Final Examination of Multivariate Statistics-03 (2021)

European Bank Credit Card Holders Segmentation for Customer Retention

using Principal Component Analysis and K-Means Clustering
Diva T. Mughni, Fakhira F. Putri, Rifa Salsabila, Victoria E.B. Dianita, Yohanna G. Christie
Department of Industrial Engineering, Faculty of Engineering, Universitas Indonesia, Depok 16424,
Indonesia
Abstrac

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 Final Examination of Multivariate Statistics-03 (2021)

European Bank Credit Card Holders Segmentation for Customer Retention

using Principal Component Analysis and K-Means Clustering
Diva T. Mughni, Fakhira F. Putri, Rifa Salsabila, Victoria E.B. Dianita, Yohanna G. Christie
Department of Industrial Engineering, Faculty of Engineering, Universitas Indonesia, Depok 16424,
Indonesia
Abstract: This paper represents an application of Principal Component Analysis and K-Means Clustering approach of
which is utilized to determine the clusterization of European Bank Credit Card Holders and its characteristics that
obviously create a strategy of appropriate treatment. The secondary data was collected by a recorded system of European
credit card users data which compounds over several banks and utilizes the R software to do the data processing. At the
end of analysis, it is found that there are three clusters, which are Bourjois, Jane and Joes, and The Red Flags. Bourjois
are the cluster with an outstanding transaction history with huge credit limit along with full payment history, Jane and
Joes are the ones with common purchase with full payment and average credit limit with moderate payment period, while
The Red Flags are the cluster with a fairly small credit limit, lower percentage of full payment paid, and shorter payment
period. For customer retention purposes, it is recommended that banks focus on Bourjois who are the most interesting
prospect.
Keywords: Principal Component Analysis, K-Means Clustering, Customer Segmentation

1. Introduction
These days, people tend to be consumptive to
keep up with the trends. So, it is not surprising that
many people are in debt because their expenses are
greater than their income. Many methods are available
for get loan, one of the most popular method is a credit
card. In 2017, Canada is the country with the largest
credit card users in the world and America is in the 6th
rank (Statista, 2017). But the situation is different from
European countries which have a contrasting culture of
choosing a form of credit. Even though Europeans have
nearly the same level of household debt as America, the
use of credit cards is relatively low. This might be
happens because most of Europeans startup provides
point-of-sale financing that allows customers to pay for
their purchases in installments which is Klarna
Payment. So they prefer to take purchase-by-purchase
loans and not maintain a revolving line of credit.
Not only is the number of credit card users
low, the number of credit card transaction values in the
UK has been decreasing every year. The rocketing
popularity of contactless payment methods to replace
their cash payment makes them less interested in using
credit cards as the main means of payment. Especially
with the £45 spending limits in contactless payment as
preventive action to protect customers from fraud,
making European citizens feel more secure in carrying
out their daily transactions.
Owing to those backgrounds, this research is
conducted to find clusters in credit card holders using
data collected by a recorded system of European credit
card users data which compounds over several banks.
which was published on kaggle in 2017. The use of
secondary data is due to time and place constraints to
get the latest data. Hence, the research is conducted in
order to categorize customers of European Bank
Companies into segments that define the basic customer
characteristics where customers are viewed as members
of relatively homogeneous groups portrayed through
common characteristics relevant to marketing.
2. Literature Review
The variables that are chosen for the study,
which include the transaction behaviour of the
customers, are adjusted according to the study
objectives to retain existing bank customers. The
adjustment is aided from the assessment of the variables
in the existing dataset and previous clustering literatures
within the banking industry with different settings,
datasets, and clustering purposes.
Birir et al. (2020) applied principal component
analysis and k-means clustering to cluster bank
customers in Africa for marketing purposes to bank
customers prospects. There are 60 total variables which
contain purchase information of customers alongside
the purchase location and the merchant groups
associated with the purchase.
Rao et al. (2010) used k-means clustering and
Bayesian classification for bank customers retention
initiatives. There are seven variables which include the
inflow and outflow of the transaction as well as the
personal information of the customers.
Farajian et al. (2010) incorporated k-means
clustering and apriori algorithm for grouping bank
customers and creating customer profiling to gain more
competitive advantage in the banking industry. The total
variables for the study are 11 that contain the
transaction information and the customer profile.
Leung (2009) suggested the use of k-means
clustering to group bank customers for credit card
scoring purposes. The variables in the study consist of
the transaction history and the tenure with a total of 10
variables.
Chang et al. (2018) employed clustering with a
bottom-up method for understanding the transaction
patterns and existing demographic information to
support marketing strategies in a Chinese bank. The
variables used include the demographic information and
transaction behaviour that account for 18 variables.

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 Final Examination of Multivariate Statistics-03 (2021)
3. Methods
3.1 Research Design
This research using a dataset from European
banks consisting of the credit card usage of 8950
registered users within six months in 2017. The data
is recorded by their system. The data consists of 17
variables which are balance, balance frequency,
purchases, one-off purchases, installment purchases,
cash advance, cash advance, purchases frequency,
one-off purchases frequency, purchase installment
frequency, cash advance, cash advance frequency,
cash advance transactions, purchases transactions,
credit limit, payments, minimum payments,
percentage of full payment, and tenure.
Before conducting analysis, the missing
values of data have to be checked. In this data, all
missing values have been replaced with mean values
of their respective columns. The next step is to
detect if there are outliers in each variable. All
variables in this data show they have outliers, except
in the TENURE variable. However, outliers have
been replaced with the first and third quartile of
each variable because the residuals are not normally
distributed (Appendix 1). TENURE shows it does
not have outliers because they only have little
distance between data in its histogram (Appendix
2).
Before performing PCA, Standardization is
required to standardize the entire variable's scale,
dispersion of the standard deviation, and the mean
of each variable to avoid it affecting the clustering
results. Therefore the variables need to be
standardized by making sure the scale is already
uniform so that the standard deviation of each
variable is one and the centered mean is zero. After
the variable is standardized, the variable is ready to
be used in the next stage.
Methods that will be used in this research is
K-means clustering because this method focuses
more on examining the clusters rather than
examining a wide array of clustering methods.
Beside that, this research using dataset consisting of
more than 1.000 size. Also, outliers in these data
have already been treated. K-means clustering is
partitioning the data into a pre-set number of
clusters and continued by a series of iterations to
group the objects into clusters.
3.2 Checking Assumption of Cluster Analysis
In order to cluster, the dataset must satisfy its
assumptions. The dataset consists of 8950 samples
of credit card users and no outliers so it satisfies the
first requirement of cluster analysis that the sample
is representative to its population. Then, there must
be no multicollinearity or correlation between
variables. This checking can use the VIF test. If
there is a variable that has 5<VIF<10, it indicates
there is a problematic collinearity between variables.
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After the VIF test is conducted, there are nine
variables that have 5<VIF<10 and the correlation
matrix shows between variables have high
correlation. Then, these data must conduct
component analysis to reduce the impact of
multicollinearity.
3.3 Checking Assumption of Component Analysis
There are assumptions that must be made
adequately before conducting component analysis,
that is the dataset must be sufficient before
component analysis. To determine if the dataset is
sufficient or not, this research conducts Bartlett test
of sphericity and KMO test. Its hypothesis testing is:
H0 : Variables are correlated or same with
identity matrix
H1 : Variables are not correlated or diverse
from identity matrix
Reject H0 if p value < 0,05. Meanwhile, the KMO
test is used for determining the level of correlation
between variables besides determining if the dataset
is sufficient to do component analysis. The
hypothesis is :
H0 : Data is sufficient to do component analysis
H1 : Data is not sufficient to do component
analysis
Reject H0 if overall MSA < 0.50. After all
assumptions have been fulfilled, we can do factor
analysis by using Principal Component Analysis
(PCA).
3.4 Identification of Principal Component Analysis
In order to select the optimal number of
Principal Components (PCs) to retain, we can use
either the percentage of variance or the scree test
criterion. The percentage of variance’s criterion is an
approach based on achieving a specified cumulative
percentage of total variance extracted by successive
factors. The purpose is to ensure practical
significance for the derived factors by ensuring that
they explain at least a specified amount of variance.
No absolute threshold has been adopted for all
applications. To ensure the practical significance for
the derived factors we use at least 95 percent of
variance as satisfactory. We need to compute the
cumulative percentage of the total variance of the
PCs by using RStudio.
3.5 Visualization of Variable’s Loadings using Dot Plots
PCA is a tool for graphical analysis and
visualization of the data. It can show important
insights of the data. To better understand the
customer segmentation, we will use the visualization
of variable’s loadings.
We construct dotplots that display the value
of the principal component loadings. Loading
describes the relationship between the original
variables and the new principal component. The
factor-loading matrix contains the factor loading of
 Final Examination of Multivariate Statistics-03 (2021)
each variable on each factor From the loadings
plots, we identify the components of each of the 10
PCs with factor loadings of ±. 50 to be generally
considered necessary for practical significance.
4. Result and Discussion
4.1 Multicollinearity
These data indicate they have multicollinearity
between variables by using the VIF test. From the result
of the VIF test, there are 9 variables that have
5<VIF<10.
Then, correlation matrix has been used to
show the high correlation between variables.
​ by the PC, the more information that is summarized by
The value of 1 and -1 indicates they have high
correlation (solid blue and red). The value of 0 shows
they have low correlation between variables (white
color)
4.2 Principal Component Analysis Assumptions
Checking
4.1.1 Bartlett Test of Sphericity
The resulting p value is 0. This indicates that
the p value has a very small value; it has proven by
seeing the result of parameters p value that <0.001. So,
reject the null hypothesis that shows variables are
correlated.
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4.1.2 Measure of Sampling Adequacy
Because the overall MSA > 0.5 and all
variables have MSA > 0.5; So, accept H0 that resulting
the amount of data is sufficient for component analysis.
As an addition insight, because the overall MSA is 0.72,
we can interpret the correlation between variable is in
Average level 0.7<KMO<0.8. So , it can be conclude
that the amount of these data is sufficient to do
component analysis
4.3 Principal Components Identification
From the plot of the cumulative percent of
variance, we can see that PC1, PC2, PC3, PC4, PC5,
PC6, PC7, PC8, PC9, and PC10 explain about 95.28%
variance in the data. The greater the variance explained
that PC. The variance explained by each of the five
principal components is shown in table below:
Next, we can use the scree plot to select the
optimal number of PCs, as shown in figure above.
The scree plot above can be used to determine
the optimal number of PCs to represent the data. In the
plot, we look for an elbow. We can see that there is an
elbow in the plot after approximately the tenth principal
component. Thus, 10 PCs seem to be the optimal
number of PCs. Since both the percentage of variance
or the scree test and the scree plot criterion indicate that
there should be ten principal components retained for
further analysis, we use optimal number of PCs = 10.
So, initially we had 17 variables in our dataset,
now it is only 10. Thus, our variables get reduced by
applying the PCA.
We generated the dotplots of PC1, PC2, PC3,
PC4, PC5, PC6, PC7, PC8, PC9, and PC10 as shown in
 Final Examination of Multivariate Statistics-03 (2021)

Figure 2 below. From the dot plots, we can identify the

components of each of the 10 PCs as follows:
Component of PC5:
● Percent of full payment paid by user
Component of PC6:
● Tenure of credit card service for user
Component of PC7:
● Limit of Credit Card for use
Component of PC9:
● Amount of Payment done by user
Component of PC10:
The retained principal components are also
● Minimum amount of payments made
proven to be valid as shown in the sample-split
by user
validation result. The splitted samples yield equivalent
● Percent of full payment paid by user
loadings which signify the stability of the rotation result
regardless of the sample used. Hence, having 5
There is no component that can be identified
principal components that include five variables is
and considered significant from PC1, PC2, PC3, PC4,
appropriate for the study.
and PC8.
4.4 Bank Customer Clusters for Customer Retention
There are three clusters that account for most
variability in the total within sum of squares as shown
in the elbow. The clusters are named as Bourjois, Jane
& Joes, and The Red Flag each with distinct
characteristics based on the mean and mean centroid
result.
Cluster Bourjois has relatively higher means
on all of the variables which are credit limit, payments,
minimum payments, PRC full payment and tenure. This
represents a customer segment with an outstanding
transaction history who have huge credit limits, tend to
purchase with full payment and prefer to purchase in
installment with a fairly long payment period.
Cluster Jane & Joes Interpret the customer
segment as the one with good transaction history which
has potential that can still be maximized. These
customers commonly purchase with full payment and
have average credit limit with moderate payment
period. Meanwhile, cluster The Red Flag is
characterized as one indicates that the customer has an
inadequate transaction history who has a fairly small
credit limit with lower percentage of full payment paid
and prefer shorter payment period.
. The distinct characteristics of the clusters are
also proven by the cluster visualization that shows the
unique centroids of each cluster (Fig.6).

Fig.2 - Factor Loadings of the 10 optimal Principal

Components

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 Final Examination of Multivariate Statistics-03 (2021)
Fig. 4 - The Elbow Method Result
Fig. 5 - Mean and Mean Centroid of The Clusters
Fig. 6 - Clusters Visualization in Two
and Three Dimensions
4.5 Data Validation
The utilization of silhouette method is
proposed for measuring similarity of an object to its
own cluster compared to other clusters. The clusters
prove to be well-clustered according to the validation
assessment which is interpreted by the value of average
silhouette width for every cluster that has value 0<x<1
(Fig. 7 & 8). Furthermore, the silhouette technique
gives a more precise score and number of k for k-means
algorithm rather than elbow’s performance.
Fig. 7 - Cluster Sizing
Fig. 8 - Silhouette Validation
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5. Conclusion
In this paper, we investigated the application of
principal component analysis and K-means clustering in
the segmentation for customer retention of European
bank credit card holders. We identified active customers
in order to apply appropriate marketing strategies
towards each homogeneous group.
As we show that the results of the Principal
Component Analysis (PCA) as an unsupervised
statistical technique, it can be used for dimension
reduction and yield 5 significant variables which
includes PRC_FULL_PAYMENT, TENURE,
MINIMUM_PAYMENT, CREDIT_LIMIT_, and
PAYMENT. The PCA effectively reduces the number of
variables in our dataset from 17 to 5. The PCA is
proven to effectively reduce the multicollinearity
between high correlated variables in the dataset.
Moreover, the K-means clustering is employed
by focusing on the nonhierarchical method and elbow
method. The nonhierarchical method is urged due to the
focus on examining clusters, the existence of large
dataset that consists of more than 1,000 size, and the
outliers that may cause a concern. Thus, the final result
of K-means clustering is yielding 3 homogeneous
clusters that have each unique characteristic which are
Bourjois cluster due to its high credit limit, amount of
payment, % full payment and long tenure, Jane & Joes
cluster with its medium credit limit, amount of
payment, % full payment and moderate tenure, and The
Red Flags with its small credit limit, amount of
payment, % full payment and short tenure.
For future research, the researcher recommends
marketing that focuses on customer group 1 which
prefers to purchase in installment with a fairly long
payment period but less interested in using cash in
advance.
6. Recommendations for Marketing Strategies
Based on the results of our clustering analysis,
we can recommend the following marketing strategies
to the credit card company regarding their customer’s
segmentation:
● Customers in Group 1 - Bourjois
Customers in this group are recognized as the
most potential which is worthy to be offered higher
reward treatments for a long period and needs to be
maintained due to its sizing of total customers is the
largest.
● Customers in Group 2 - Jane & Joes
Customers in this group are counted as the small risky
segmentation which is good to provide less interest rate
on purchase transactions & variation of any special
deals to promote the consumption habits for them.
● Customers in Group 3 - The Red Flags
Customers in this group are counted as the most risky
customers and need to have premium & loyalty cards
would be beneficial for every each potential
transactions and focus on minor section of discounted
stuffs.
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