How to Leverage Contextual Bandits for E-Commerce Success

Oct 4, 2023 11:00:00 AM
9 min read

The customer experience can make or break any business, and e-commerce is no exception. To truly deliver, online retailers need to understand what their shoppers want and what matters most to them.

Persons head full of creative ideas. As we enter the final stretch of 2023, one thing is certain: The majority of consumers expect some degree of personalization when shopping. Because of this, more and more digital stores are searching for ways to enhance the e-tail experience and the necessary data to make it possible. Traditional methods like A/B testing continue to serve their purpose, but as the e-commerce landscape continues to evolve, so must the approaches used to engage and convert shoppers. This is where contextual bandits step in.

Contextual bandits are transforming the way e-commerce brands test and optimize their communication strategies. This innovative machine learning framework is designed to offer a dynamic and efficient way to personalize the online shopping experience. In this blog, we’ll explain what contextual bandits are, how they work, and how they differ from A/B testing. We’ll also share some practical applications so you can engage and delight more customers.

What are contextual bandits?

Curious shopper looking through magnifying glass.In e-commerce, contextual bandits refer to a type of machine learning algorithm that enables online retailers to make smart decisions that are relevant to each shopper’s specific needs. Unlike conventional recommendation systems that rely solely on historical data, contextual bandits factor in real-time user context, preferences, and behavior patterns.

For an online consumer, it’s like having a personal shopping assistant that curates products, offers, and other content that aligns perfectly with their interests. This helps boost key performance indicators (KPIs) like conversion rates and average order value.

How do contextual bandits work?

Now that we’ve explained what contextual bandits are, let's explore how they work:

Step 1: Data Collection

metric-pieContextual bandit algorithms gather information about each customer, such as demographics, past purchases, and browser history. They also analyze any additional context as the shopper actively interacts with the digital storefront. This context is then used to forecast which products, recommendations, or informational content will be most appealing to the shopper at that specific moment.

Step 2: Learning

Granify decision brain in a jar, deciding the optimal revenue path, leading to the larger of two money bags. Learning and adapting are a big part of what makes contextual bandits so valuable. The algorithm uses the data it’s accumulated to develop a model that anticipates the outcomes of different actions, such as personalized recommendations, pricing adjustments, or content messaging. From here, it allots a "score" to each action based on its predicted performance in the current context.

A learning algorithm can test different actions and automatically learn which one has the most rewarding outcome for a specific scenario. For example, in e-commerce, an algorithm randomly selects an enticing exit-intent popup when a shopper adds an item to their cart to motivate them to complete their purchase. It then monitors whether the shopper interacts with the popup or not. Using this feedback, the algorithm fine-tunes its future actions to maximize the reward; in this instance, the shopper's interaction with the popup.

Step 3: Exploration & Exploitation

To enhance their performance and refine theirIllustration of a magnifying glass. strategies over time, contextual bandits strike a balance between exploration and exploitation. In simpler terms, they occasionally suggest items or actions that may not yield the highest predicted outcome in order to gather more data—all while prioritizing known preferences to maximize immediate gains such as clicks and conversions.

This adaptive approach enables the system to improve its insight into user preferences and context.

Step 4: Feedback Loop

Over time, the system adjusts and refines its decision-making process based on the feedback it receives from customer interactions. As more data is collected, the recommendations will become increasingly accurate and personalized, ultimately driving up sales and elevating customer engagement and loyalty.

What’s the difference between contextual bandits and A/B testing?  

While both contextual bandits and A/B testing aim to optimize the customer experience, they contrast greatly in their approach and utilization.

Real-time vs. Batch Testing

Person with computer chip brain. An exclamation mark is seen next to them, as though they've had an idea. A/B testing is typically used to compare two or more variations of a given element (such as a web page or marketing campaign) to determine which performs better regarding a particular metric, like click-through rate, conversion rate, or revenue. Its primary objective is to find the top-performing option among the alternatives being tested.

In contrast, contextual bandits prioritize real-time decision-making, delivering personalized recommendations and selections as shoppers engage with the platform. The contextual bandit’s main goal is to optimize cumulative rewards over time by picking the most suitable action for each circumstance.

Continuous Learning

A/B testing provides insights into which variations are better but does not adapt in real-time, since the test is based on prescribed treatments for distinct segments of users. Though this testing is informative, it tends to be more static and requires manual intervention to implement changes.

Contextual bandits make instant decisions and constantly learn and adapt based on user interactions. This makes them ideal for dynamic, tailored applications and enables continuous improvement without the need for manual adjustments.

Exploration vs. Exploitation

Person using binoculars surrounded by projected e-commerce insights behind them. In its traditional form, A/B testing doesn’t inherently prioritize exploration, but rather, tests predetermined variations. Its strength rests in exploitation and finding the best-known option among the alternatives being tested. As mentioned earlier, contextual bandits strike a balance between the two. They explore new actions to gather data and enhance their decision-making while also leveraging the activities currently deemed the most beneficial according to available information.

Personalization

A/B tests provide insights into which variation works best on average for a group of users. However, they don't inherently offer personalization. To achieve this, separate A/B tests would need to be set up, and continuously iterated on, for different user segments. On the other hand, contextual bandits automatically adapt to individual user preferences and context. Any action selected is based on the specific context and user characteristics, allowing for a highly tailored user experience.

Efficiency

To compare the performance of multiple variations and controlled experiments, A/B testing requires a relatively large and static dataset, as well as continuous manual setup. This can make it quite resource-intensive.

Two hands clasping each other. Contextual bandits adapt in real-time, focusing primarily on actions that are likely to perform well. Rather than simply comparing two groups, contextual bandits take into account contextual variables that may impact overall performance, making them an effective way to optimize e-commerce marketing campaigns.

Contextual Bandits Vs. A/B Testing: The Pros and Cons

A/B testing and contextual bandits each have their own set of advantages and disadvantages for e-commerce brands. Here's a breakdown of the pros and cons of each approach:

 

A/B TESTING

CONTEXTUAL BANDITS

PROS

Relies on historical data, making it suitable for scenarios where you have an established user base and clear hypotheses to test

Is well-established, easy to interpret, and provides statistically precise outcomes

Allows businesses to analyze the performance of different variations for specific user segments, helping you make informed decisions for different customer groups

Great for comparing different variations and finding a clear winner among them

Can adapt to changing user behavior and contexts in real-time, making them ideal for e-commerce

Enable personalized recommendations and actions, which enhance the user experience and conversions

Balance exploration and exploitation, making them efficient at discovering optimal strategies over time

Continuously learn from user interactions, improving their decision-making abilities as they gather more data

CONS

Need to define and set up experiments in advance, which limits their ability to adapt to changing user behavior and contexts

Not suited for personalization since it would require running multiple A/B tests for different segments

Very time-consuming, especially if you need to wait for a statistically significant result, which may delay decision-making and optimizations

More complicated to set up than A/B tests, as it involves machine learning models and real-time decision-making

Requires a continuous stream of data, including user features and feedback, which may not be available or feasible for all e-commerce brands

May make suboptimal decisions in the early stages of learning, which can impact short-term performance

Could raise ethical concerns related to privacy and user manipulation, so careful consideration and disclosure is necessary

 

Where can contextual bandits be applied in e-commerce?

Contextual bandits have an array of applications, including:

Ad Campaign Optimization

E-commerce brands running online advertising campaigns can use contextual bandits to dynamically allocate budgets across different campaigns, channels, or keywords based on real-time performance data. This ensures optimum resource allocation and ROI.

Personalized Product Recommendations

Shopper sitting in armchair with a laptop. The shopper is about to make a purchase from home.Contextual bandits can be used to personalize product recommendations for individual users based on their browsing history, purchase behavior, and real-time interactions. Whether it's suggesting complementary items or highlighting products with high purchase probabilities, these recommendations will elevate the customer experience and lead to improved engagement.

Shopper smiling with two shopping bags in hand. A speech bubble shows a 'thumbs-up' emoticon, conveying the shoppers satisfaction. User Experience

When users perform searches on e-commerce platforms, contextual bandits can help in ranking and displaying search results based on relevance to the user's preferences and historical behavior. It can also optimize the overall user experience by selecting the most appropriate site layout, content, and design elements for each user based on their preferences and behavior.

Inventory Management

Contextual bandits can aid in managing inventory by predicting demand for products and suggesting when to replenish or promote certain items based on real-time market conditions. It can also choose the optimal shipping options and delivery times for each customer based on their location, preferences, and shipping cost considerations.

Dynamic Pricing Optimization

Illustration of a pile of coins with dollar signs on them. E-commerce companies can use contextual bandits to ensure customers get the most competitive prices to maximize revenue and profitability. Prices can be adjusted based on factors like user demand, competitor pricing, and historical data.

Email Marketing

Contextual bandits can optimize email marketing campaigns by picking the most relevant products or offers to include for each user to increase open rates, click-through rates, and ultimately, conversion rates. This will allow you to predict which email content will resonate best with different segments of your email list.

Checkout Flow Optimization

Improve your checkout process by using contextual bandits to offer individualized incentives or discounts at the right moment to minimize cart abandonment, which causes nearly $4 trillion in lost revenue annually.

Let’s put things in context. 

Person smiling and giving thumbs up to a computer. The computer is displaying a thumbs up on the screen in return. Contextual bandits are a powerful tool, thanks to their quick adaptation, real-time personalization, and endless learning capabilities. By implementing its broad range of applications, you’ll be able to deliver a more engaging experience to your customers, while maximizing revenue and operational efficiency.

Yes, applying contextual bandits to your data can be challenging without a dedicated machine learning team, but the benefits might be worth it. Just remember, it’s important to test these algorithms to ensure they align you’re your e-commerce objectives. Follow these guidelines, and your conversions could go from ordinary to extraordinary in no time.


Granify: Your Personalization Bandit 

Two hands reaching out, about to shake, in front of a green circle. Harness the power of personalization with Granify! Our machine-learning experts can help you implement and leverage contextual bandits to drive higher conversions, revenue, and customer satisfaction. Why wait for a knight in shining armor when Granify's bandits can save the day now? 

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