Business Analytics :

Primer
Bhaskar Sinha
 Week 1: Descriptive
Analytics
◆ A Business Decision Problem

◆ Forecasting with Past Historical

Data
◆ Moving Averages
◆ Exponential Smoothing

◆ Thinking about Trends and

Seasonality

◆ Forecasting for new Products

◆ Fitting distributions

Business Analyics : Session 1

 Week 1: Descriptive
Analytics
◆ A Business Decision Problem Session 1

◆ Forecasting with Past Historical

Data
◆ Moving Averages
◆ Exponential Smoothing

◆ Thinking about Trends and

Seasonality

◆ Forecasting for New Products

◆ Fitting distributions

Business Analyics : Session 1

 Week 1: Descriptive
Analytics
◆ An Business al Decision Problem

◆ Forecasting with Past Historical

◆ Data
Moving Averages
Session 2
◆ Exponential
Smoothing

◆ Thinking about Trends and

Seasonality

◆ Forecasting for New Products

◆ Fitting distributions

Business Analyics : Session 1

 Week 1: Descriptive
Analytics
◆ A Business al Decision Problem

◆ Forecasting with Past Historical

Data
◆ Moving Averages
◆ Exponential Smoothing

◆ Thinking about Trends and Seasonality Session 3

◆ Forecasting for New

Products
◆ Fitting distributions

Business Analyics : Session 1

 Week 1: Descriptive
Analytics
◆ A Business Decision Problem

◆ Forecasting with Past Historical

Data
◆ Moving Averages
◆ Exponential Smoothing

◆ Thinking about Trends and

Seasonality

◆ Forecasting for New Products

◆ Fitting distributions
Session 4

Business Analyics : Session 1

 Week 1: Descriptive
Analytics
◆ A Business Decision Problem Session 1

◆ Forecasting with Past Historical

Data
◆ Moving Averages
◆ Exponential Smoothing

◆ Thinking about Trends and

Seasonality

◆ Forecasting for New Products

◆ Fitting distributions

Business Analyics : Session 1

 Descriptive
Analytics
◆ Before we dive into analyzing data, let us a look at a
fundamental problem that firms face

◆ A Business problem:
– How much to produce?

– We need to know or estimate the cost of the product,

price of the product, and some data on the demand of
the product.

◆ Let us explore a problem to get started.

Business Analyics : Session 1

 A Fundamental Business Problem: An
example
◆ Suppose that you are making Business decisions for a retailer
who orders a product from a supplier and sells it to customers.

◆ The ordered product items are received and placed on store

shelf.

◆ There is a large customer population

– Each customer may choose to buy or not buy the product.
– If the customer chooses to buy, he arrives at the store to buy
the product.
– He buys it as long as it is available on the shelf.

◆ However, you have to order the product before you see the
customer demand, since you have to have the items available
on shelf.

◆ You get only one chance to order (i.e., you can cannot change
Business Analyics : Session 1
 A Business Problem: Costs

◆ You order the product from the supplier at cost = 3

talers/item. (Talers are the currency units).

◆ After your order is received and placed on shelves,

demand occurs.

◆ The product on the shelf sells at price = 12

talers/item.

◆ All unsold items are salvaged. Salvage value =0

talers/item.

◆ Let us look at timeline of events.

Business Analyics : Session 1

 Timeline of Events (Operations)

Submit an Uncertain Demand occurs.

order to your Items on shelves sell as long as they are
supplier. available
cost = 3 Selling price = 12
talers/item talers/item.

All left over items that are

Receive all ordered unsold are salvaged.
items and shelve
them. Salvage value = 0 talers/item.

◆ Demand is uncertain. Suppose you bought 10 items

– A High Demand Scenario: Demand is 100. You will sell all 10 items,
and make a profit of 10*(12-3)=90 talers.
– A Low demand Scenario: No demand (i.e., demand = 0). You sell
nothing and lose 10*3=30 talers.

Business Analyics : Session 1

 Problem
Recap

◆ You don’t know what the demand is going to be…

◆ You have to decide on the number of units to order from

supplier before seeing the customer demand.

◆ What could help?

– Past demand data…

– Fortunately, we have the demand data from past 100

periods.

Business Analyics : Session 1

 Past Demand
Data
100
90
80
70
60
50
40
30
20
10
0
0 10 20 30 40 50 60 70 80 90
100

◆ The chart shows the demands (y-axis) observed in

past
Business Analyics 100
: Session 1 periods (x-axis).
 Past Demand
Data
◆ Some more information from past demand data

◆ From the observations over the past 100 such

periods.
– Maximum Demand observed was 81.
– Minimum Demand observed was 15.
– The arithmetic average of those 100 observations is
52.8

◆ Based on the data, I am going to ask you to go

through an exercise
– on deciding how much to order.

Business Analyics : Session 1

 Before you make your
decision
◆ There is no penalty for a wrong answer, or conversely, no
extra course credit for the right answer.

◆ You get one attempt at making your decision.

◆ The objective of the exercise is not to test or grade you, but

to set a baseline “initial thinking” as we start the course.

◆ Write down your answer on a sheet of paper and keep the

sheet through the course(module).

◆ We will see the best answer and you will then get a
chance to compare your answers and calibrate learning
progress.

Business Analyics : Session 1

 Question:How much would you
order…
◆ Suppose you are a manager contemplating the
question of how many items to order from the supplier.
◆ Choose the quantity (Q) that you will order.
◆ Once you select Q, the market will produce 50 random
demand instances from the distribution of demand
similar to the Figure I showed you.
◆ Each random demand instance will correspond to the
demand value you may face in the coming selling season.
◆ Your objective is to select Q to maximize total profit
that you will earn when faced with these 50 random
demand values.

Business Analyics : Session 1

 Newsvendor
Problem
◆ The problem you just saw is called a Newsvendor problem.
– Its characteristics are:
» You have an objective (usually maximize profits, minimize costs,
improve market share, etc.)
» You have to make one decision (usually, how much to buy, or plan
for).
» … before you see the future demand
» Demand occurs, and profits and costs are realized.

◆ This is called the newsvendor problem:

– because it is similar to a vendor who sells newspapers:
» Buy too much and you may be left with unsold newspapers,
» or buy too little, and you will forgo revenue opportunity.

◆ In this course, we will show you how to think about and

analyze this problem.

Business Analyics : Session 1

 A Business Application at Time
Inc.
◆ Time Magazine Supply chain:
– Stores were either selling out inventories (too little inventory)
– or sold only a small fraction of allocation (too much inventory).

◆ Time Magazine evaluated and adjusted for every issue:

– National print order (total number of copies printed and shipped),
– Wholesale allotment structure (How those copies are allotted to
wholesalers).
– Store distribution (Final distribution to stores).

◆ Note: above three decisions are made before the actual demand
is realized
– Need to analyze past data
– Forecast future demand.

◆ Time Magazine reports saving $3.5M annually from

tackling the newsvendor problem.
– Koschat
Business Analyics : Session 1 et al, Interfaces, Volume 33, No 3. May-June 2003,
 Broader applications of the Newsvendor
problem
◆ Governments order flu vaccines before the flu season
begins, and before the extent or the nature of the flu
strain is known
– How many vaccines to order?

◆ Smart phone users buy mobile data plans before they

know their actual future usage
– What is the right plan for you?

◆ Consumers buy health insurance plans, before they

know their actual health expenditures
– How to think about the right plans?

◆ For all the above examples: some forecast of future

demand is essential
Business Analyics : Session 1
 Introduction to
Forecasting
◆ What is forecasting?
– Primary Function is to Predict the Future

◆ Why are we interested?

– Dictates the decisions we make today

◆ Examples: who uses forecasting in their jobs?

– forecast demand for products and services
– forecast inventory and capacity needs daily

◆ What makes a good forecast?

– It should be timely, reliable.
– It should be as accurate as possible, and
– It should be in meaningful units
– The method should be easy to use and be understood in
Business Analyics practice.
: Session 1
 Characteristics of
Forecasts
◆ Point forecasts are usually wrong! Why?
– Examples: In December 2015, there will be 37cms
of snow.
– We will sell 314 umbrellas during the rains next
week.

– Demand could be a random variable.

◆ Therefore, a good forecast should be more than a single

number
– mean and standard deviation
– range (high and low) (e.g. weather forecasts).

Business Analyics : Session 1

 Modeling Uncertain Future: Probability
Distributions
◆ We often do not control purchasing behavior – as a result,
we cannot predict future demand with certainty

◆ How do we describe uncertain future demand?

◆ We can try to decide what future demand scenarios are

possible, for each scenario, estimate the likelihood of its
realization

◆ Where do scenarios come from?

– Past data
– Expert estimates

Business Analyics : Session 1

 An Example of a Model of Future
Demand

◆ Let’s start by looking at a small number of scenarios, say,

three: “high demand”, “ordinary demand” and “low
demand”.

◆ Let’s say that “high demand” scenario corresponds to the

demand value of 80, “ordinary demand” scenario – to the
value of 50, and “low demand” scenario - to a value of 20

◆ For each scenario, a likelihood of its occurring must be

estimated

Business Analyics : Session 1

 Example of a Model of Future Demand: How
Likely is Each Scenario
◆ For each scenario, a likelihood of its coming true must be
estimated

◆ Where do estimates of likelihood come from?

– Statistical analysis of past data

◆ Suppose that after analyzing the past data and using subjective
inputs, we estimate that scenarios have the following likelihoods
of being realized in the next selling season:

– Likelihood of “high” demand is 20%

– Likelihood of “normal” demand is 70%
– Likelihood of “low” demand is 10%

Business Analyics : Session 1

 Three Scenarios and Probability
Distribution
◆ In other words, we project that the demand is not equal to a
certain number with probability 1, but, rather can take one
of three values with those probabilities

◆ We have just created a probability distribution for the future

demand:
– D1 = 80 with probability 𝑝1 = 0.2
– D2 = 50 with probability 𝑝2 = 0.7
– D3 = 20 with probability 𝑝 ) = 0.1

◆ Probability distributions like that one, described by a number

of distinct scenarios with attached probabilities, are called
discrete

◆ Note that the probabilities are

– greater than zero, and
Business Analyics : Session 1
 Three Scenarios Probability Distribution:
Scenarios and Their Probabilities

Probabilit
y 0.8

0.6

0.4

0.2

2 4 6 8 Deman
0 0 0 0 d

Business Analyics : Session 1

 Describing Probability Distribution: Mean and
Standard Deviation

◆ For any probability distribution, including a simple one

reflecting three demand scenarios, two useful descriptive
quantities are often calculated: mean (also called expected
value) and standard deviation

◆ For a discrete probability distribution, the mean is defined as a

sum of the products of scenario values and their probabilities

◆
For our demand distribution, the mean D, = 𝑝1D1 + 𝑝2D2 +
𝑝 ) D ) = 0.2 ∗ 80 + 0.7 ∗ 50 + 0.1 ∗ 20 = 53.

◆ Mean reflects the demand value that we will get, on average,

in a selling season, if we keep observing the demand
realizations over infinite number of selling seasons

Business Analyics : Session 1

 Three Scenarios Probability Distribution:
Mean

Probabilit
Mean =
y
0. 53
8

0.
6

0.
4

0.2 4 6 8
2 Deman
0 0 0 0 d

Business Analyics : Session 1

 Describing Probability Distribution: Mean and
Standard Deviation

◆ Standard deviation describes, roughly speaking, how far away

actual random variable values are from the mean, on average.
In other words, it describes how, in a colloquial sense, “spread
out” the distribution is around its mean

◆ Standard deviation is defined as a square root of the sum of

products of scenario probabilities and the squares of the
difference between scenario value and the mean value

◆ For example, for the three-scenario demand probability

distribution we consider, the standard deviation is calculated
as

SD = 𝑝1 ∗D1 − 𝐷, 2 + 𝑝2 ∗ D2 − 𝐷, 2 + 𝑝 ) ∗ (D ) −

Business Analyics : Session 1 𝐷,)2

 Three Scenarios Probability Distribution: Mean
and Standard Deviation
◆ Knowledge of mean and standard deviation values helps to
support a general intuition about the nature of a random
variableProbabilit
Mean =
y
0. 53
8

0.
6

0.
0.
4 SD =
2
16.16

2 4 6 8 Deman
0 0 0 0 d

Business Analyics : Session 1

 Mean and Standard Deviation: More than three
scenarios
◆ What if we have more than three scenarios?
– D1 with probability 𝑝1
– D2 with probability 𝑝2
– D3 with probability 𝑝 )

– Dn with probability 𝑝𝑛
……

and 𝑝1 + 𝑝2 + 𝑝) + ⋯ + 𝑝𝑛 = 1

◆ What about mean and standard deviation of this demand

distribution for n
scenarios?
Mean = D, = 𝑝1 D1 + 𝑝2 D2 + 𝑝) D) + ⋯ + 𝑝𝑛 D=
stdev( )
Business Analyics : Session 1
 Discrete vs. Continuous Probability
Distributions
◆ So far, we have looked at a discrete probability distributions with
a number of future scenarios with an “attached” probability for
each scenario

◆ But what will happen to a discrete probability picture when

– a) random variable being modeled has a really large
number of scenarios on any small interval of possible
interval of values and
– b) the probability that any one scenario is realized is
really small

◆ Think of examples such as stock prices, or the amount of

rainfall in a region.

◆ In such cases, it makes sense to describe such probability

Businessdistribution
Analyics : Session 1 using groups of scenarios rather than focusing
 Continuous Distribution: Random
Variable X
◆ Distributions like this are called
continuous

Probability Density

Values of
X

Business Analyics : Session 1

 Continuous Distribution: Random
Variable X
◆ Distributions like this are called
continuous

Probability Density

X1 X2

Values of X

◆ The area is equal to probability to that the random variable X

takes values in the interval between X1 and X2
◆ The area under the entire curve is equal to 1
Business Analyics : Session 1
 Normal
Distribution
◆ One of the most popular examples of a continuous probability
distribution is normal distribution
◆ Normal distribution:
– Allows the underlying random variable to take any value from negative
infinity to positive infinity, and
– is completely characterized by two parameters – mean  and standard
deviation .

Probability
Density
Function

←− ∞
∞ →
Values of
X

Business Analyics : Session 1

 Normal
Distribution
◆ There exist statistical formulas (also implemented in Excel) that
calculate a probability that a normal random variable X with
given mean  and standard deviation  produces a value within
a specified interval of values
[Xmin, Xmax]

Probability
Density
Function

←− X 𝑚i𝑛 X 𝑚𝑎 ∞
∞ 𝑥 →
Values of
X

Business Analyics : Session 1

 Other Continuous Probability
Distributions
◆ There exist a large number of other “popular” continuous
probability distribution: exponential, beta, etc. with easily
computable mean and variance/standard deviation

◆ Each of those distributions is often used to describe specific

uncertain setting/quantity

◆ For example, normal distribution is used to describe a

distribution of future relative (percentage) changes in the values
of stocks, FX rates

◆ Another example: exponential distribution can be used in

characterizing time between successive arrivals of customers
in service systems (e.g. call centers).

Business Analyics : Session 1

 Returning back: Characteristics of
Forecasts
◆ Point forecasts are usually wrong! Why?
– Demand could be a random variable

◆ Therefore, a good forecast should be more than a single

number

◆ Forecasts should include some distribution information

– mean and standard deviation
– range (high and low)

◆ Aggregate forecasts are usually more accurate

◆ Accuracy of forecasts erodes as we go further into the

future

Business Analyics : Session 1

◆
 Subjective Forecasting
Methods
◆ Composites
– Sales Force Composites: Aggregation of sales personnel
estimates.
– Election Polling Composites: sites that aggregate polls.

◆ Customer Surveys

◆ Jury of Executive Opinion

◆ The Delphi Method

– Individual opinions are compiled and reconsidered. Repeat
until overall group consensus is (hopefully) reached.

◆ We will return to subjective forecasting methods at the

end of
the : Session
Business Analyics Week 1 1 (Last Session).
 How to forecast with past data,
objectively?
◆ We can leverage past data to come up with forecasts:
– Two primary methods: causal models and time series methods

◆ Causal Models

– Let D be the demand or future outcome to be predicted and assume

that there are n variables (or root causes) that influence the demand.

– A causal model is one in which demand D is formulated as a

theoretical function of all those n causes.

– Causal models are generally intricate and complex, and need

advanced tools in addition to domain expertise.

– In this course, we will focus mainly on time series based models.

Business Analyics : Session 1

 Time Series
Methods
◆ A time series is just collection of past values of the
variable being predicted.

◆ Can be considered as a “naïve” method. Goal is to isolate

patterns in past data.

◆ Past data might have characteristics such as:

– Trend
– Seasonality/Cycles
– Randomness

Business Analyics : Session 1

 Next
…
◆ An Business al Decision
Problem
◆ Forecasting with Past Historical
Data
◆ Moving Averages
Session 2
◆ Exponential Smoothing
◆ Thinking about Trends and
Seasonality

◆ Forecasting for new products

◆ Fitting distributions

Business Analyics : Session 1