Behavioral Modeling

What is Behavioral Modeling?

Behavioral modeling is an approach used by companies to better understand and
predict consumer actions. Behavioral modeling uses available consumer and
business spending data to estimate future behavior in specific circumstances.
Behavioral modeling is used by financial institutions to estimate the risk
associated with providing funds to an individual or business and by marketing
firms to target advertising. Behavioral economics also relies on behavioral
modeling to predict behaviors of agents that fall outside of what would be
considered entirely fact-based or rational behavior.

KEY TAKEAWAYS

 Behavioral modeling attempts to explain why an individual makes a

decisions and the model is then used to help predict future behavior.
 Companies use behavioral modeling to target offers and advertising to
customers. Banks also use behavioral modeling to create deeper risk
profiles of customer groups.
 Behavioral modeling mainly uses a company's dataset, but it may also pull
in other relevant, public sources.
Understanding Behavioral Modeling
Behavioral modeling simply tries to capture some of the psychology of decision
making to provide a better simulation of how decisions are made by a consumer
and the probability of a particular consumer making one choice over another.
Behavioral modeling is used by companies to hone their value propositions or
target marketing campaigns based on the outputs of the model. In this sense,
behavioral modeling mainly consists of analyzing data to categorize subsets of
people who share similar habits and purchase triggers.

Financial institutions, such as banks and credit card companies, use behavioral
modeling to segment and profile the users of their services. For example, a credit
card company will examine the types of businesses that a card is normally used
at, the location of stores, the frequency and amount of each purchase to estimate
both future purchase behavior, and whether a cardholder is likely to run into
repayment problems. This data is usually aggregated to clump customers in
groups that have similar needs and usage patterns. The customers in a particular
group may be offered different promotions to either encourage more card usage
or even consolidation of other debts into the existing account.
Real World Examples of Behavioral Modeling
Once you are a customer of a company, they generally want you to be consistent
or increasing your interaction and purchases. This is also true of credit card
providers. A credit card company may notice, for example, that a cardholder has
shifted from making purchases at discount stores to high-end stores over the last
six months. By itself, this may indicate that the cardholder has seen an increase
in income, or it could mean that the cardholder is spending more than they can
afford. To narrow down the options and create a more accurate risk profile, the
card company will also look at other data points, such as whether the cardholder
is only paying the minimum payment or if the cardholder has made late
payments. Late payments may be an indicator that the cardholder is at a greater
risk of insolvency.

Behavioral modeling is also used by retailers to make estimates about consumer

purchases. A retailer could, for example, examine the types of products that a
consumer purchases in-store or online and then estimate the likelihood that the
consumer will purchase a new product based on how similar it is to their previous
purchases. This is especially useful to retailers who provide customer loyalty
programs, which allow them to track individual spending patterns with more
granularity. For example, if a store determines that consumers that purchase
shampoo will also purchase soap if provided a coupon, the store may provide a
coupon for soap at a point-of-sale terminal to a consumer who only purchases
shampoo. This type of behavioral modeling has been refined into a subfield
known as behavioral analytics.