DSC4213 Analytical Tools for

Consulting

Session 2 Retailer Data Analysis

Prof. WANG Tong

Dept. of Decision Sciences
NUS Business School
 Last time …

• Review of Linear Regression

• Homework
– Do self-study on how to use StatTools to do regression
• http://www.palisade.com/GuidedTour/EN/StatTools/

– Read the retailer case and understand the context of fashion retailing

– Explore the retailer dataset and prepare a one-or-two-page summary on

• What are the major factors affecting sales/revenue of a product?
• How to measure the impact of each factors?
• How about the remaining uncertainty in sales after taking the factors into account?
• How to build a demand model based on your answers to the above?

Aug 2016 DSC4213 Session 2 - Prof. WANG Tong 2

 Understand the Historical Data

• Retailer does not know the demand model beforehand

• Historical sales data on 15 previous fashion items (retailer.xls)
– De-seasonalized: data has been normalized to remove seasonal effects
item 2 item 6 item 12
Week Qty Price Sales Week Qty Price Sales Week Qty Price Sales
1 2000 60 115 1 2000 60 94 1 2000 60 58
2 1885 60 105 2 1906 60 85 2 1942 60 65
3 1780 60 136 3 1821 60 170 3 1877 60 77
4 1644 60 115 4 1651 60 155 4 1800 60 59
5 1529 60 73 5 1496 60 126 5 1741 60 64
6 1456 60 102 6 1370 60 64 6 1677 60 74
7 1354 54 58 7 1306 60 105 7 1603 60 82
8 1296 54 187 8 1201 48 229 8 1521 60 63
9 1109 54 198 9 972 48 253 9 1458 60 35
10 911 54 196 10 719 48 179 10 1423 36 267
11 715 54 132 11 540 48 163 11 1156 36 257
12 583 54 60 12 377 48 223 12 899 36 213
13 523 54 119 13 154 48 154 13 686 36 135
14 404 54 131 14 0 48 0 14 551 36 74
15 273 54 215 15 0 48 0 15 477 36 185
16 58 16 0 16 292

Aug 2016 DSC4213 Session 2 - Prof. WANG Tong 3

 Understand the Historical Data

• Quick observations
– Partially observed demand due to stock-out --- censored data

– Different demand for each item --- uncertainty across items

– For a given item and price, weekly demand is random --- uncertainty over time

– Markdowns stimulate demand --- price response

time

product

price

Aug 2016 DSC4213 Session 2 - Prof. WANG Tong 4

 Data Cleaning & Exploration

• Data cleaning: ignore the weeks with stock-outs (rule out censored data)
• Calculate average weekly sales for each item and price (average out
uncertainty over time)
item 2 Out of Average weekly sales at given price Demand
Week Qty Price Sales stock? (ignores weeks with stockouts) stimulation
1 2000 60 115 Item 60 54 48 36
2 1885 60 105 1 58 76 1.30
3 1780 60 136 2 108 144 1.34
4 1644 60 115 3 59 82 1.39
5 1529 60 73 4 61 78 1.27
5 93 114 1.23
6 1456 60 102
6 out 114 209 1.83
7 1354 54 58
7 67 120 1.77
8 1296 54 187
8 53 97 1.83
9 1109 54 198
9 74 132 1.79
10 911 54 196 10 67 97 1.44
11 715 54 132 11 out 100 264 2.63
12 583 54 60 12 64 189 2.94
13 523 54 119 13 66 197 3.00
14 404 54 131 14 61 164 2.67
15 273 54 215 15 62 175 2.81
16 58

Aug 2016 DSC4213 Session 2 - Prof. WANG Tong 5

 Data Analysis with Linear Regression

• Convert Item, Week, Price into categorical variables

• Model 1: Sales ~ Item + Week + Qty + Price

– Week and Qty are not significant at all

• Model 2: Sales ~ Item + Price

– Residuals do not look very homogeneous

• Model 3: log(Sales) ~ Item + Price

Aug 2016 DSC4213 Session 2 - Prof. WANG Tong 6

 Data Analysis with Linear Regression

• Interpret the coefficients obtained

– Price effect

$60 $54 $48 $36

100% 128% 172% 282%

– Item effect

Aug 2016 DSC4213 Session 2 - Prof. WANG Tong 7

 Build the Demand Model

• Key observations from the analysis:

– Sales for different items are quite variable (under the same price)

– Responsiveness to price cut is quite similar

• Demand model: D(p) = N * R(p)

– N: full price weekly demand. It captures

• Uncertainty across products (dogs or hits)
• Uncertainty over time (different customer arrival patterns)

– R(p): price stimulation function. It can be obtained from historical data!

Aug 2016 DSC4213 Session 2 - Prof. WANG Tong 8

 Analysis on Price Sensitivity
Out of Average weekly sales at given price Demand

stock? (ignores weeks with stockouts) stimulation Average

Item 60 54 48 36
1 58 76 1.30 1.31
2 108 144 1.34
3 59 82 1.39
4 61 78 1.27
5 93 114 1.23
6 out 114 209 1.83 1.73
7 67 120 1.77
8 53 97 1.83
9 74 132 1.79
10 67 97 1.44
11 out 100 264 2.63 2.81
12 64 189 2.94
13 66 197 3.00
14 61 164 2.67
15 62 175 2.81
avg 74 99 131 198
ratio 1.34 1.77 2.68

Unbiased estimate of avg demand stimulation for each price cut

1.00 1.30 1.74 2.79

Aug 2016 DSC4213 Session 2 - Prof. WANG Tong 9

 Estimation of the Price Response Function

• A linear demand model (let R(60) = 1)

4.000
price R(p) Linear Price Response
60 1.000 3.500
54 1.303
48 1.743 3.000
38 2.793 2.793
2.500

2.000
model: R = a + bp 1.743
a 5.837 1.500
b -0.083 1.303
1.000 1.000

0.500

0.000
25 30 35 40 45 50 55 60

Aug 2016 DSC4213 Session 2 - Prof. WANG Tong 10

 Estimation of the Price Response Function

• An exponential demand model

6.000
Exponential Price Response
price R(p)
60 1.000 5.000
54 1.303
48 1.743
38 2.793 4.000

3.000
2.793
model: log(R) = a + bp
or equivalently R = exp(a+bp) 2.000
a 2.806 1.743
b -0.047 1.303
1.000 1.000

0.000
25 30 35 40 45 50 55 60

Aug 2016 DSC4213 Session 2 - Prof. WANG Tong 11

 Estimation of the Price Response Function

• An iso-elastic demand model

8.000
price R(p) Iso-elastic Price Response
60 1.000 7.000
54 1.303
48 1.743 6.000
38 2.793
5.000

4.000
model: log(R) = a + b log(p)
or equivalently R = exp(a)*p^(b) 3.000
2.793
a 9.191
b -2.239 2.000
1.743
1.303
1.000 1.000

0.000
25 30 35 40 45 50 55 60

Aug 2016 DSC4213 Session 2 - Prof. WANG Tong 12

 Estimation of the Market Size N

• Let price response at full price R(60) = 1

• Historical data: At p = 60, the demand averaged across weeks and items =
74

• Average market size E[N] = 74

• Then for any price p, the expected weekly demand

E[D(p)] = 74 * (5.837 - 0.083p)

– But we still have no idea about the actual N for the current item on sale
• Product-related uncertainty
• Time-related uncertainty

Aug 2016 DSC4213 Session 2 - Prof. WANG Tong 13

 Estimation of the Market Size N
Histogram
35 120.00%

30
100.00%

25
80.00%

20
Frequency

60.00% Frequency

15 Cumulative %

40.00%
10

20.00%
5

0 0.00%
0 20 40 60 80 100 120 140 160 180 200 More

Aug 2016 DSC4213 Session 2 - Prof. WANG Tong 14

 Your Turn to Explore, Think, and Innovate

• Hints:
– Think about how to better estimate the real N (how to predict whether it is a dog
or a hit) from the real-time sales you observe
– Once you know N pretty well, how do you price and mark down? Maybe it is
easier to start from the extreme cases
• What if N is extremely high?
• What if N is extremely low?
• Then what if you have a moderate N? (often the solution is sort of combination of the
solutions for two extreme cases)
– Do not forget the salvage value $25, how does it change your trade-off?

– Learning by doing: develop a strategy, do several test runs in the Retailer game,
summarize the result and think how to improve, and re-start the whole process
– Do not be too superficial or too technical! A good solution is often simple,
intuitive, and easy to implement.

Aug 2016 DSC4213 Session 2 - Prof. WANG Tong 15

 Further Analysis

• Estimate N by observing real-time sales in the early weeks

– Better than other ways of forecasting
– Reduce uncertainty across items
– Disregard uncertainty across weeks

• For a given N:
– If N is very high, the optimal pricing strategy?

– What if N is very low, the optimal pricing strategy?

Aug 2016 DSC4213 Session 2 - Prof. WANG Tong 16

 Breakeven Analysis (for small N)

• If N is very low,
– Capacity constraint (2000 units inventory) no longer matters
– The optimal price maximizes revenue

p * D(p) * 15 + 25 * (2000 - D(p) * 15)

Price Weekly Demand Sales in 15 weeks Total Revenue

p N*R(p) 15*N*R(p)
$60 N 15N 525N + 50,000

$54 1.3N 19.55N 567N + 50,000

$48 1.74N 26.15N 601N + 50,000

$36 2.79N 41.90N 461N + 50,000

Aug 2016 DSC4213 Session 2 - Prof. WANG Tong 17

 Breakeven Analysis (for small N)

• E.g. N = 50
$3,000.00

$2,500.00

$2,000.00

$1,500.00

$1,000.00

$500.00

$0.00
25 30 35 40 45 50 55 60

Weekly Revenue Total Sales in 15 wks

Aug 2016 DSC4213 Session 2 - Prof. WANG Tong 18

 Breakeven Analysis (for small N)

• Max p * D(p) * 15 + 25 * (2000 - D(p) * 15) is equivalent to max (p - 25) * R(p)

• If markdown by 10%
– Loss of incremental revenue: from $60-$25 to $54-$25 => 17% loss
– Gain of demand: from N to 1.3N => 30% increase
– Overall: 0.83 * 1.3 = 1.08 => 8% increase in revenue

Price Revenue Demand Revenue

Change Loss Stimulation Change
-10% (54-25)/(60-25) = 83% 130% +8%
-20% (48-25)/(60-25) = 66% 174% +15%
-40% (36-25)/(60-25) = 31% 279% -14%
• Summary
– A price cut to $36 is never optimal!
– $48 is the optimal price when there is no capacity constraint!
– Role of the salvage value

Aug 2016 DSC4213 Session 2 - Prof. WANG Tong 19

 Summary of the Analysis

• Estimate N by observing real-time sales

• If N is large (N>133), set p = $60 all the time (total sales = 15*N > 2000)

• If N is small (N<76), set p = $48 all the time (total sales = 26.15N < 2000)

• More complicated markdown strategies are needed for a moderate N

(76 < N < 133)
– Never reduce the price to $36!

Aug 2016 DSC4213 Session 2 - Prof. WANG Tong 20

 Next time …

• In-class competition (5 rounds)

• Markdown strategies for nontrivial cases (moderate N)

– Inventory-clearance strategy (T* strategy)

– Linear Programming formulation and solution

– A stochastic perspective

Aug 2016 DSC4213 Session 2 - Prof. WANG Tong 21