Predictive modeling

Predictive modeling is the process by which a model is created or chosen to try to best predict the probability of an
outcome (Geisser, 1993).
In many cases the model is chosen on the basis of detection theory to try to guess the probability of an outcome given
a set amount of input data.
For example, given an email determining how likely that it is spam.
Models can use one or more classifiers in trying to determine the probability of a set of data belonging to another set,
say spam or not.
There are three types of predictive models:

 Propensity models (predictions)

 Clustering models (segments)
 Collaborative filtering (recommendations)
Propensity models are what most people think of when they hear “predictive analytics”. Propensity models make
predictions about a customer’s future behavior. With propensity models you can anticipate a customers’ future
behavior.
Model 1: Propensity to engage
A propensity to engage model predicts the likelihood that a person will engage in some activity, like unethical
behavior or post purchases. For example, a propensity to engage model can predict how likely it is that a customer will
click on your email links. Armed with this information you can decide not to send an email to a certain “low
likelihood to click” segment.
Model 2: Propensity to buy
The propensity to buy model tells you which customers are ready to make their purchase, so you can find who to
target. Moreover, once you know who is ready and who is not helps you provide the right aggression in your offer.
Those that are likely to buy won’t need high discounts (You can stop cannibalizing your margin) while customers who
are not likely to buy may need a more aggressive offer, thereby bringing you incremental revenue.
For example, a “propensity to buy a new vehicle” model built with only data the automotive manufacturer has in their
database can be used to predict percent of sales. By incorporating demographic and lifestyle data from third parties,
the accuracy of that model can be improved. That is, if the first model predicts 50% sales in the top five deciles (there
are ten
deciles), then the latter could improve the result to 70% in the top five deciles.

Cluster Models

Clustering is the predictive analytics term for customer segmentation. Clustering, like classification, is used to
segment the data. Unlike classification, clustering models segment data into groups that were not previously defined.
Cluster analysis itself is not one specific algorithm, but the general task to be solved. It can be achieved by various
algorithms that differ significantly in their notion of what constitutes a cluster and how to efficiently find them.

With clustering you let the algorithms, rather than the marketers, create customer segments. Think of clustering as
auto-segmentation. Algorithms are able to segment customers based on many more variables than a human being ever
could. It’s not unusual for two clusters to be different on 30 customer dimensions or more.
Model 1: Behavioral clustering
Behavioral clustering informs you how people behave while purchasing. Do they use the web site or the call center?
Are they discount addicts? How frequently do they buy? How much do they spend? How much time will go buy
before they purchase again? This algorithm helps set the right tone while contacting the customer. For instance,
customers that buy frequently but with low sized orders might react well to offers like ‘Earn double rewards points
when you spend $100 or more.
Behavioral clustering can also informs us on other behaviors, such as crime and is used in performing crime analysis.
In the example below there are three crime clusters.

Model 2: Product based clustering (also called category based clustering)

Product based clustering algorithms discover what different groupings of products people buy from. This is useful
information when deciding which product offers or email content to send to each of these customer segments.
Model 3: Brand based clustering
Brand-based clustering, on the other hand, focuses on the brand of items customers purchase. Marketers can use this
information to project what other brands those customers are likely to buy. Customers are then ordered according to
Nike, Adidas, Under Armour, etc. Now you know what specific brands to pitch to certain customers. When a brand
releases new products – you know who is likely to be interested.

Collaborative Filtering: In Collaborative Filtering, we tend to find similar users and recommend what similar users
like. In this type of recommendation system, we don’t use the features of the item to recommend it, rather we classify
the users into the clusters of similar types, and recommend each user according to the preference of its cluster.
Most collaborative filtering systems apply the so-called similarity index-based technique. In the neighborhood-based
approach, a number of users are selected based on their similarity to the active user. Inference for the active user is
made by calculating a weighted average of the ratings of the selected users.
Collaborative-filtering systems focus on the relationship between users and items. The similarity of items is
determined by the similarity of the ratings of those items by the users who have rated both items.
There are two classes of Collaborative Filtering:
1. User-based, which measures the similarity between target users and other users.
2. Item-based, which measures the similarity between the items that target users rate or interact with and other
items.
Some key examples of recommender systems at work include:

 Product recommendations on Amazon and other shopping sites

 Movie and TV show recommendations on Netflix
 Article recommendations on news site