Data-Driven Decision Making

Data-Driven Decision Making

Data science involves principles, processes, and techniques for understanding phenomena the analysis of data. Data science is helping to improve the decision making, as this generally is of direct interest to business.

Figure  Data science in the context of various data-related processes in the organization

Let’s start at the top. Data-driven decision-making (DDD) refers to the practice of basing decisions on the analysis of data, rather than purely on intuition. For example, a marketer could select advertisements based purely on her long experience in the field and her eye for what will work. Or, she could base her selection on the analysis of data regarding how con‐ sumers react to different ads. She could also use a combination of these approaches. DDD is not an all-or-nothing practice, and different firms engage in DDD to greater or lesser degrees.

The benefits of data-driven decision-making have been demonstrated conclusively. Economist Erik Brynjolfsson and his colleagues from MIT and Penn’s Wharton School conducted a study of how DDD affects firm performance (Brynjolfsson, Hitt, & Kim, 2011). They developed a measure of DDD that rates firms as to how strongly they use data to make decisions across the company. They show that statistically, the more data-driven a firm is, the more productive it is—even controlling for a wide range of possible confounding factors. And the differences are not small. One standard deviation higher on the DDD scale is associated with a 4%–6% increase in productivity. DDD also is correlated with higher return on assets, return on equity, asset utilization, and market value, and the relationship seems to be causal.

The sort of decisions mainly fall into two types: (1) decisions for which “discoveries” need to be made within data, and (2) decisions that repeat, especially at massive scale, and so decision-making can benefit from even small increases in decision-making accuracy based on data analysis.

In 2012, Walmart’s competitor Target was in the news for a data-driven decision-making case of its own, also a type 1 problem (Duhigg, 2012). Like most retailers, Target cares about consumers’ shopping habits, what drives them, and what can influence them. Consumers tend to have inertia in their habits and getting them to change is very difficult. Decision makers at Target knew, however, that the arrival of a new baby in a family is one point where people do change their shopping habits significantly. In the Target analyst’s words, “As soon as we get them buying diapers from us, they’re going to start buying everything else too.” Most retailers know this and so they compete with each other trying to sell baby-related products to new parents. Since most birth records are public, retailers obtain information on births and send out special offers to the new parents.

However, Target wanted to get a jump on their competition. They were interested in whether they could predict that people are expecting a baby. If they could, they would gain an advantage by making offers before their competitors. Using techniques of data science, Target analyzed historical data on customers who later were revealed to have been pregnant, and were able to extract information that could predict which consumers were pregnant. For example, pregnant mothers often change their diets, their ward‐ robes, their vitamin regimens, and so on. These indicators could be extracted from historical data, assembled into predictive models, and then deployed in marketing campaigns. We will discuss predictive models in much detail as we go through the book. For the time being, it is sufficient to understand that a predictive model abstracts away most of the complexity of the world, focusing in on a particular set of indicators that correlate in some way with a quantity of interest (who will churn, or who will purchase, who is pregnant, etc.). Importantly, in both the Walmart and the Target examples, the data analysis was not testing a simple hypothesis. Instead, the data were explored with the hope that something useful would be discovered.

Our churn example illustrates a type 2 DDD problem. MegaTelCo has hundreds of millions of customers, each a candidate for defection. Tens of millions of customers have contracts expiring each month, so each one of them has an increased likelihood of defection in the near future. If we can improve our ability to estimate, for a given customer, how profitable it would be for us to focus on her, we can potentially reap large benefits by applying this ability to the millions of customers in the population. This same logic applies to many of the areas where we have seen the most intense application of data science and data mining: direct marketing, online advertising, credit scoring, financial trading, help-desk management, fraud detection, search ranking, product recommendation, and so on.

The diagram in Figure 1 shows data science supporting data-driven decision-making, but also overlapping with data-driven decision-making. This highlights the often over‐ looked fact that, increasingly, business decisions are being made automatically by computer systems. Different industries have adopted automatic decision-making at different rates. The finance and telecommunications industries were early adopters, largely be‐ cause of their precocious development of data networks and implementation of massive-scale computing, which allowed the aggregation and modeling of data at a large scale, as well as the application of the resultant models to decision-making.

In the 1990s, automated decision-making changed the banking and consumer credit industries dramatically. In the 1990s, banks and telecommunications companies also implemented massive-scale systems for managing data-driven fraud control decisions. As retail systems were increasingly computerized, merchandising decisions were auto‐ mated. Famous examples include Harrah’s casinos’ reward programs and the automated recommendations of Amazon and Netflix. Currently we are seeing a revolution in ad‐ vertising, due in large part to a huge increase in the amount of time consumers are spending online, and the ability online to make (literally) split-second advertising decisions.

Courtesy: LANE & Viktor Mayer