RETAIL GLOSSARY

# Cluster Analysis

A method of grouping stores or products based on similarities in sales patterns, customer preferences, or other attributes, used to inform assortment planning decisions.

## What is Cluster Analysis?

Cluster analysis is a technique that groups similar data points together based on patterns and relationships. It helps identify clusters within a dataset without predefined labels. The analysis maximises similarity within clusters and dissimilarity between clusters. It has applications in market segmentation, customer profiling, image recognition, and anomaly detection. Cluster analysis provides valuable insights for decision-making, such as identifying target customer segments and optimising resource allocation. It uncovers hidden patterns and supports data-driven decision-making.

## How Cluster Analysis works

• Data Preparation: The first step is to collect and preprocess the data. This involves selecting relevant variables, removing outliers or missing values, and normalising the data if necessary.

• Similarity Measurement: Cluster analysis relies on measuring the similarity or dissimilarity between data points. Common distance metrics like Euclidean distance or cosine similarity are often used to determine how close or similar two data points are.

• Clustering Algorithms: There are various clustering algorithms available, such as k-means, hierarchical clustering, and DBSCAN. These algorithms use different approaches to assign data points to clusters based on their similarity.

• Determining Optimal Clusters: One challenge in cluster analysis is determining the optimal number of clusters. This can be done using techniques like the elbow method, silhouette analysis, or domain knowledge to find a suitable number of clusters that best represent the underlying patterns in the data.

• Interpretation and Evaluation: Once clusters are formed, it's important to interpret and evaluate the results. This involves analysing the characteristics and behaviours of each cluster to gain insights into the underlying patterns or trends in the data.

• Iterative Refinement: Cluster analysis is often an iterative process. It may involve adjusting parameters, trying different algorithms, or incorporating additional variables to improve the clustering results.
By following these steps, cluster analysis helps identify meaningful groups or clusters within a dataset, providing valuable insights and facilitating decision-making processes.

## Pros of Cluster Analysis

1. Pattern Recognition: Cluster analysis helps identify patterns and similarities in data that may not be apparent through other analytical methods. It allows for the discovery of hidden structures, relationships, or subgroups within a dataset, enabling better understanding and interpretation of complex data.
2. Data Segmentation: Cluster analysis aids in segmenting a dataset into distinct groups or clusters based on their similarities. This segmentation can be useful in various applications, such as customer segmentation in marketing, patient segmentation in healthcare, or product segmentation in inventory management. It allows for targeted strategies and personalised approaches tailored to each segment.
3. Decision Making: Cluster analysis provides insights that can support informed decision-making. By grouping similar data points together, it helps identify meaningful categories or segments that can guide strategic planning, resource allocation, and process improvements. It facilitates the identification of key characteristics or behaviours within each cluster, aiding in the development of targeted strategies or interventions.

## Cons of Cluster Analysis

1. Subjectivity in Interpretation: Cluster analysis relies on various algorithms and parameters to determine cluster assignments. The interpretation of results and the choice of the optimal number of clusters can be subjective and dependent on the analyst's judgment. Different approaches or parameter settings can lead to different outcomes, introducing a level of subjectivity in the interpretation of results.
2. Sensitivity to Input Data: The quality and selection of input data can significantly impact the results of cluster analysis. The presence of outliers, missing values, or noise in the data can affect the clustering process and lead to unreliable or misleading results. Preprocessing and data cleaning steps are crucial to minimize the impact of these issues on the analysis.
3. Lack of Ground Truth: Cluster analysis is an unsupervised learning technique, meaning it does not rely on predefined class labels or ground truth information. While this provides flexibility in discovering hidden patterns, it also makes it challenging to evaluate the quality or accuracy of the clustering results objectively. Without a known ground truth, it can be difficult to assess whether the clusters obtained are meaningful or relevant to the underlying data.

## FAQ

Below you will find answers to common questions
How can cluster analysis help me segment my customer base?
Cluster analysis can be a valuable tool for customer segmentation in retail. By analysing customer data such as purchase history, demographics, and behaviour, cluster analysis can identify distinct groups or segments within the customer base. These segments can provide valuable insights into different customer preferences, needs, and behaviors. Retailers can then tailor their marketing strategies, product offerings, and customer experiences to better target and serve each segment, leading to improved customer satisfaction and higher sales.
How can cluster analysis help me optimise store layout and product placement?
Cluster analysis can assist retailers in optimising store layout and product placement. By analysing customer purchase patterns and preferences, cluster analysis can identify groups of customers with similar buying behaviours. These clusters can inform decisions regarding store layout, such as the placement of different product categories, shelves, or promotional displays. For example, if a particular cluster of customers frequently purchases health and wellness products, retailers can strategically position these products in prominent areas to attract and engage that customer segment. This can enhance the overall shopping experience, increase customer satisfaction, and drive sales.