1.

INTRODUCTION
1.1 BUSINESS ANALYTICS DEFINED
1.2 A CATEGORIZATION OF ANALYTICAL METHODS AND MODELS
1.3 BIG DATA
1.4 BUSINESS ANALYTICS IN PRACTICE

1.1 BUSINESS ANALYTICS DEFINED

What makes decision making difficult and challenging? Uncertainty is probably the number one
challenge. If we knew how much the demand will be for our product, we could do a much better job of
planning and scheduling production. If we knew exactly how long each step in a project will take to be
completed, we could better predict the project’s cost and completion date. If we knew how stocks will
perform, investing would be a lot easier.
Another factor that makes decision making difficult is that we often face such an enormous number of
alternatives that we cannot evaluate them all. What is the best combination of stocks to help me meet
my financial objectives? What is the best product line for a company that wants to maximize its market
share? How should an airline price its tickets so as to maximize revenue?
Business analytics is the scientific process of transforming data into insight for making better decisions.
Business analytics is used for data-driven or fact-based decision making, which is often seen as more
objective than other alternatives for decision making. As we shall see, the tools of business analytics can
aid decision making by creating insights from data, by improving our ability to more accurately forecast
for planning, by helping us quantify risk, and by yielding better alternatives through analysis and
optimization. Indeed, a recent study based on a large sample of firms that was conducted by researchers
at MIT’s Sloan School of Management and the University of Pennsylvania, concluded that firms guided
by data-driven decision making have higher productivity and market value and increased output and
profitability.

1.2 A CATEGORIZATION OF ANALYTICAL METHODS AND MODELS

Business analytics can involve anything from simple reports to the most advanced optimization
techniques (methods for finding the best course of action). Analytics is generally thought to comprise
three broad categories of techniques: descriptive analytics, predictive analytics, and prescriptive
analytics.

Descriptive Analytics
Descriptive analytics encompasses the set of techniques that describes what has happened in the past.
Examples are data queries, reports, descriptive statistics, data visualization including data dashboards,
some data-mining techniques, and basic what-if spreadsheet models.
A data query is a request for information with certain characteristics from a database. For example, a
query to a manufacturing plant’s database might be for all records of shipments to a particular
distribution center during the month of March. This query provides descriptive information about these
shipments: the number of shipments, how much was included in each shipment, the date each
shipment was sent, and so on. A report summarizing relevant historical information for management
might be conveyed by the use of descriptive statistics (means, measures of variation, etc.) and data
visualization tools (tables, charts, and maps). Simple descriptive statistics and data visualization
techniques can be used to find patterns or relationships in a large database.
Data dashboards are collections of tables, charts, maps, and summary statistics that are updated as new
data become available. Dashboards are used to help management monitor specific aspects of the
company’s performance related to their decision-making responsibilities. For corporate-level managers,
daily data dashboards might summarize sales by region, current inventory levels, and other company-
wide metrics; front-line managers may view dashboards that contain metrics related to staffing levels,
local inventory levels, and short-term sales forecasts.

Predictive Analytics
Predictive analytics consists of techniques that use models constructed from past data to predict the
future or ascertain the impact of one variable on another. For example, past data on product sales may
be used to construct a mathematical model to predict future sales, which can factor in the product’s
growth trajectory and seasonality based on past patterns. A packaged food manufacturer may use point-
of-sale scanner data from retail outlets to help in estimating the lift in unit sales due to coupons or sales
events. Survey data and past purchase behavior may be used to help predict the market share of a new
product. All of these are applications of predictive analytics.
Linear regression, time series analysis, some data-mining techniques, and simulation, often referred to
as risk analysis, all fall under the banner of predictive analytics. We discuss all of these techniques in
greater detail later in this text.
Data mining, techniques used to find patterns or relationships among elements of the data in a large
database, is often used in predictive analytics. For example, a large grocery store chain might be
interested in developing a new targeted marketing campaign that offers a discount coupon on potato
chips. By studying historical point-of-sale data, the store may be able to use data mining to predict
which customers are the most likely to respond to an offer on discounted chips by purchasing higher-
margin items such as beer or soft drinks in addition to the chips, thus increasing the store’s overall
revenue.
Simulation involves the use of probability and statistics to construct a computer model to study the
impact of uncertainty on a decision. For example, banks often use simulation to model investment and
default risk in order to stress test financial models. Simulation is also often used in the pharmaceutical
industry to assess the risk of introducing a new drug.

Prescriptive Analytics
Prescriptive analytics differ from descriptive or predictive analytics in that prescriptive analytics indicate
a best course of action to take; that is, the output of a prescriptive model is a best decision. The airline
industry’s use of revenue management is an example of a prescriptive analytics. Airlines use past
purchasing data as inputs into a model that recommends the best pricing strategy across all flights for
maximizing revenue. Other examples of prescriptive analytics are portfolio models in finance, supply
network design models in operations, and price markdown models in retailing. Portfolio models use
historical investment return data to determine the mix of investments that yield the highest expected
return while controlling or limiting exposure to risk. Supply network design models provide the cost-
minimizing plant and distribution center locations subject to meeting the customer service
requirements. Given historical data, retail price markdown models yield revenue-maximizing discount
levels and the timing of discount offers when goods have not sold as planned. All of these models are
known as optimization models, that is, models that give the best decision subject to constraints of the
situation.
Another type of modeling in the prescriptive analytics category is simulation optimization, which
combines the use of probability and statistics to model uncertainty with optimization techniques to find
good decisions in highly complex and highly uncertain settings. Finally, the techniques of decision
analysis can be used to develop an optimal strategy when a decision maker is faced with several
decision alternatives and an uncertain set of future events. Decision analysis also employs utility theory,
which assigns values to outcomes based on the decision maker’s attitude toward risk, loss, and other
factors.

ANALYTICS in ACTION: PROCTER & GAMBLE USES BUSINESS ANALYTIS tO REDESIGN ITS SUPPLY CHAIN
J. Camm, T. Chorman, F. Dill, J. Evans, D. Sweeney, and G. Wegryn, “Blending OR/MS, Judgment and GIS: Restructuring P&G’s Supply Chain,”
Interfaces 27, no. 1 (1997): 83–97.
Consumer goods giant Procter & Gamble (P&G), the maker of such well-known brands as Tide, Olay, Crest, Bounty,
and Pampers, sells its products in over 180 countries around the world. Supply chain coordination and efficiency
are critical to the company’s profitability. After many years of acquisitions and growth, P&G embarked on an effort
known as Strengthening Global Effectiveness. A major piece of that effort was the North American Supply Chain
Study, whose purpose was to make the supply chain in North America as efficient as possible, while ensuring that
customer service requirements were met.
A team of P&G analysts and managers partnered with a group of analytics faculty at the University of Cincinnati to
create a system to help managers redesign the supply effort in North America. The fundamental questions to be
answered were: (1) Which plants should make which product families? (2) Where should the distribution centers
be located? (3) Which plants should serve which distribution centers? (4) Which customers should be served by
each distribution center? The team’s approach utilized all three categories of business analytics: descriptive,
predictive, and prescriptive.
At the start of the study, data had to be collected from all aspects of the supply chain. These included demand by
product family, fixed and variable production costs by plant, and freight costs and handling charges at the
distribution centers. Data queries and descriptive statistics were utilized to acquire and better understand the
current supply chain data. Data visualization, in the form of a geographic information system, allowed the
proposed solutions to be displayed on a map for more intuitive interpretation by management. Because the supply
chain had to be redesigned for the future, predictive analytics was used to forecast product family demand by
three-digit zip code for ten years into the future. This future demand was then input, along with projected freight
and other relevant costs, into an interactive optimization model, that minimized cost subject to service constraints.
The suite of analytical models was aggregated into a single system that could be run quickly on a laptop computer.
P&G product category managers made over a thousand runs of the system before reaching consensus on a small
set of alternative designs. Each proposed design in this selected set was then subjected to a risk analysis using
computer simulation, ultimately leading to a single goforward design.
The chosen redesign of the supply chain was implemented over time and led to a documented savings in excess of
$250 million per year in P&G’s North American supply chain. The system of models was later utilized to streamline
the supply chains in Europe and Asia, and P&G has become a world leader in the use of analytics in supply chain
management.
1.3 BIG DATA
Big data is a term that describes the large volume of data – both structured and unstructured – that inundates a
business on a day-to-day basis. But it’s not the amount of data that’s important. It’s what organizations do with the
data that matters. Big data can be analyzed for insights that lead to better decisions and strategic business moves. 1

You may read more about big data and this infographic at https://www.sas.com/en_ph/insights/big-data/what-is-big-
data.html#technical
1.4 BUSINESS ANALYTICS IN PRACTICE
1
https://www.sas.com/en_ph/insights/big-data/what-is-big-data.html#technical
Business analytics involves tools as simple as reports and graphs, as well as some that are as
sophisticated as optimization, data mining, and simulation. In practice, companies that apply analytics
often follow a trajectory similar to that shown in Figure 1.2. Organizations start with basic analytics in
the lower left. As they realize the advantages of these analytic techniques, they often progress to more
sophisticated techniques in an effort to reap the derived competitive advantage. Predictive and
prescriptive analytics are sometimes therefore referred to as advanced analytics. Not all companies
reach that level of usage, but those that embrace analytics as a competitive strategy often do.
Analytics has been applied in virtually all sectors of business and government. Organizations such as
Procter & Gamble, IBM, UPS, Netflix, Amazon.com, Google, the Internal Revenue Service, and General
Electric have embraced analytics to solve important problems or to achieve competitive advantage. In
this section, we briefly discuss some of the types of applications of analytics by application area.

Financial Analytics

Applications of analytics in finance are numerous and pervasive. Predictive models are used to forecast
future financial performance, to assess the risk of investment portfolios and projects, and to construct
financial instruments such as derivatives. Prescriptive models are used to construct optimal portfolios of
investments, to allocate assets, and to create optimal capital budgeting plans. For example, GE Asset
Management uses optimization models to decide how to invest its own cash received from insurance
policies and other financial products, as well as the cash of its clients such as Genworth Financial. The
estimated benefit from the optimization models was $75 million over a five-year period.9 Simulation is
also often used to assess risk in the financial sector; one example is the deployment by Hypo Real Estate
International of simulation models to successfully manage commercial real estate risk.

Human Resource (HR) Analytics

A relatively new area of application for analytics is the management of an organization’s human
resources (HR). The HR function is charged with ensuring that the organization (1) has the mix of skill
sets necessary to meet its needs, (2) is hiring the highest-quality talent and providing an environment
that retains it, and (3) achieves its organizational diversity goals. Sears Holding Corporation (SHC),
owners of retailers Kmart and Sears, Roebuck and Company, has created an HR analytics team inside its
corporate HR function. The team uses descriptive and predictive analytics to support employee hiring
and to track and influence retention.

Marketing Analytics

Marketing is one of the fastest growing areas for the application of analytics. A better understanding of
consumer behavior through the use of scanner data and data generated from social media has led to an
increased interest in marketing analytics. As a result, descriptive, predictive, and prescriptive analytics
are all heavily used in marketing. A better understanding of consumer behavior through analytics leads
to the better use of advertising budgets, more effective pricing strategies, improved forecasting of
demand, improved product line management, and increased customer satisfaction and loyalty. For
example, each year, NBC-Universal uses a predictive model to help support its annual up-front market.
The upfront market is a period in late May when each television network sells the majority of its on-air
advertising for the upcoming television season. Over 200 NBC sales and finance personnel use the
results of the forecasting model to support pricing and sales decisions.

In another example of high-impact marketing analytics, automobile manufacturer Chrysler teamed with
J. D. Power and Associates to develop an innovate set of predictive models to support its pricing
decisions for automobiles. These models help Chrysler to better understand the ramifications of
proposed pricing structures (a combination of manufacturer’s suggested retail price, interest rate offers,
and rebates) and, as a result, to improve its pricing decisions. The models have generated an estimated
annual savings of $500 million.

Health Care Analytics

The use of analytics in health care is on the increase because of pressure to simultaneously control cost
and provide more effective treatment. Descriptive, predictive, and prescriptive analytics are used to
improve patient, staff, and facility scheduling; patient flow; purchasing; and inventory control. A study
by McKinsey Global Institute (MGI) and McKinsey & Company estimates that the health care system in
the United States could save more than $300 billion per year by better utilizing analytics; these savings
are approximately the equivalent of the entire gross domestic product of countries such as Finland,
Singapore, and Ireland.

The use of prescriptive analytics for diagnosis and treatment may prove to be the most important
application of analytics in health care. For example, working with the Georgia Institute of Technology,
Memorial Sloan-Kettering Cancer Center developed a real-time prescriptive model to determine the
optimal placement of radioactive seeds for the treatment of prostate cancer. Using the new model, 20–
30 percent fewer seeds are needed, resulting in a faster and less invasive procedure.

Supply Chain Analytics

One of the earliest applications of analytics was in logistics and supply chain management. The core
service of companies such as UPS and FedEx is the efficient delivery of goods, and analytics has long
been used to achieve efficiency. The optimal sorting of goods, vehicle and staff scheduling, and vehicle
routing are all key to profitability for logistics companies such as UPS, FedEx, and others like them.
Companies can benefit from better inventory and processing control and more efficient supply chains.
Analytic tools used in this area span the entire spectrum of analytics. For example, the women’s apparel
manufacturer Bernard Claus, Inc., has successfully used descriptive analytics to present the status of its
supply chain to managers visually. ConAgra Foods uses predictive and prescriptive analytics to better
plan capacity utilization by incorporating the inherent uncertainty in commodities pricing. ConAgra
realized a 100 percent return on their investment in analytics in under three months—an unheard of
result for a major technology investment.

Analytics for Government and Nonprofits

Government agencies and other nonprofits have used analytics to drive out inefficiencies and increase
the effectiveness and accountability of programs. Indeed, much of advanced analytics has its roots in the
U.S. and English military dating back to World War II. Today, the use of analytics in government is
becoming pervasive in everything from elections to tax collection. For example, the New York State
Department has worked with IBM to use prescriptive analytics in the development of a more effective
approach to tax collection. The result was an increase in collections from delinquent payers of $83
million over two years. The U.S. Internal Revenue Service has used data mining to identify patterns that
distinguish questionable annual personal income tax filings. In one application, the IRS combines its data
on individual taxpayers with data, received from banks, on mortgage payments made by those
taxpayers. When taxpayers report a mortgage payment that is unrealistically high relative to their
reported taxable income, they are flagged as possible underreporters of taxable income. The filing is
then further scrutinized and may trigger an audit.

Likewise, nonprofit agencies have used analytics to ensure their effectiveness and accountability to their
donors and clients. Catholic Relief Services (CRS) is the official international humanitarian agency of the
U.S. Catholic community. The CRS mission is to provide relief for the victims of both natural and human-
made disasters and to help people in need around the world through its health, educational, and
agricultural programs. CRS uses an analytical spreadsheet model to assist in the allocation of its annual
budget based on the impact that its various relief efforts and programs will have in different countries.

Sports Analytics

The use of analytics in sports has gained considerable notoriety since 2003 when renowned author
Michael Lewis published Moneyball, the story of how the Oakland Athletics used an analytical approach
to player evaluation in order to assemble a competitive team with a limited budget. The use of analytics
for player evaluation and on-field strategy is now common, especially in professional sports. Examples
are professional sports teams that use analytics to assess players for the amateur drafts20 and to decide
how much to offer players in contract negotiations; professional motorcycle racing teams that use
sophisticated optimization for gearbox design to gain competitive advantage21; and teams that use
analytics to assist with on-field decisions such as which pitchers to use in various games of a Major
League Baseball playoff series. The use of analytics for off-the-field business decisions is also increasing
rapidly. Ensuring customer satisfaction is important for any company, and fans are the customers of
sports teams. Following the lead of Marriott Hotels, which created the Courtyard by Marriott, “designed
by business travelers for business travelers,” the Cleveland Indians professional baseball team used a
type of predictive modeling known as conjoint analysis to design its premium seating offerings at
Progressive Field based on fan survey data. Using prescriptive analytics, franchises across several major
sports dynamically adjust ticket prices throughout the season to reflect the relative attractiveness and
potential demand for each game.

Web Analytics

Web analytics is the analysis of online activity, which includes, but is not limited to, visits to Web sites
and social media sites such as Facebook and LinkedIn. Web analytics obviously has huge implications for
promoting and selling products and services via the Internet. Leading companies apply descriptive and
advanced analytics to data collected in online experiments to determine the best way to configure Web
sites, position ads, and utilize social networks for the promotion of products and services. Online
experimentation involves exposing various subgroups to different versions of a Web site and tracking
the results. Because of the massive pool of Internet users, experiments can be conducted without
risking the disruption of the overall business of the company. Such experiments are proving to be
invaluable because they enable the company to use trial-and-error in determining statistically what
makes a difference in their Web site traffic and sales.