Customer Segmentation Using
Hierarchical Agglomerative Clustering
Phan Duy Hung Nguyen Thi Thuy Lien
FPT University FPT University
Hanoi, Vietnam Hanoi, Vietnam
hungpd2@fe.edu.vn liennttmse0096@fpt.edu.vn
ABSTRACT
Customer segmentation plays an important role in customer
relationship management. It allows companies to design and
establish different strategies to maximize the value of customers.
Customer segmentation refers to grouping customers into
different categories based on shared characteristics such as age,
location, spending habit and so on. Similarly, clustering means
putting things together in such a way that similar type of things
remain in the same group. In this study, a machine learning (ML)
hierarchical agglomerative clustering (HAC) algorithm is
implemented in the R programming language to perform customer
segmentation on credit card data sets to determine the appropriate
marketing strategies.
CCS Concepts
• Applied computing → Electronic data interchange
• Information systems → Clustering and classification.
Keywords
Customer segmentation; Clustering; Agglomerative Hierarchical;
Machine learning.
1. INTRODUCTION
1.1 Problem and motivation
Data mining and analysis allows extraction of knowledge from
historical data, and thus formulation of a background for
predicting future outcomes. In Data mining, agglomerative
clustering algorithms are widely used because of their flexibility
and conceptual simplicity [1]. It works by grouping data objects
into a tree of clusters [2].
The purpose of customer segmentation is to divide the user-base
into smaller groups that can be targeted with specialized content
and offers [3]. Customer segmentation enables companies to
address each specific group of customers in the most efficient
way. For decades, investors have relied on customer segmentation
models built around basic demographic data such as age, income,
education, gender and so on. In fact, these are poor predictors of
consumer behavior. Instead, banks and credit unions should
segment consumers by their level of digital sophistication and
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ICISS 2019, March 16-19, 2019, Tokyo, Japan
© 2019 Association for Computing Machinery.
ACM ISBN 978-1-4503-6103-3/19/03…$15.00
https://doi.org/10.1145/3322645.3322677
33
Nguyen Duc Ngoc
FPT University
Hanoi, Vietnam
ngocndmse0093@fpt. edu.vn
financial acumen [4].
Artificial neural networks and k-means clustering are widely used
for market segmentation [5]. K-means algorithm is simple and
efficient. For small k’s, k-mean is considered a linear algorithm
and has good performance. On another hand, hierarchical
algorithm provides better quality clusters as compared to k-mean
algorithm. Especially for small datasets where performance is not
of importance, clustering using hierarchical algorithm is the
superior method [7].
1.2 Related works
There are many researchs about hierarchical agglomerative
clustering. In [8], Li et al. proposes a Q-criterion based
hierarchical clustering algorithm, named HACNJ. HACNJ has the
same complexity with the basic hierarchical clustering, with a
time complexity of O(n3), and a space complexity of O(n2),
which are prohibitive when dealing with large datasets. Through
experiment on the Iris dataset, they verified that HACNJ is
effective.
Yogita Rani and Dr. Harish Rohil in [2] presented a detailed
discussion on some improved hierarchical clustering algorithms.
These algorithms are intended to overcome the limitations of pure
hierarchical clustering algorithms. The mentioned algorithms
include CURE (Clustering Using REpresentatives), BIRCH
(Balanced Iterative Reducing and Clustering using Hierarchies),
ROCK (RObust Clustering using linKs), CHEMELEON
Algorithm, Linkage Algorithms, Leaders – Subleaders Leaders-
Subleaders and Bisecting k-means.
In [5], authors Kamthania D. et al made an attempt to propose a
model for formulating business strategies based on the users'
interest and location. They used Principal Component Analysis
(PCA) technique followed by k-mode clustering algorithm.
Furthermore, the geographical location was fetched from an e-
commerce website for data visualization. The paper proposed a
complete and simplified system from pre-processing data to
visualization, suitable for small businesses. This system identifies
the popularity of each product over a time period, and from there,
targets the potential customers. In the future, the architecture
proposed by the authors can be extended to integrate with real-
time analytical tools. And the proposed system can be scaled up
by adopting HDFS and MapReduce techniques to build a fully-
fledged production system.
These studies have mentioned some aspects of clustering,
machine learning, and market segmentation. But they all have
some limitations when put to practice or when applied to other
defined datasets. Besides, there are other possible approaches that
are worth taking a look at. In this paper, with a small dataset, we
will implement customer segmentation using a hierarchical
clustering algorithm.
1.3 Contribution
The main contribution of this paper is to make an experimental
combination of R language machine learning, especially
hierarchical agglomerative clustering algorithm, with several
ancillary techniques. The cloud environment helps to solve the
problem of large data volumes. The results will show that this
method is suitable for practical implementation.
The remainder of the paper is organized as follows: section 2
describes data collection, environment preparation and data
normalization techniques. Section 3 then covers the
implementation using the hierarchical agglomerative clustering
algorithm. Finally, section 4 concludes the paper and provide
some of the authors’ perspectives.
2. DATA COLLECTION AND
PREPARATION
A Google cloud virtual machine with hardware parameters of
26GB of RAM and 4vCPUs is used as the experiment
environment.
The operating system information and the frameworks are:
Ubuntu 16.04, R language 3.5.2, Python 3.7.1, Java 1.8.
(a) data with outliers
Figure 1. Trimming outliers.
3. IMPLEMENTATION
3.1 Assessing Clustering Tendency
There is a big problem in clustering analysis. That clustering
methods have the ability to return clusters even when the dataset
contains no meaningful clusters. Hence, the assessment of the
clustering tendency or the feasibility of the clustering analysis is
important to evaluate whether the datasets are clusterable.
In [13], Bezdek and Hathaway developed the visual assessment of
cluster tendency (VAT) technique. This technique can be
performed in R quite easily. First, compute the dissimilarity
matrix between observations using the function dist(). Next, use
the function fviz_dist() in the factoextra package to display the
dissimilarity matrix. Results when applied on the selected dataset
as shown in Figure 2.
34
In this paper, a credit cards dataset is used. The dataset [9]
summarizes the usage behavior of about 9000 active credit card
holders for 6 months. This data includes 18 features where
CREDIT_LIMIT, PURCHASES and PAYMENTS will be used to
perform customer segmentation task.
Before performing clustering, some preprocessing steps have to
be performed to clean and rearrange the data. The first idea is
checking the sparsity and the amount of missing data. There are
many packages in the R language that support these tasks. The
aggr() function in the VIM package helps to list missing values
visually [10]. The missing values in the Credit Card dataset (in the
MINIMUM_PAYMENTS and CREDIT_LIMIT columns) are
replaced by the median [11].
The second step is to check for outlier values. Treatment or
change of outlier or extreme values in observations is not a
standard procedure. However, it can strongly bias or change the
estimates and predictions accordingly. Therefore, it is necessary
deal with these exceptions [12]. Using box plots to identify the
outliers, any data lies outside the upper or lower fence lines is
considered outliers (see Figure 1). And then these exotic values
are trimmed out [11].
(b) data after trimming outliers
The red color presents low dissimilarity and the blue color shows
high dissimilarity. This figure confirms that credit cards dataset is
clusterable.
3.2 Determining Optimal Cluster
In [14], Kassambara describes 3 different methods for
determining the optimal number of clusters. These methods
include direct and statistical testing method.
Elbow method: The oldest one called the Elbow method, a visual
method. The idea is starting with k=2 and keep increasing k in
each step by 1. The value of k will be the point at which the total
within-cluster sum of square (WSS) drops dramatically. After that
point the graph reaches a plateau when k increases further [15].
Figure 3 shows the final optimal cluster calculated by the Elbow
method.
 Figure 2. Dissimilarity matrix.
Figure 3. Elbow optimal clustering.
Average silhouette method: This method measures the quality of a
clustering by determining each object that lies within its cluster. A
clustering is good if it has high average silhouette width. Figure 4
shows the visualized result from Average silhouette method. The
optimal number of clusters is 2, at the point has the highest
average silhouette method.
Gap statistic method: The third method is the Gap statistic
method, introduced by Tibshirani et al [17]. This method
compares the total intra-cluster variation for different values of k
with their expected values under null reference distribution of the
data (i.e. a distribution with no obvious clustering). Figure 5
shows the result of the Gap statistic method which is performed
by using R.
35
Figure 4. Optimal number of clusters by Silhouette method.
Figure 5. Optimal number of clusters by the Gap statistic
method.
These methods can be performed in R using the fviz_nbclust()
function. In the case of the Credit Card dataset, the Average
silhouette method suggests 2 clusters while Elbow method and
Gap statistic method suggest 3 clusters. Hence, 3 should be
chosen as the point to cut dendrogram tree.
3.3 Dendrogram
Finally, agglomerative hierarchical clustering analysis is
performed by using the hclust() method from Cluster package in
R. The result dendrogram is shown in Figure 6 below.

Figure 6. Cluster dendrogram.
Figure 7. SPLOM Lattice Scatter Plot Matrices for Flow Data.
4. CONCLUSION AND PERSPECTIVES
The strong rising trend of marketing services these years has
given data analysts new tasks and challenges, requiring more
advanced and complex analytical methods, which also provide
meaningful results in future strategic planning.
This study uses the hierarchical agglomerative clustering
algorithm on a Credit cards dataset to perform customer
segmentation. Based on the obtained results, analysts can promote
appropriate marketing strategies that are more profitable. The
36
The final goal of this study is customer segmentation, taking that
as a background for building marketing strategies. The
distribution of observations in clusters is easily seen in Figure 7
through the following Scatter Plot Matrix (SPLOM).
From the result above, we see that the first cluster is a group of
customers with medium to high credit limits, but they do not make
many purchases. This group accounted for a relatively large
number of customers. Unfortunately, it does not seem to be
suitable for marketing strategies. The second cluster comprises of
the customers with the lowest credit limit and smallest purchases,
and hence they have low payments. Customers in the third cluster
are those with high spending. They have a credit limit that ranges
from low to high. The number of customers in this group is also
quite large. A marketing strategy that targets this group might be
effective.
Depending on the dendrogram, the number of clusters can be
adjusted to the dataset to produce more meaningful groups for
analysts.
proposed system includes a set of methods to solve all stages from
data preprocessing to result visualization. The drawback of this
method is quite slow and hardware dependent. Therefore, it is
advisable to use a cloud environment for large datasets.
This papers also can give a reference to many field in Data
Analytics, for example, Bioinformatics [22,23,24], Pattern
Recognition [25,26], etc.
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