Probability Models in Marketing

Marketing models attempt to describe or predict

behaviour
Usually include a random element to allow for
imperfect knowledge
We will develop probability models that specify a
random model for individual behaviour
Sum this across individuals to get a model of
aggregate measures
May need to incorporate differences between
individuals into the model
Uses of Probability Models
Understand and profile individual behaviour
Understand market-level patterns, and their
origin in individual behaviours
Provide norms or benchmarks for comparison
Ehrenburg: Understanding Buyer Behaviour; and
Repeat-Buying (1988)
Latter book available free online at
http://www.empgens.com/ehrenberg.html#repeat
Prediction or forecasting of:
Aggregate results beyond current observation period
Individual behaviour, given knowledge of past actions

Product Trial Example
Have a newly launched product
Multi-pack juice drink, aimed at children
Launched in test market
May be rolled out nationally if successful
Measure trial over time
Based on household scanner panel data, e.g.
ACNielsens HomeScan
Have data from first 13 weeks
Want to predict trial 13 weeks later

Cumulative Trial Penetration
Week
Cum. % Hhlds
Tried Product
(n=1499)
1 0.6%
2 1.1%
3 1.2%
4 2.5%
5 3.1%
6 3.6%
7 3.8%
8 4.0%
9 4.4%
10 4.6%
11 5.0%
12 5.1%
13 5.2%
Cumulative Trial
Cumulative % of Households Who Have Tried Product
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
7.0%
8.0%
9.0%
10.0%
1 2 3 4 5 6 7 8 9 10 11 12 13
Week
Develop Probability Model
Variable of interest (for individual households)
When did they first try the product?
Treat time of first purchase T as a random
variable
Assume this has an exponential distribution, with trial
rate
Probability of trial by time t for each household is


Averaging this across all households would give the
same result, but this would not be realistic why?
( ) ( )
t
e t T P t F

= s = 1
Market Level Model
Assume there are two groups of consumers
One group may try product (>0)
Other group will never try product (~0)
In proportions p and 1-p respectively
Exponential with never-triers model:





Note: technically this is not a cdf as it does not =1 as t
approaches infinity, but as we are only dealing in relatively
small values of t this approximation is valid.

( ) ( ) ( ) ( )
|
.
|

\
|

~
= + = = s
t
e 1 p
0 | t F p 1 | t pF t T P

u
Estimate Parameters
Model has parameters p and
Estimate these parameters using maximum
likelihood
The likelihood function is the probability that this
dataset would be observed
Viewed as a function of the parameters
Assumes the model holds
L(parameters) = P(this data observed|parameters)
The maximum likelihood estimates (MLEs) of the
parameters are the values that maximise L(.), for the
given dataset
Can equivalently maximise l(.), the log-likelihood
Implementing MLE
The maximum likelihood method can be
implemented relatively easily in many software
environments
E.g. R, SAS, Excel
It may already be implemented if the model is
commonly used
R code for exponential w. never-triers model:
trial<-c(8,14,16,32,40,47,50,52,57,60,65,67,68)
Trial1 <- trial c(0,trial[1:12])
F <- function(t,p,lambda) {
p*(1-exp(-lambda*t))
}



R Code (continued)
l <- function(p,lambda,data) {
week <- 1:13
if ((p>=0) && (p<=1)) {
sum(data*log(F(week,p,lambda) - F(week-1,p,lambda))) +
(1499-sum(data))*log(1-F(13,p,lambda))
} else {NaN}
}
optim(c(.2,.2),function(param) {-l(param[1],param[2],Trial1)})

Result: maximum value of log-likelihood is -445.84,
which is achieved at p=0.060 and =0.109
Complications due to sample design and weighting have
been ignored
Forecasting
Can use fitted model to forecast trial
Let N(t) be a random variable, being the
number of households in the panel
purchasing the product by time t
Forecast trial as:
( ) | | ( )
( )
t
e p n
t F n t N E

=
=
0 5 10 15 20 25
2
0
4
0
6
0
8
0
1
0
0
Cumulative Trial Forecast
Week
C
u
m
.

N
o
.

o
f

H
o
u
s
e
h
o
l
d
s

T
r
y
i
n
g

P
r
o
d
u
c
t
Model Extensions
Current model assumes same trial rate for
all households, except never triers
May be overly simplistic
Can allow for multiple segments of
households, each with different underlying
trial rate

( ) ( ) 1 , 0 ,
1
1
1
= = =

= =
K
k
k
K
k
k k
p t F p t F
Model Extensions
Finite mixture models can
be hard to fit
Local minima are common
Another alternative that
allows for consumer
heterogeneity is a
continuous mixture model
Assume trial rates are
distributed with pdf g()
The discrete mixture model
can be thought of as an
approximation to the
underlying continuous
distribution of trial rates
Gamma Trial Rate Distribution
Assume trial rates are distributed
according to a gamma distribution


where is a shape parameter and is an
inverse scale parameter
The gamma distribution is a flexible,
unimodal, mathematically tractable
distribution
( )
( )
0 ,
1
>
I
=


o
|

| o
o
e g
Market-Level Model
The resulting cumulative distribution of first
trial times, at an overall market level, is





This is called an exponential-gamma model
( ) ( )
( ) ( )
o
|
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|

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|
+
=
s =
s =
}

t
d g t T P
t T P t F
1
0
Estimating Parameters
R Code for finding MLEs:
Fg <- function(t,alpha,beta) {
1 - (beta/(beta+t))^alpha
}
lg <- function(alpha,beta,data) {
week <- 1:13
sum(data*log(Fg(week,alpha,beta) - Fg(week-1,alpha,beta))) +
(1499-sum(data))*log(1-Fg(13,alpha,beta))
}
optim(c(1,1),function(param) {-lg(param[1],param[2],trial1)})
Result: maximum value of log-likelihood is -446.64,
which is achieved at =0.0416 and =6.32
Further Extensions
Could add a never try component into
the exponential-gamma model
Could incorporate the effects of marketing
covariates
E.g. advertising weight over time
Could incorporate the effects of household
covariates
E.g. presence of children
Building a Probability Model:
General Approach
1. Determine the marketing problem or
information needed
2. Identify the behaviour of interest at the
individual level
Make sure this is observable; denote by x
3. Choose an appropriate probability distribution
f(x|)
The parameters of this distribution can be thought
of as latent traits of each individual
Latent or underlying traits; not observed directly but affect x
General Approach (continued)
4. Specify a distribution for the latent traits
across the population
Denote this by g()
Called the mixing distribution
Can be discrete, continuous or a combination
5. Obtain the resulting aggregate market-
level distribution (if this is observed or of
interest) by integrating with respect to

General Approach (continued)
6. Estimate the parameters of the mixing
distribution
Usually done using maximum likelihood
Check model fit, graphically if possible
7. Use the fitted model to solve the
marketing problem or to obtain the
required information
Outdoor Advertising Example
Advertisers can buy a monthly showing on a
set of specific billboards
Effectiveness of the showing is primarily
evaluated through three measures
Reach, frequency and gross ratings points (GRPs)
Measures derived from daily travel maps filled in
by a sample of people
An exposure is counted when a respondent goes
past one of the billboards, while facing the billboard
Have data from each person for one week
Want to project from this data to get measures
for the relevant month (or four weeks)
Measures of Advertising Exposure
Three measures are commonly used
Reach is the proportion of people exposed to the
advertising at least once during the month
Frequency is the number of times each person is
exposed to the advertising message
Usually summarised as the average frequency, which is the
average number of exposures experienced among those who
were exposed
Gross rating points (GRPs) is the mean number of
exposures per 100 people
This is just the product of the reach (expressed as a
percentage) with the average frequency
Distribution of
Billboard Exposures
(during one week)
# of Exposures # of People # of Exposures # of People
0 48 12 5
1 37 13 3
2 30 14 3
3 24 15 2
4 20 16 2
5 16 17 2
6 13 18 1
7 11 19 1
8 9 20 2
9 7 21 1
10 6 22 1
11 5 23 1
Model: Aim and Approach
Goal: Develop a model that uses one
week data to provide an estimate of the
monthly performance measures
Approach
Model the weekly exposure distribution
Derive the monthly exposure distribution
under this model, and estimate summary
statistics for the month
Probability Model
Let X denote the number of billboard
exposures during one week
For each person, X is assumed to have a
Poisson distribution with rate parameter

We assume that the exposure rates
have a gamma distribution
( )
( )
0 ,
1
>
I
=


o
|

| o
o
e g
( )
! x
e
x X P
x

= =
Probability Model
Aggregating across the population (i.e.
integrating with respect to ) gives



This Poisson-Gamma distribution is also
known as the negative binomial
distribution, or NBD
It has mean / and variance (+1)/
2
( ) ( ) ( )
( )
( )
x
x
x
d g x X P x X P
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+ I
+ I
=
= = =
}

| |
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o
o

o
1
1
1 !
0
Estimating Model Parameters
R Code:
expodist <-
c(48,37,30,24,20,16,13,11,9,7,6,5,5,3,3,2,2,2,1,1,2,1,1,1)
lnbd <- function(alpha,beta,data) {
expos <- 0:23
prob <- beta/(beta+1)
sum(data*log(dnbinom(expos,alpha,prob)))
}
optim(c(1,1),function(param) {-lnbd(param[1],param[2],expodist)})
Result: maximum value of log-likelihood is -649.7, which
is achieved at =0.969 and =0.218
0 2 4 6 8 10 12 14 16 18 20 22
Observed exposure distribution
Exposure distribution from fitted model
Exposure Distributions
0
1
0
2
0
3
0
4
0
NBD For More Than 1 Week
Let X(t) denote the number of exposures
experienced by a person over t weeks
Suppose that over one week, the
exposure distribution for that person is
Poisson()
Then X(t) is also Poisson, with rate
parameter t
NBD For More Than 1 Week
The market-level exposure distribution is



This has mean
( ) ( ) ( ) ( ) ( )
( )
( )
x
t
t
t x
x
d g x t X P x t X P
|
|
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+ I
=
= = =
}

| |
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o

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!
0
( ) | | . | ot t X E =
0 2 4 6 8 10 12 14 16 18 20 22
Exposure Distributions: 1 week vs 4 weeks
0
1
0
2
0
3
0
4
0
5
0
6
0
Performance of Monthly Showing
For t=4:
P(X(t)=0) = 0.056
E[X(t)] = 17.82
So:
Reach = 1 - P(X(t)=0) = 94.4%
Average Frequency = E[X(t)] / (1 - P(X(t)=0)
= 18.9
GRPs = 100* E[X(t)] =1782
Log-Likelihood Calculation
If data available as counts (for discrete or
discretised data), can use
Sum of (count times log probability)
E.g. sum(data*log(dnbinom(expos,alpha,prob)))
Sum of (count times (increase in distribution
function))
E.g.
sum(data*log(F(week,p,lambda) - F(week-1,p,lambda)))
+ (1499-sum(data))*log(1-F(13,p,lambda))

Direct Marketing Example
Have customer database containing data
on past purchases
126 segments defined based on purchase
histories
Well cover segmentation methods later
Believe that some customers are more
likely to respond to mail-out than others
Send test mail-out to 3% sample of customers
Analyse response by segment to identify most
profitable groups to target


Target Segments
Profitable to send mail-out if it costs less than the profit
on resulting sales
i.e. if the expected rate of purchase response (PRR) is above the
following cut-off:
PRR > cost per letter of mail-out / unit margin
Mail-out cost is 33.43 cents per letter
Unit margin is $161.50
Cut-off rate is 0.21%
Standard approach
Conduct full mail-out to all segments with test PRR above this
cut-off value 51 segments in this case
There is a problem with this rule what is it?
Manager chose to mail-out to 47 of these segments, plus
another 24 segments
Purchase Response Rates
Test vs Full Mail-out (47 Segments)
0%
1%
2%
3%
4%
5%
6%
7%
8%
0% 2% 4% 6% 8%
Test PRR
F
u
l
l

P
R
R
Develop Probability Model
Objective is to enable better decisions
based on the test mail-out dataset
Outcome variable is the number of
responses for a specified number of letters
mailed, by segment
Suggests a binomial distribution

Model Development
Notation:
N
s
= size of segment s (for s = 1, 2, , S)
m
s
= number of test letters sent to members of
segment s
X
s
= number of purchases due to responses from
segment s
Assume that all members of segment s have the
same probability of purchase response p
s
, and
they respond/purchase independently
Then X
s
is a binomial random variable
Applying the Model
What is our best estimate of p
s
given a
response of x
s
to a test mail-out of size
m
s
?
Intuitively we might expect a weighted
average of the population mean response
and the response in that segment, i.e.:


( ) ( )
s
s
s s s
m
x
m x p E e
| o
o
e +
+
= 1 ,
Bayes Theorem
The prior distribution g(p) describes the distribution p is
believed to follow, before any data is collected
The posterior distribution g(p|x) reflects the distribution p
is believed to follow, taking the observed data x into
account
According to Bayes theorem,



i.e. the posterior is proportional to the prior times the
likelihood
( )
( ) ( )
( ) ( )
}
=
dp p g p x f
p g p x f
x p g
Empirical Bayes Approach
In a true Bayesian analysis, the prior
distribution is specified before looking at
the data
For an empirical Bayes analysis, a prior
distribution is calculated from the data
The posterior distribution is then
calculated using Bayes theorem, as on the
previous slide
Model-based Decision Rule
Roll-out to segments with


66 segments qualify under this criterion
To test this approach, compare its
performance with the managers approach
(and the standard rule)

( ) 0021 . 0
5 . 161
3343 . 0
, = > =
s s s s
m x X p W
Results
Model is over $6,000 more profitable than the managers
selection
The model is evaluated on the 55 segments for which there is data
Standard Manager Model
# Segments 51 66
Actual # Seg. 47 71 55
Contacts 682,392 858,728 732,675
Purchases 4,463 4,804 4,582
Profit $492,651 $488,773 $495,060
Concepts Introduced
Binary choice processes
Beta-Binomial model
Regression to the mean
How to use models to allow for this effect
Bayes theorem
Empirical Bayes methods
Application of EB to direct marketing campaigns
Types of Observed Variables
Have introduced three types of
behavioural outcomes
Timing when?
Counting how many?
Choice whether/which?
These are widely encountered in a range
of situations
Applications of Timing Models
Product trial
Repeat purchasing
Response times
Direct mail
Mail or e-mail survey responses
Customer retention or attrition
Other durations
Time spent on a web site
Job tenure for salespersons
Applications of Counting Models
Number of advertising exposures
Number of pages viewed per web session
Salesperson productivity
Sales concentration among customers
E.g. 80/20 rule
Number of each item bought, or number of
distinct items, per shopping occasion
Number of trips
Shopping, bus or plane travel, park visits, fishing
Applications of Choice Models
Brand choice, e.g.
choice modeling questionnaire (exclusive choice)
scanner panel data (non-exclusive choice)
Media exposure
Binary variables
Response
Direct mail
Click-through for Web banner advertisements
Survey non-response (non-contacts, refusals)
Brand usage, awareness, image/associations
Combined Models
Two outcome variables
Counting + counting
Purchase - # of shopping trips & # of units bought per trip
Web site traffic - # of visits & # of pages viewed per visit
Counting and timing
Purchases spacing of trips & # of items bought/trip
Web site - # of visits & duration of each visit
Counting and choice
# of visits & whether trip involved purchase
choice of brand & # of units purchased
Generalisations
If there are problems with model fit, we can use
a different distribution or relax the usual
assumptions
Non-exponential distribution for purchasing intervals
E.g. gamma distribution (Exp=Gamma(1,))
Implies non-Poisson distribution of counts
Non-gamma or non-beta heterogeneity
E.g. never try/buy group
Non-stationarity latent traits may change over time
However the usual models appear quite robust
to departures from the standard distributions and
assumptions

Other Extensions
Introducing covariates
Finite mixture/latent class models
Hierarchical Bayes methods
These account properly for uncertainty at the
population/market level