FUNDAMENTALS OF DESCRIPTIVE ANALYTICS (BUMA 30063)

11/27/2023
behaviors,
Cluster Analysis purchase
distance
metrics to
history,
Cluster Analysis identify
psychographics,
 also known as clustering, is a technique clusters of
etc., to identify
used in data analysis and machine learning data points
market
to group similar data points or objects that are closer
segments that
based on certain characteristics or to each other
have similar
features they possess. in feature
needs
 Segmentation space.
or behaviors.
- A way of organizing customers
into groups with similar traits,
product preferences, or
The auto insurance company, Geico, intends
expectations.
to tailor its insurance options. Your objective
 Clustering
is to understand the key factors customers
- A broader analytical technique
prioritize in their insurance provider. You've
used in various domains to
created a survey for current Geico customers,
identify patterns and groupings in
aiming to gauge their perception of the
data, without a specific marketing
importance of two aspects when selecting
or business context.
auto insurance: cost savings on premiums and
the availability of a local agent.
Segmentation vs. Clustering
Usage Used in a
broader range
of fields
Primarily used including data
in marketing analysis,
and business machine
strategy. learning,
image
processing,
etc.
Purpose Divides a
market or
customer base
into Groups data
distinct and points into
relatively clusters based
homogeneous on
segments similarities in
based on their features
Likert-Scale
various or attributes.
characteristics,
A Likert-type scale, which takes its name from
behaviors, or
psychologist Rensis Likert, is a frequently
preferences.
employed psychometric measurement tool for
Method Involves Utilizes
evaluating individuals attitudes, opinions,
analyzing mathematical
perceptions, or behaviors. The approach
customer algorithms
entails providing respondents with a
demographics, and
statement or multiple statements and
 FUNDAMENTALS OF DESCRIPTIVE ANALYTICS (BUMA 30063)
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prompting them to express their degree of
agreement or disagreement using a
predetermined range of response choices.
Cluster Analysis Goal
The primary inputs for cluster analysis are
measures of similarity between customers,
such as (a) correlation coefficients and (b)
distance measures.
 Correlation coefficients
- Measure the association between
two variables. They range from
−1, which indicates a negative
association like that between
sales and price (when prices go
up, sales go down, and vice versa),
to 1, which indicates a positive
association like that between
sales and advertising (when
advertising goes up, so do sales—
at least, that’s the intention). Zero
implies no linear association
between the variables.
 Distance measures
- are measures of the difference
between two customers on the
variables used for segmentation.
Steps in Cluster Analysis
1. Formulate the problem.
2. Compute distance between customers
along the selected variables.
3. Apply the clustering procedure to the
distance measures.
4. Decide on the number of clusters.
5. Profile clusters.
1.) Step 1: Formulate the problem.
 The first step is to select the variables that
you wish to use as the basis for clustering.
Those variables determine how well your
segmentation works in terms of
marketing.
 Identifiability
- Refers to the extent to which
- managers can recognize segments
in the marketplace. Ex:
Demographics
 Sustainability
- Criterion that is satisfied if the
segments represent a large
enough portion of the market to
ensure that marketing programs
can be customized profitably.
 Accessibility
- The extent to which managers can
reach the identified segments
through marketing campaigns is
captured by the accessibility
criterion.
 Actionability
- Refers to whether customers in a
certain segment and the
marketing mix necessary to satisfy
their needs are consistent with
the goals and core competencies
of the firm. Ex: Channel of comm
like FB Chatbot, Emails, Physical
Meetings
2.) Step 2: Compute Distance
 The main input into any cluster-analysis
procedure is a measure of distance
between individuals who are being
clustered. The objective of a distance
measure is to quantify the difference
between two individuals on the variables
you are using for the segmentation.
 A shorter distance between two
individuals implies that they have similar
preferences on the segmentation
variables, and may be in the same cluster.
 A longer distance implies that they have
dissimilar preferences and may be in
different clusters.
What is the Euclidean distance between Joe
and Sam?
 FUNDAMENTALS OF DESCRIPTIVE ANALYTICS (BUMA 30063)
11/27/2023
customers to clusters has not
changed over multiple iterations.

3.) Step 3: Apply the Clustering Procedure

 K-means clustering is one of the more
popular algorithms used for clustering,
and it is gaining even more popularity
with the growth of machine learning. It
belongs to the nonhierarchical class of
clustering algorithms, meaning the
clustering algorithm does not impose a
hierarchical structure on the variables
used for the segmentation.
 For K-means clustering, the manager has
to specify the number of clusters, k,
required before starting the clustering
algorithm. The basic algorithm for K-
means clustering is as follows:
1. Choose the number of clusters, k.
2. Generate k random points as
cluster centroids.
3. Assign each point to the nearest
cluster centroid.
4. Recompute the new cluster
centroid.
5. Repeat the two previous steps until
some convergence criterion is met.
Usually the convergence criterion is
met when the assignment of
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REPEAT UNTIL TALLY!!!

4.) Step 4: Decide on Number of Clusters

 A commonly used method to
determine the optimal k is the “elbow
criterion.” The elbow criterion means
finding a number of clusters such that
adding another cluster does not add
sufficient information. In other words,
this is the point at which another
cluster would add complexity to the
marketing process that is not justified
by the returns from customizing
marketing to the additional segment.
 In simpler terms, the "elbow " is
where the plot starts to bend,
indicating the point where increasing
the number of clusters does not
significantly improve the model's
performance or fit to the data.
5.) STEP 5: Profile Clusters
 Profiling clusters means describing
them in terms of the variables used for
clustering—or in terms of additional
data, such as demographics. This way,
a company can extrapolate from data
on its own customers to find the most
likely potential customers.