Predictive modeling is a statistical technique using machine learning and data mining to predict and forecast likely future outcomes with the aid of historical and existing data. It works by analyzing current and historical data and projecting what it learns on a model generated to forecast likely outcomes. Predictive modeling can be used to predict just about anything, from TV ratings and a customer’s next purchase to credit risks and corporate earnings.
A predictive model is not fixed; it is validated or revised regularly to incorporate changes in the underlying data. In other words, it’s not a one-and-done prediction. Predictive models make assumptions based on what has happened in the past and what is happening now. If incoming, new data shows changes in what is happening now, the impact on the likely future outcome must be recalculated, too. For example, a software company could model historical sales data against marketing expenditures across multiple regions to create a model for future revenue based on the impact of the marketing spend.
Predictive analytics is a branch of advanced analytics that makes predictions about future outcomes using historical data combined with statistical modeling, data mining techniques and machine learning. Companies employ predictive analytics to find patterns in this data to identify risks and opportunities.
Predictive analytics is often associated with big data and data science. Companies today are swimming in data that resides across transactional databases, equipment log files, images, video, sensors or other data sources. To gain insights from this data, data scientists use deep learning and machine learning algorithms to find patterns and make predictions about future events. These include linear and nonlinear regression, neural networks, support vector machines and decision trees. Learnings obtained through predictive analytics can then be used further within prescriptive analytics to drive actions based on predictive insights.
Classification model: Considered the simplest model, it categorizes data for simple and direct query response. An example use case would be to answer the question “Is this a fraudulent transaction?”
Clustering model: This model nests data together by common attributes. It works by grouping things or people with shared characteristics or behaviors and plans strategies for each group at a larger scale. An example is in determining credit risk for a loan applicant based on what other people in the same or a similar situation did in the past.
Outliers model: This model works by analyzing abnormal or outlying data points. For example, a bank might use an outlier model to identify fraud by asking whether a transaction is outside of the customer’s normal buying habits or whether an expense in a given category is normal or not. For example, a $1,000 credit card charge for a washer and dryer in the cardholder’s preferred big box store would not be alarming, but $1,000 spent on designer clothing in a location where the customer has never charged other items might be indicative of a breached account.
Forecast model: This is a very popular model, and it works on anything with a numerical value based on learning from historical data. For example, in answering how much lettuce a restaurant should order next week or how many calls a customer support agent should be able to handle per day or week, the system looks back to historical data.
Time series model: This model evaluates a sequence of data points based on time. For example, the number of stroke patients admitted to the hospital in the last four months is used to predict how many patients the hospital might expect to admit next week, next month or the rest of the year. A single metric measured and compared over time is thus more meaningful than a simple average.
Common predictive algorithms are:
Generalized Linear Model (GLM) for Two Values: This algorithm narrows down the list of variables to find “best fit.” It can work out tipping points and change data capture and other influences, such as categorical predictors, to determine the “best fit” outcome, thereby overcoming drawbacks in other models, such as a regular linear regression.
Random Forest: This algorithm is derived from a combination of decision trees, none of which are related, and can use both classification and regression to classify vast amounts of data.
Gradient Boosted Model: This algorithm also uses several combined decision trees, but unlike Random Forest, the trees are related. It builds out one tree at a time, thus enabling the next tree to correct flaws in the previous tree. It’s often used in rankings, such as on search engine outputs.
Prophet: This algorithm is used in time-series or forecast models for capacity planning, such as for inventory needs, sales quotas and resource allocations. It is highly flexible and can easily accommodate heuristics and an array of useful assumptions.
K-Means: A popular and fast algorithm, K-Means groups data points by similarities and so is often used for the clustering model. It can quickly render things like personalized retail offers to individuals within a huge group, such as a million or more customers with a similar liking of lined red wool coats.