UNIT 12

FACTOR ANALYSIS
 SLIDE
SLIDE 7-1
16-1

Introduction to Factor Analysis

 Factor analysis is a multivariate statistical technique in which
there is no distinction between dependent and independent
variables.
 In factor analysis, all variables under investigation are analysed
together to extract the underlined factors.
 Factor analysis is a data reduction method.
 It is a very useful method to reduce a large number of variables
resulting in data complexity to a few manageable factors.
 These factors explain most part of the variations of the original
set of data.
 A factor is a linear combination of variables.
 It is a construct that is not directly observable but that needs to
be inferred from the input variables.
 The factors are statistically independent.
 SLIDE
SLIDE 7-1
16-2

Uses of Factor Analysis

 Scale construction: Factor analysis could be used to develop
concise multiple item scales for measuring various constructs.
 Establish antecedents: This method reduces multiple input
variables into grouped factors. Thus, the independent variables
can be grouped into broad factors.
 Psychographic profiling: Different independent variables are
grouped to measure independent factors. These are then used
for identifying personality types.
 Segmentation analysis: Factor analysis could also be used for
segmentation. For example, there could be different sets of two-
wheelers-customers owning two-wheelers because of different
importance they give to factors like prestige, economy
consideration and functional features.
 SLIDE
SLIDE 7-1
16-3

Uses of Factor Analysis

 Marketing studies: The technique has extensive use in the field
of marketing and can be successfully used for new product
development; product acceptance research, developing of
advertising copy, pricing studies and for branding studies.

For example we can use it to:

• identify the attributes of brands that influence consumers’

choice;

• get an insight into the media habits of various consumers;

• identify the characteristics of price-sensitive customers.

 SLIDE
SLIDE 7-1
16-4

Conditions for a Factor Analysis

Exercise
The following conditions must be ensured before executing the
technique:
 Factor analysis exercise requires metric data. This means the data
should be either interval or ratio scale in nature.
 The variables for factor analysis are identified through exploratory
research which may be conducted by reviewing the literature on the
subject, researches carried out already in this area, by informal
interviews of knowledgeable persons, qualitative analysis like focus
group discussions held with a small sample of the respondent
population, analysis of case studies and judgement of the researcher.
 As the responses to different statements are obtained through different
scales, all the responses need to be standardized. The standardization
helps in comparison of different responses from such scales.
 SLIDE
SLIDE 7-1
16-5

Conditions for a Factor Analysis

Exercise
 The size of the sample respondents should be at least four to five
times more than the number of variables (number of statements).
 The basic principle behind the application of factor analysis is
that the initial set of variables should be highly correlated. If the
correlation coefficients between all the variables are small, factor
analysis may not be an appropriate technique.
 The significance of correlation matrix is tested using Bartlett’s test
of sphericity. The hypothesis to be tested is
H0 : Correlation matrix is insignificant, i.e., correlation matrix is an
identity matrix where diagonal elements are one and off
diagonal elements are zero.
H1 : Correlation matrix is significant.
 SLIDE
SLIDE 7-1
16-6

Conditions for a Factor Analysis

Exercise
 The test converts it into a chi-square statistics with degrees of
freedom equal to [(k(k-1))/2], where k is the number of variables
on which factor analysis is applied. The significance of the
correlation matrix ensures that a factor analysis exercise could
be carried out.
 The value of Kaiser-Meyer-Olkin (KMO) statistics which takes a
value between 0 and 1 should be greater than 0.5 for the
application of factor analysis.
 The KMO statistics compares the magnitude of observed
correlation coefficients with the magnitudes of partial correlation
coefficients.
 A small value of KMO shows that correlation between variables
cannot be explained by other variables.
 SLIDE
SLIDE 7-1
16-7

Key terms used in Factor Analysis

 Factor Scores – It is the composite scores estimated for each
respondent on the extracted factors.
 Factor Loading – The correlation coefficient between the factor
score and the variables included in the study is called factor loading.
 Factor Matrix (Component Matrix) – It contains the factor loadings
of all the variables on all the extracted factors.
 Eigenvalue – The percentage of variance explained by each factor
can be computed using eigenvalue. The eigenvalue of any factor is
obtained by taking the sum of squares of the factor loadings of each
component.
 Communality - It indicates how much of each variable is accounted
for by the underlying factors taken together. In other words, it is a
measure of the percentage of variable’s variation that is explained
by the factors.
 SLIDE
SLIDE 7-1
16-8

Steps in a Factor Analysis Exercise

There are basically two steps that are required in a factor analysis exercise.

Extraction of factors:

 The first and the foremost step is to decide on how many factors are
to be extracted from the given set of data. The principal component
method is discussed very briefly here.
 As we know that factors are linear combinations of the variables
which are supposed to be highly correlated, the mathematical form of
the same could be written as
 SLIDE
SLIDE 7-1
16-9

Steps in a Factor Analysis Exercise

 The principal component methodology involves searching for
those values of Wi so that the first factor explains the largest
portion of total variance. This is called the first principal factor.
 This explained variance is then subtracted from the original input
matrix so as to yield a residual matrix.
 A second principal factor is extracted from the residual matrix in
a way such that the second factor takes care of most of the
residual variance.
 One point that has to be kept in mind is that the second principal
factor has to be statistically independent of the first principal
factor. The same principle is then repeated until there is little
variance to be explained.
 SLIDE
SLIDE 7-1
16-10

Steps in a Factor Analysis Exercise

 To decide on the number of factors to be extracted Kaiser
Guttman methodology is used which states that the number of
factors to be extracted should be equal to the number of factors
having an eigenvalue of at least 1.

Rotation of factors:
 The second step in the factor analysis exercise is the rotation of
initial factor solutions. This is because the initial factors are very
difficult to interpret. Therefore, the initial solution is rotated so as
to yield a solution that can be interpreted easily.
 The varimax rotation method is used.
 SLIDE
SLIDE 7-1
16-11

Steps in a Factor Analysis Exercise

 The varimax rotation method maximizes the variance of the
loadings within each factor.
 The variance of the factor is largest when its smallest loading
tends towards zero and its largest loading tends towards unity.
 The basic idea of rotation is to get some factors that have a few
variables that correlate high with that factor and some that
correlate poorly with that factor.
 Similarly, there are other factors that correlate high with those
variables with which the other factors do not have significant
correlation.
 Therefore, the rotation is carried out in such way so that the factor
loadings as in the first step are close to unity or zero.
 SLIDE
SLIDE 7-1
16-12

Steps in a Factor Analysis Exercise

 To interpret the results, a cut-off point on the factor loading is
selected.
 There is no hard and fast rule to decide on the cut-off point.
However, generally it is taken to be greater than 0.5.
 All those variables attached to a factor, once the cut-off point is
decided, are used for naming the factors. This is a very
subjective procedure and different researchers may name same
factors differently.
 A variable which appear in one factor should not appear in any
other factor. This means that a variable should have a high
loading only on one factor and a low loading on other factors.
 SLIDE
SLIDE 7-1
16-13

Steps in a Factor Analysis Exercise

 If that is not the case, it implies that the question has not been
understood properly by the respondent or it may not have been
phrased clearly.
 Another possible cause could be that the respondent may have
more than one opinion about a given item (statement).
 The total variance explained by Principal component method and
Varimax rotation is same. However, the variance explained by
each factor could be different.
 The communalities of each variable remains unchanged by both
the methods.
 SLIDE
SLIDE 7-1
16-14

Applications of Factor Analysis in

other Multivariate Techniques
1. Multiple regression – Factor scores can be used in place of independent
variables in a multiple regression estimation. This way we can overcome the
problem of multicollinearity.
2. Simplifying the discrimination solution – A number of independent
variables in a discriminant model can be replaced by a set of manageable
factors before estimation.
3. Simplifying the cluster analysis solution - To make the data manageable,
the variables selected for clustering can be reduced to a more manageable
number using a factor analysis and the obtained factor scores can then be
used to cluster the objects/cases under study.
4. Perceptual mapping in multidimensional scaling - Factor analysis that
results in factors can be used as dimensions with the factor scores as the
coordinates to develop attribute-based perceptual maps where one is able to
comprehend the placement of brands or products according to the identified
factors under study.