Applying mathematical optimization

to marketing and risk strategies in

consumer financial services
Robin Way, SAS
(robin.way@sas.com)
1 October 2007

Copyright © 2007, SAS Institute Inc. All rights reserved.

Agenda

ƒ Define mathematical optimization

ƒ Structure of an optimization problem
ƒ Analytic insights: newly addressable questions
ƒ Field case studies

2
Copyright © 2007, SAS Institute Inc. All rights reserved.

1
 What is mathematical optimization?
(In the context of risk mgmt & marketing) Drivers influencing
an optimization-enhanced
customer strategy

ƒ Optimization helps decision-makers Decision-making

evaluate and select the best customer culture
strategies on an ongoing basis, via…
Emphasis on results
ƒ Maximizing economic outcomes of
marketing offers and risk policies… Analytical modeling
ƒ Taking into account the firm’s resource & decisioning
and budget constraints, and contact infrastructure
policies, by…
Business process
ƒ Assigning the value-maximizing offer
and risk strategies to each account. Bias for action &
continuous
improvement
3
Copyright © 2007, SAS Institute Inc. All rights reserved.

Delivering effective marketing & risk strategies:

conceptual process flow
Strategy formulation:
$
$

Cells, data, models $ $

Scoring Suppressions Offer / cell

Contact strategies
design & sizing

Analytics & scoring

Optimization
Optimized marketing & risk
strategy assignment

Strategy execution

Performance
List processing Batch execution Inline execution
measurement
4
Copyright © 2007, SAS Institute Inc. All rights reserved.

2
 Example optimization problem
ƒ Five alternative balance transfer offers at varying
purchase APRs
ƒ Objective
• Maximize net income of BT portfolio offer
ƒ Subject to constraints
• Eligible universe of 10mm accounts
• Total mailed per month < 4mm
• One offer per account per month
• Minimum 75,000 mailed per cell
• Blended APR across all offers > 5.9%
• Blended risk score across all offers > 670
• Suppress on risk score < 600, net income for offer < 0
5
Copyright © 2007, SAS Institute Inc. All rights reserved.

Optimization modeling:
Decisions & boundaries
Possible Decisions
(Scores & Attributes) Optimal Decisions
(Assignments)
Optimal Decisions (Assignments)
Response Optimal Decisions (Assignments)
Booking Objective functions
Objective functions
ROI functions
Objective
Net revenue ROI ROI
Margin M = 1 to m customers
M = 1N
to m customers
n offers
M = 1 to m customers
Expected losses N = 1 to n offers
N = 1 to n offers
M = 1 to m customers
N = 1 to n offers Scenarios &
Solvers economic
Boundaries tradeoffs
Boundary Impacts

Eligibility Marginal costs (shadow prices)

Boundary Impacts
Suppressions MarginalBoundary
cost curves
Impacts
Contact Policies Customer-offer tradeoffs
Marginal costs (shadow prices)
Marginal
Marginal cost(shadow
costs curves prices)
Bundles & Sequences (reduced
Customer-offer costs)
tradeoffs
Marginal cost(reduced
curves costs)
Customer-offer tradeoffs (reduced costs)
Constraints C =C1=to 1 ctochannels
c channels
(Budget, Capacity, Cell size) M = 1Nto=m customers
C =1 1toton coffers
channels
NS == 11 to n offers
Nto=s1segments
to n offers
C = 1 to c channels T =S1=to1 Sttoperformance
s segments months
= 1 to s segments
T = 1 to t performance months
M = 1 to m customers T = 1 to t performance months
N = 1 to n offers
S = 1 to s segments
T = 1 to t performance months

6
Copyright © 2007, SAS Institute Inc. All rights reserved.

3
 Structure of an optimization problem
ƒ Strategy
ƒ Projects & scenarios
ƒ Communications & measures
ƒ Objective
ƒ Constraints & suppressions
ƒ Contact policies
ƒ Reports
ƒ Input & output data

7
Copyright © 2007, SAS Institute Inc. All rights reserved.

Overall process for an optimization project

Create customer table View input data

Configure control table scripts
Create control tables
Create data library
Edit control tables
Associate data library with MO
Validate data tables & create
project
Launch & log into MO
Create new scenario ƒ Four basic steps
Revise existing measures, • Create & validate
create new calculated measures
analytic data files
Populate objective, suppressions,
constraints • Build project &
scenario
Populate contact & agent policies
• Configure &
Set execution options & execute
execute scenarios
• Identify “best”
View reports, compare with other
scenarios scenario(s) &
publish results
Publish selected scenarios

Share & archive published

Open project
scenario result tables and reports

8
Copyright © 2007, SAS Institute Inc. All rights reserved.

4
 Example optimization input data:
Tables and selected fields

9
Copyright © 2007, SAS Institute Inc. All rights reserved.

Analytic insights: newly addressable questions

ƒ Allocating scarce resources:
If we increase our budget by 10%, how much more response and revenue will we
generate, and what is the set of incremental offers that should be assigned to realize
this lift in response?
ƒ Economic trade-offs of decisions:
Why is Offer X being assigned to twice as many customers as Offer Y, what are the
economic trade-offs of artificially increasing the assignments of Offer Y, and how do
the sets of customers that are assigned each offer compare?
ƒ Mutual marketing & risk strategy considerations:
If I increase the number of contacts each customer can receive by one more per
month, does that have a better or worse impact on NCL-adjusted margin compared to
adjusting my credit policy to allow in 5% more prospects with FICO scores below 700?
What happens if I enforce both of these policy changes simultaneously, and how does
the overall offer mix change?
ƒ Performance measurement:
If I want to test for a 25 basis point difference in the response rate between Offer X and
Offer Y, how many customers do I have to assign to each offer? What is the trade-off
on margin if I want to test for a 50 basis point difference in response rate?
ƒ Decisions at the customer-offer level:
If I select a set of customers and require that they receive Offer Z (instead of Offers X
or Y which are economically optimal for those customers), what is the change in
margin on an individual customer basis?
10
Copyright © 2007, SAS Institute Inc. All rights reserved.

5
 Economic trade-offs across multiple scenarios

11
Copyright © 2007, SAS Institute Inc. All rights reserved.

Economic trade-offs within a single scenario

as a function of constraints

Opportunity cost
represents the change in
the optimization objective
(e.g., response-weighted
revenue) given a unit
change in the constraint.

12
Copyright © 2007, SAS Institute Inc. All rights reserved.

6
 Economic trade-offs, compared between
two competing constraints in a single scenario
Sensitivity curves show
the change in the
optimization objective
(e.g., response-weighted
revenue) for a range of
changes in each
constraint, holding other
constraints constant.

Reducing minimum cell

size will increase the
objective, at a relatively
constant rate.

Reducing the budget will

reduce the objective, but
more gradually, and only
when the budget is set
lower than approximately
$46,000
13
Copyright © 2007, SAS Institute Inc. All rights reserved.

Delivering results quickly

ƒ Performance depends on computing resources,
accounts, offers, and constraints
ƒ Compared with the empirical upper bound on the
objective function, the SAS optimization engine delivers
exceptional results in a short time

14
Copyright © 2007, SAS Institute Inc. All rights reserved.

7
 Card risk management case study:
Credit line increase profitability optimization
Strategy Dimensions
ƒ Extending new credit to good- ƒ Multiple EBIT simulations across
status, moderate-utilization 15 CLI strategies
accounts will stimulate spend and
grow revolving balances ƒ Multiple performance periods,
segments, portfolios, and nearly
Objective 40 scenarios
ƒ Maximize simulated EBIT, net of
credit losses, relative to control Compute performance
strategy
ƒ Solved 1.5mm account / 15 offer
Suppressions & constraints scenario at the account-CLI level
in under 5 minutes
ƒ Credit line total for single/multiple
lines Results
ƒ Credit line % increase
ƒ Growth in incremental EBIT
ƒ Net positive EBIT increase for each
increase in CLI
ƒ Contact strategy: cap to single CLI
offer including $0 CLI

15
Copyright © 2007, SAS Institute Inc. All rights reserved.

Card marketing case study:

Portfolio promotion response optimization
Strategy
ƒ Identify merchant-specific behavior
and target adoption of recurring
billing/payment program
ƒ Maximize lift of promotional
incentives, to stimulate new spend
and longevity among revolvers
ƒ Convert some transactors into
revolvers by positioning the card as
more than a payment mechanism
Objective
ƒ Maximize incremental response-
weighted incremental revenue
Suppressions & constraints
ƒ No non-profitable offers; no high-
incentive offers to low-margin accounts
and low-value accounts
ƒ Cap on budget (mail, incentives)
ƒ Performance testing cell size floors on
outbound and expected inbound
responses
Results
ƒ On 8.6mm scored accounts, we
assigned >700k offers
ƒ 225bps response
(compared with 150bps BAU)

16
Copyright © 2007, SAS Institute Inc. All rights reserved.

8
 Card marketing case study:
Acquisition balance transfer response optimization

Strategy Results
ƒ More effective targeting of prospects will ƒ On 1.2mm prospects and $750k
improve ROI on acquisition spend while budget, generated an expected
simultaneously managing to current 12-month BT volume in excess
credit-issuing risk policies of $300mm
Objective ƒ New model expands the reach of
ƒ Maximize acquisition response-weighted optimization analytics in the
BT volumes, net of expected credit organization to marketing and
losses risk business decision makers
Suppressions & Constraints
ƒ Floor on blended average APR and
blended average risk score
ƒ Cap on budget and outbound mail
ƒ Contact strategy: single offer per
prospect

17
Copyright © 2007, SAS Institute Inc. All rights reserved.

Card risk management case study:

Cash line advance optimization
Strategy Suppressions & constraints
ƒ Increase account profitability by ƒ Cash line / credit line < 100%
extending cash line
ƒ EBIT > 0
ƒ This scenario still under
development; presented here for ƒ Cash line advance >
knowledge transfer purposes size of current cash transaction
ƒ Total incremental cash advance <
Objective exposure constraint
ƒ Maximize BI = ƒ Cash line advance <
EBIT(size of cash transaction) + Load factor * Current cash line
EBIT (incremental cash line)
ƒ Each EBIT term =
Dimensions
(fee + interest) – (COF + GCL) ƒ 12 buckets for cash line advance
($0 to $3000)
Special requirements
ƒ Could be performed at segment
ƒ Desirable to invoke optimized cash level or account level
advance on-demand when cash
advance request occurs
ƒ Requires training a post-
optimization predictive model 18
Copyright © 2007, SAS Institute Inc. All rights reserved.

9
 Recap

ƒ Define mathematical optimization

ƒ Structure of an optimization problem
ƒ Analytic insights: newly addressable questions
ƒ Field case studies

19
Copyright © 2007, SAS Institute Inc. All rights reserved.

Applying mathematical optimization

to marketing and risk strategies in
consumer financial services
Robin Way, SAS
(robin.way@sas.com)
1 October 2007

Copyright © 2007, SAS Institute Inc. All rights reserved.

10