random process in which for each iteration we have a
transition from the current state to another state. The number of states is
finite, and the probability of passing from one state to another is only
determined by the current state and not by the previous ones (called the
Markov property). Once the goals and the business model that we want to
represent have been defined, the first step is to identify the different states
and the probability of transition from one to another in a probability
transition matrix.

Figure 88: Probability Transition Matrix

In the proposed example, two companies (1 and 2) are fighting to dominate a

specific market. There are five different states:
-          “0”: equal market share;
-                  “adv1” and “adv2”: when a company gains a significant
advantage in the market share;
-          “1” and “2”: when a company dominates the market.
In this model we want to represent a situation in which only one company
can survive and its goal is to dominate the market. The second assumption is
that the more it gains market share, the more probable it is that the company
will dominate the market. The last assumption is that company “2” is
slightly better positioned than company “1.” Hypothetically, we can imagine
that each month we have a new iteration in which the business tactics are
modified; we can then simulate the probability after 20 months that company
“2” will dominate the market. In our simulation there is almost a 60%
chance that company “2” will dominate the market (Figure 89).

Figure 89: Markov Chain Output

The example presented and the related template concern a “discrete-time

Markov chain,” but a “continuous-time Markov process” model also exists.
For more complex analysis, we can use either Excel add-ins[34] or statistical
tools.
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79. SALES FUNNEL ANALYSIS

OBJECTIVE
Improve the conversion of prospective customers buy optimizing the sales
funnel.
DESCRIPTION
Models that estimate demand usually focus on a specific aspect of the sales
channel. For example, a pricing model usually defines the choice of
customers in front of a set of possible products or services; however, it does
not take into consideration the awareness of a product in the market (it
usually assumes full awareness to simplify the analysis).
Ideally, these pricing models (see PRICING AND DEMAND models) have
to be included in a broader framework called the sales funnel. A sales funnel
consists of four main elements:
-          Market: the total number of potential customers;
-          Awareness: the people in the market who know the product;
-          Consideration: the people who know the product and take it into
consideration for purchasing;
-                  Conversion: of the people who consider the product, those who
actually buy it.
These elements are related to each other, for example:
-                  70% of people in the market are aware of the product (market
awareness);
-          80% of people who are aware of the product consider purchasing
it;
-          10% of people considering it actually purchase it.
 Figure 90: Sales Funnel

We can calculate that 56% of all potential customers know the product (70%
* 80%) and that 5.6% buy the product (70% * 80% * 10%). We also can
calculate that 8% of people who know the product will buy it (5.6% / 70%).
An increase in the number of people in the market will result in an increase
in purchases, since (usually) we assume that the relationships or ratios
remain the same: 70%, 80%, and 10%. Data on market changes can be
derived from public population data. For example, if our potential clients are
males with an annual income between €40,000 and €80,000 and this sector
of the population increases, then our “market” increases.
Besides the market, we can act on the relationships between market
awareness, awareness consideration, and consideration conversion to
increase the sales.
Market Awareness
In our example 70% of people know our product, but we can increase this
ratio by investing in advertising, public relations, special offers, and so on.
The effect on sales of an increase in people’s awareness can be calculated
using the other ratios, which we assume do not change (80% awareness
consideration and 10% consideration conversion). However, we have to
consider that this assumption may not be completely true and either use
corrective measures or just be cautious in interpreting the results. In fact, the
remaining 30% of the people in the market who do not know the product
may have lower consideration and conversion ratios, for example because
they are more loyal to a specific brand and they do not know us or because
they are not interested in looking for an alternative product. In this case,
even if we make them aware of our product, it is probable that the awareness
consideration ratio of these people will be far lower than our 80%.
Awareness Consideration
Out of the people who know our product, some of them will not consider it
for a purchase either because they are loyal to a brand or because they think
that our quality and/or price levels are not acceptable. There are two main
ways to improve consideration:
-          If the price or quality are good but the low consideration is due to
people having a worse perception than the reality, we should invest in
communication;
-          If people have a correct perception of the price and quality, we can
improve them (higher quality and lower price).
Investing in communication will improve the number of aware people who
consider our product, and we can calculate the increase in sales using the
consideration conversion ratio of 10%. We assume that the conversion ratio
does not change, but, as in the abovementioned example, this assumption
may not be completely accurate.
If we improve the quality or lower the price, it is probable that the
consideration conversion rate will also change, since the product is more
attractive to those people who have already considered it.
Consideration Conversion
In this case price and quality are the main drivers, but here they are
compared with other alternatives (this is a similar concept to the reference
price vs maximum price explained in the introduction to PRICING AND
DEMAND models). The effect of a price modification can be derived from
several pricing and elasticity models.


Optimization
With the proposed model, we calculate the impact on volume, more
specifically the number of additional customers, but we should include other
elements to decide which strategy to pursue:
-          Revenues: revenues depend on the average number of purchases
and on the average price. Take into consideration that if we lower the
price we may also have a positive effect on the number of purchases
(depending on the product) but there will also be a negative effect
since we are selling cheaper;
-                  Costs: the costs of advertising, communications, and quality
improvements have to be included in the model.
Once we have defined the structure of the costs and revenues associated with
the model, we can use Excel Solver to find the optimal investment plan (see
80. OPTIMIZATION).
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80. OPTIMIZATION
OBJECTIVE
Optimize the output of a model by changing the values of several decision
variables.
DESCRIPTION
Optimization means finding those values of certain decision variables that
optimize the result (or output variable). Decision variables are elements in
which we can intervene, for example the price of a product or the investment
in advertising, while the result is the combination of formulas and functions
contained in the model after modifying our decision variables (an example
would be “profits”).
Here I am using the same example as in chapter 79. SALES FUNNEL, in
which I defined the four stages of a potential customer: market, awareness,
consideration, and conversion. The relationship between the elements is
represented by ratios; for example, 70% of people in the market are also
aware of our product, 80% of aware people consider our product for a
purchase, and 10% of those considering our product finally purchase it. To
improve our sales, we can act on three decision variables: increase
awareness, increase consideration, or increase conversion. For the sake of
simplicity, we assume that we can increase awareness directly by investing
in advertising, we can increase consideration by investing in communication,
and we can improve conversion by lowering prices. We also assume that a
client purchases just one product.
 Figure 91: Sales Funnel of the Starting Situation (Scenario 0)

The first step is to define the model to be optimized by identifying the

relationships between the variables (Figure 92). The target variable is
“profits,” which depend on three variables: the variable costs (which do not
change), price, and number of products sold. The number of products sold
depends on the conversion rate and the number of people who consider our
product. We can continue with this reasoning until the end of the diagram.
All the connections in the diagram have been defined with functions in the
template, and in particular we are interested in the relations of our main three
decision variables (price, communication, and advertising). These are the
variables that we can modify according to our business decisions to increase
our profits:
-                  Price: we can decrease the price of our product to increase the
conversion rate and therefore the number of products sold (see the
Excel template for the precise calculation), but at the same time it has
a direct negative effect on profits, since the number of products is
multiplied by a lower price.
-                  Communication costs: we can increase the communication
expenses to improve the consideration of our product (the more we
convince people, the more costly it will be to convince new ones).
-          Advertising costs: we can increase our investment in advertising
to augment the number of aware potential customers, but, as for
communication, it will become more and more expensive as we
approach 100% of the market.

Figure 92: Model Definition (Optimization)

At this point we open Solver in Excel (Data – Data Analysis – Solver)[35]
and define our variables (see Figure 93):
-          Objective is the cell with revenues – costs, and we check that we
want that cell to be the maximum (the yellow cell in the template);
-                  Changing variable cells are the cells containing our decision
variables (price, communication costs, and advertising costs); select
them using CTRL if they are not consecutive cells (green cells);
-          Constraints (red cells): we define three types of constraints:
That our awareness, consideration, and conversion rates cannot
be more than 100%;
That we have a total budget of €120,000 for advertising and
communication expenses;
That all non-constrained variables must be non-negative (check
this box in Solver).
-          Optimization method: we use a GRG non-linear method, since not
all of our combinations of functions (objective, decision variables, and
constraints) are linear. If we try to use the Simplex linear method,
Solver will report that it cannot solve the model.[36]
 Figure 93: Results of the Optimization Using Solver

The results show that we can increase our profits by investing €112,000 in
advertising and €8,000 in communication and lowering the price by 4%.
They also show that the most important strategy action concerns the
awareness rate, which was increased by 33% until reaching 93% of the
market, as shown in Figure 94.

Figure 94: Sales Funnel after the Optimization (Scenario 1)

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Challengers. John Wiley and Sons, 2010.
Schumacker, Randall E., and Richard G. Lomax. A Beginner’s Guide to
Structural Equation Modeling. Routledge, 2016.
Tetlock, Philip E., and Dan Gardner. Superforecasting: The Art and Science
of Prediction. Crown, 2015.
https://hbr.org/2006/01/competing-on-analytics
http://www.excelmasterseries.com/
http://blog.excelmasterseries.com/
http://www.real-statistics.com/
https://en.wikipedia.org/wiki/Fermi_problem
http://www.businessmodelgeneration.com/canvas/bmc
https://www.udacity.com/course/how-to-build-a-startup--ep245
https://www.xlstat.com/es/soluciones/funciones/choice-based-conjoint-
analysis
https://hbr.org/2007/10/how-valuable-is-word-of-mouth
http://www.quantitativeskills.com/sisa/rojo/distribs.htm
https://www.researchgate.net/publication/270887299_Path_Analysis_Step_b
y_Step_Using_Excel
http://www.watoowatoo.net/sem/sem.html
www.powerandsamplesize.com
http://conversionxl.com/ab-testing-statistics/
https://www.optimizesmart.com/understanding-ab-testing-statistics-to-get-
real-lift-in-conversions/
http://www.real-statistics.com/multivariate-statistics/factor-
analysis/principal-component-analysis/
http://www.real-statistics.com/multivariate-statistics/factor-analysis/
https://www.researchgate.net/publication/7151927_Confirmatory_factor_ana
lysis_using_Microsoft_Excel
https://hbr.org/1971/07/how-to-choose-the-right-forecasting-technique
http://people.stern.nyu.edu/adamodar/pdfiles/papers/probabilistic.pdf
http://econpapers.repec.org/software/uthexclio/
https://www.me.utexas.edu/~jensen/ORMM/excel/markov.html
www.solver.com
 

[1] https://hbr.org/2006/01/competing-on-analytics;
  Thomas H. Davenport and Jeanne G. Harris, Competing on Analytics: The New Science of Winning
(Harvard Business School, 2007).
[2] Guide to the Business Analysis Body of Knowledge: BABOK Guide (International Institute of
Business Analysis, 2015).
[3] James Cadle, Debra Paul, and Paul Turner, Business Analysis Techniques: 99 Essential Tools for
Success. 2nd ed. (BCS Learning & Development Limited, 2014).
[4] Philip E. Tetlock and Dan Gardner, Superforecasting: The Art and Science of Prediction (Crown,
2015).
[5] Philip E. Tetlock and Dan Gardner, Superforecasting: The Art and Science of Prediction (Crown,
2015).
[6] For more information read the following book: Daniel Kahneman, Thinking, Fast and Slow
(Farrar, Straus and Giroux, 2011).
[7] For the complete example, visit https://en.wikipedia.org/wiki/Fermi_problem.
[8] W. Chan Kim and Renée Mauborgne. Blue Ocean Strategy: How to Create Uncontested Market
Space and Make the Competition Irrelevant (Harvard Business School, 2005).
[9] https://www.blueoceanstrategy.com/tools/
[10] This is a tool that was used originally for the definition of new products or businesses, but, since
the purpose of this book is to provide analytical tools, we use the business model canvas as a model to
analyze business strategies.
[11] Alexander Osterwalder, Yves Pigneur, Tim Clark, and Alan Smith, Business Model Generation:
A Handbook for Visionaries, Game Changers, and Challengers (John Wiley and Sons, 2010).
[12] http://www.businessmodelgeneration.com/canvas/bmc
[13] https://www.udacity.com/course/how-to-build-a-startup--ep245
[14] Christoph Breidert, Estimation of Willingness-to-Pay: Theory, Measurement, Application
(Deutscher Universitätsverlag, 2006).
[15] https://www.xlstat.com/es/soluciones/funciones/choice-based-conjoint-analysis
[16] https://hbr.org/2007/10/how-valuable-is-word-of-mouth
[17] V. Kumar, J. Andrew Petersen, and Robert P. Leone, “How Valuable is Word of Mouth?” HBR
(2007).
[18] Peter S. Fader and Bruce G.S. Hardie, “Implementing the BG/BB Model for Customer-Base
Analysis in Excel,” 2011, http://www.brucehardie.com/notes/010/.
[19] Estimated amount = Intercept + Coefficient 1 * Variable 1 + Coefficient 2 * Variable 2.
Be aware that, if we have transformed some of the variables, we cannot simply multiply the
coefficient but should make some additional calculations.
[20] To improve normality and variance conditions, we can try applying a log transformation to the
response (dependent) variable. We can also use other types of transformations, but we must remember
that the interpretation of the results is more complex when we transform our variables.
[21] Errors are only represented for endogenous variables (variables that receive arrows) and not for
exogenous variables (independent variables).
[22] Randall E. Schumacker and Richard G. Lomax, A Beginner's Guide to Structural Equation
Modeling (Routledge, 2016).
[23]
https://www.researchgate.net/publication/270887299_Path_Analysis_Step_by_Step_Using_Excel
[24] There are also other methods that can be more or less conservative, for example the Šidák
correction or the false discount rate controlling procedure.
[25] In some cases it is also possible to use two samples and match each component on a certain
dimension.
[26] http://conversionxl.com/ab-testing-statistics/
https://www.optimizesmart.com/understanding-ab-testing-statistics-to-get-real-lift-in-conversions/
[27] T = true, F = false, P = positive, and N = negative.
[28] In spite of this example, PCA is usually performed when we have a larger number of variables.
[29] http://www.real-statistics.com/multivariate-statistics/factor-analysis/principal-component-
analysis/
[30] http://www.real-statistics.com/multivariate-statistics/factor-analysis/
[31] As a guideline we can consider a KMO higher than 0.8 to be a good fit for a factor analysis,
from 0.7 to 0.8 a sufficient fit, and from 0.7 to 0.5 a low to very low fit for a factor analysis.
[32] For more information about different models, read this interesting article:
https://hbr.org/1971/07/how-to-choose-the-right-forecasting-technique
[33] Usually the life cycle of a product takes years to reach maturity, but, if we have a shorter life
cycle, we can use deseasonalized monthly data (for example using a moving average).
[34] https://www.me.utexas.edu/~jensen/ORMM/excel/markov.html
[35] Be sure to have the Solver complement installed and habilitated; for more information visit
www.solver.com.
[36] When we have all the linear functions (objective, decisions variables, and constraints), it is more
efficient to use the Simplex LP method. This is usually the case when using simple formulas with
additions, subtractions, division, or multiplication. For more complex formulas (and especially for
power or roots), we should use a GRG non-linear method. In the case that we have non-smooth or
discontinuous data (for example if we use formulas with IF, CHOOSE, ROUND, COUNT, INT, ABS,
MIN, MAX, etc.), we should use the evolutionary method, which will find a “good solution” but
probably not the globally best solution (it is recommended to try different times with different starting
points). A more complex method for a simpler solution (i.e. the GRG non-linear method for a linear
problem) will work but it will not be the most efficient method. In the case that Solver produces an
error, select the proposed reports to obtain more information about the problem. More information is
available at www.solver.com.