Factor Analysis

What is Factor Analysis?

Factor analysis is a statistical technique that reduces a set of variables by extracting all their
commonalities into a smaller number of factors. It can also be called data reduction.
When observing vast numbers of variables, some common patterns emerge, which are known
as factors. These serve as an index of all the variables involved and can be utilized for later
analysis.

Factor analysis uses several assumptions:

The variables’ linear relationships
Absence of multicollinearity
Relevance of the variables
The existence of a true correlation between factors and variables

Types of factor analysis

There are essentially two types of factor analysis:
Exploratory Factor Analysis: In exploratory factor analysis, the researcher does not make any
assumptions about prior relationships between factors. In this method, any variable can be
related to any factor. This helps identify complex relationships among variables and group them
based on common factors.

Confirmatory Factor Analysis: The confirmatory factor analysis, on the other hand, assumes
that variables are related to specific factors and uses pre-established theory to confirm its
expectations of the model..

Therefore, it becomes a statistical technique used to see how a group shares a common
variance. While it is mostly used in psychological research, it can also be applied in areas like
business and market study to understand customer satisfaction or employee job satisfaction
and in finance, to study the fluctuation of stock prices.

Features of factor analysis

While studying customer satisfaction related to a product, a researcher will usually pose several
questions about the product through a survey. These questions will consist of variables
regarding the product’s features, ease of purchase, usability, pricing, visual appeal, and so
forth. These are typically quantified on a numeric scale. But, what a researcher looks for is the
underlying dimensions or “factors” regarding customer satisfaction. These are mostly
psychological or emotional factors toward the product that cannot be directly measured. Factor
analysis uses the variables from the survey to determine them indirectly.

Principal component analysis

This is the most commonly used method. The first factor is extracted by determining the
maximum variance. This variance is then removed and is replaced by the factor. The second
factor is then determined by the next highest variance, and the process continues until there
are no more variances.

Common factor analysis

In this method, the factors are extracted from commonly-occurring variances and do not
include the unique variances of all the variables.