Chapter 1

Introduction to
Business Analytics

Business Analytics
(Business) Analytics is the use of:
data,
information technology,
statistical analysis,
quantitative methods, and
mathematical or computer-based models
to help managers gain improved insight about
their business operations and make better, factbased decisions.

Examples of Applications

Pricing
setting prices for consumer and industrial goods, government
contracts, and maintenance contracts

Customer segmentation
identifying and targeting key customer groups in retail, insurance,
and credit card industries

Merchandising
determining brands to buy, quantities, and allocations

Location
finding the best location for bank branches and ATMs, or where to
service industrial equipment

Social Media
understand trends and customer perceptions; assist marketing
managers and product designers

Evolution of Business Analytics

Business intelligence
Information Systems
Statistics
Operations research/Management science
Decision support systems

A Visual Perspective of Business

Analytics

Impacts and Challenges

Benefits
reduced costs, better risk management, faster
decisions, better productivity and enhanced bottom-line
performance such as profitability and customer
satisfaction.

Challenges
lack of understanding of how to use analytics,
competing business priorities, insufficient analytical skills,
difficulty in getting good data and sharing information,
and not understanding the benefits versus perceived
costs of analytics studies.

Scope of Business Analytics

Descriptive analytics: the use of data to
understand past and current business
performance and make informed decisions
Predictive analytics: predict the future by
examining historical data, detecting patterns or
relationships in these data, and then extrapolating
these relationships forward in time.
Prescriptive analytics: identify the best
alternatives to minimize or maximize some
objective

Tools

Database queries and analysis

Dashboards to report key performance measures
Data visualization
Statistical methods
Spreadsheets and predictive models
Scenario and what-if analyses
Simulation
Forecasting
Data and text mining
Optimization
Social media, web, and text analytics

Example 1.1: Retail Markdown Decisions

Most department stores clear seasonal inventory
by reducing prices.
Key question: When to reduce the price and by
how much to maximize revenue?
Potential applications of analytics:

Descriptive analytics: examine historical data for similar

products (prices, units sold, advertising, )
Predictive analytics: predict sales based on price
Prescriptive analytics: find the best sets of pricing and
advertising to maximize sales revenue

Software Support

IBM Cognos Express

An integrated business intelligence and planning solution
designed to meet the needs of midsize companies,
provides reporting, analysis, dashboard, scorecard,
planning, budgeting and forecasting capabilities.

SAS Analytics
Predictive modeling and data mining, visualization,
forecasting, optimization and model management,
statistical analysis, text analytics, and more.

Tableau Software
Simple drag and drop tools for visualizing data from
spreadsheets and other databases.

Data for Business Analytics

Data: numerical or textual facts and figures that
are collected through some type of measurement
process.
Information: result of analyzing data; that is,
extracting meaning from data to support
evaluation and decision making.

Examples of Data Sources and Uses

Annual reports
Accounting audits
Financial profitability analysis
Economic trends
Marketing research
Operations management performance
Human resource measurements
Web behavior
page views, visitors country, time of view, length of time, origin
and destination paths, products they searched for and viewed,
products purchased, what reviews they read, and many others.

Data Sets and Databases

Data set - a collection of data.

Examples: Marketing survey responses, a table of
historical stock prices, and a collection of measurements
of dimensions of a manufactured item.

Database - a collection of related files containing

records on people, places, or things.
A database file is usually organized in a two-dimensional
table, where the columns correspond to each individual
element of data (called fields, or attributes), and the rows
represent records of related data elements.

Example 1.2: A Sales Transaction

Database File

Records

Entities

Fields or Attributes

Big Data

Big data to refer to massive amounts of business data

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

Metrics and Data Classification

Metric - a unit of measurement that provides a
way to objectively quantify performance.
Measurement - the act of obtaining data
associated with a metric.
Measures - numerical values associated with a
metric.

Types of Metrics

Discrete metric - one that is derived from

counting something.
For example, a delivery is either on time or not; an order
is complete or incomplete; or an invoice can have one,
two, three, or any number of errors. Some discrete
metrics would be the proportion of on-time deliveries; the
number of incomplete orders each day, and the number
of errors per invoice.

Continuous metrics are based on a continuous

scale of measurement.
Any metrics involving dollars, length, time, volume, or
weight, for example, are continuous.

Measurement Scales
Categorical (nominal) data - sorted into
categories according to specified characteristics.
Ordinal data - can be ordered or ranked
according to some relationship to one another.
Interval data - ordinal but have constant
differences between observations and have
arbitrary zero points.
Ratio data - continuous and have a natural zero.

Example 1.3: Classifying Data Elements

al
rv
te
In
al
rv
te
In
io
at
R
io
at
R

al
in
rd

al
ic

io
at
R
io
at
R
al
ic
or
eg
at
C
al
ic
or
eg
at
C
O

or
eg
at
C

Data Reliability and Validity

Reliability - data are accurate and consistent.

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

Models in Business Analytics

Model - an abstraction or representation of a real

system, idea, or object.
Captures the most important features
Can be a written or verbal description, a visual
representation, a mathematical formula, or a
spreadsheet.

Example 1.4: Three Forms of a Model

The sales of a new product, such as a first-generation iPad or
3D television, often follow a common pattern.
1. Verbal description: The rate of sales starts small as
early adopters begin to evaluate a new product and then
begins to grow at an increasing rate over time as positive
customer feedback spreads. Eventually, the market
begins to become saturated and the rate of sales begins
to decrease.

Example 1.4 (continued)

2. Visual model: A sketch of sales as an S-shaped curve
over time

Example 1.4 (continued)

3. Mathematical model: S = aebect
where S is sales, t is time, e is the base of natural
logarithms, and a, b and c are constants.

Influence Diagrams

Influence diagram - a visual representation of a

descriptive model that shows how the elements of
the model influence, or relate to, others.
An influence diagram is a useful approach for
conceptualizing the structure of a model and can assist
in building a mathematical or spreadsheet model.

Example 1.5: An Influence Diagram for Total Cost

Basic

Expanded

Example 1.6: Building a Mathematical

Model

total cost = fixed cost + variable cost

variable cost = unit variable cost quantity produced
total cost = fixed cost + variable cost
= fixed cost + unit variable cost quantity produced

Mathematical model:

TC = Total Cost
F = Fixed cost
V = Variable unit cost
Q = Quantity produced
TC = F +VQ

(1.4)

(1.1)
(1.2)
(1.3)

Decision Models

Decision model - a logical or mathematical

representation of a problem or business situation that
can be used to understand, analyze, or facilitate making
a decision.
Inputs:
Data, which are assumed to be constant for purposes of the
model.
Uncontrollable variables, which are quantities that can change but
cannot be directly controlled by the decision maker.
Decision variables, which are controllable and can be selected at
the discretion of the decision maker.

Nature of Decision Models

Example 1.7 A Break-Even Decision

Model
TC(manufacturing) = $50,000 + $125*Q
TC(outsourcing) = $175*Q
Breakeven Point: TC(manufacturing) = TC(outsourcing)
$50,000 + $125 Q = $175 Q
$50,000 = 50 Q
Q = 1,000
General Formula
F + VQ = CQ
Q = F/(C - V) (1.5)

Example 1.8: A Sales-Promotion Decision

Model
In the grocery industry, managers typically need to know
how best to use pricing, coupons and advertising
strategies to influence sales. Grocers often study the
relationship of sales volume to these strategies by
conducting controlled experiments to identify the
relationship between them and sales volumes. That is,
they implement different combinations of pricing, coupons,
and advertising, observe the sales that result, and use
analytics to develop a predictive model of sales as a
function of these decision strategies.

Example
Model

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

0.25(price)(advertising)
If the price is $6.99, no coupons are offered, and no advertising is done
(the experiment corresponding to week 1), the model estimates sales as
Sales = 500 - 0.05 $6.99 + 30 0 + 0.08 0 + 0.25 $6.99 0 = 500
units

Model Assumptions

Assumptions are made to

simplify a model and make it more tractable; that is, able to be
easily analyzed or solved.
better characterize historical data or past observations.

The task of the modeler is to select or build an

appropriate model that best represents the behavior of
the real situation.
Example: economic theory tells us that demand for a
product is negatively related to its price. Thus, as prices
increase, demand falls, and vice versa (modeled by
price elasticity the ratio of the percentage change in
demand to the percentage change in price).

Example 1.9: A Linear Demand

Prediction Model
As price increases, demand falls.

Example 1.10 A Nonlinear Demand

Prediction Model
Assumes price elasticity is constant (constant ratio of
% change in demand to % change in price)

Uncertainty and Risk

Uncertainty is imperfect knowledge of what will happen

in the future.
Risk is associated with the consequences of what
actually happens.
To try to eliminate risk in business enterprise is futile.
Risk is inherent in the commitment of present resources
to future expectations. Indeed, economic progress can
be defined as the ability to take greater risks. The
attempt to eliminate risks, even the attempt to minimize
them, can only make them irrational and unbearable. It
can only result in the greatest risk of all: rigidity.
Peter Drucker

Prescriptive Decision Models

Prescriptive decision models help decision
makers identify the best solution.
Optimization - finding values of decision
variables that minimize (or maximize) something
such as cost (or profit).

Objective function - the equation that minimizes (or

maximizes) the quantity of interest.
Constraints - limitations or restrictions.
Optimal solution - values of the decision variables at
the minimum (or maximum) point.

Example 1.11: A Prescriptive Pricing

Model
A firm wishes to determine the best pricing for one
of its products in order to maximize revenue.
Analysts determined the following model:
Sales = -2.9485(price) + 3240.9
Total revenue = (price)(sales)
= price (-2.9485 price + 3240.9)
= 22.9485 price2 + 3240.9 price

Identify the price that maximizes total revenue,

subject to any constraints that might exist.

Types of Prescriptive Models

Deterministic model all model input information
is known with certainty.
Stochastic model some model input
information is uncertain.

For instance, suppose that customer demand is an

important element of some model. We can make the
assumption that the demand is known with certainty; say,
5,000 units per month (deterministic). On the other hand,
suppose we have evidence to indicate that demand is
uncertain, with an average value of 5,000 units per
month, but which typically varies between 3,200 and
6,800 units (stochastic).

Problem Solving With Analytics

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

Recognizing a Problem
Problems exist when there is a gap between what is
happening and what we think should be happening.
For example, costs are too high compared with
competitors.

Defining the Problem

Clearly defining the problem is not a trivial task.

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

Structuring the Problem

Stating goals and objectives
Characterizing the possible decisions
Identifying any constraints or restrictions

Analyzing the Problem

Analytics plays a major role.
Analysis involves some sort of experimentation or
solution process, such as evaluating different
scenarios, analyzing risks associated with various
decision alternatives, finding a solution that meets
certain goals, or determining an optimal solution.

Interpreting Results and Making a

Decision
Models cannot capture every detail of the real
problem
Managers must understand the limitations of
models and their underlying assumptions and
often incorporate judgment into making a decision.

Implementing the Solution

Translate the results of the model back to the real
world.
Requires providing adequate resources,
motivating employees, eliminating resistance to
change, modifying organizational policies, and
developing trust.

Fun with Analytics

www.puzzlOR.com
Maintained by an analytics manager at ARAMARK.
Each month a new puzzle is posted.
Many puzzles can be solved using techniques you
will learn in this book.
The puzzles are fun challenges.
A good one to start with is SurvivOR (June 2010).
Have fun!