Aggregating and analyzing alternative data helps companies with "unlocking improvements in growth, productivity, and risk management,” according to a recent report from leading management consultancy firm McKinsey. Yet the report, ‘Harnessing the power of external data’, finds that "comparatively few” companies have taken advantage of data's potential. How can companies capitalize on third-party data sources to gain a competitive advantage?
Predictions, productivity and profits: the power of external data
Companies around the world have already experienced the transformative effects of big data. Citing a study of 179 large firms in the US, the McKinsey report notes that those who used data to make decisions increased their productivity by 5-6% above what would otherwise be expected.
The authors describe a large, unnamed insurance firm which expanded its use of external data sources “from a handful to more than 40 in the span of two years”. This decision paid off as it increased the predictive power of the firm’s models by more than 20% and allowed the insurer to save time by shortening the list of questions it typically asked its customers.
Despite a growing evidence base that complementing internal data with third-party data sources provides valuable context and insights , the report warns, ”Few organizations take full advantage of data generated outside their walls. ”A well-structured plan for using external data can provide a competitive edge,” says the report.
Alternative data supports investment and risk management
McKinsey’s research highlights alternative data’s usefulness for a wide range of business-critical activities. For example, risk management processes that integrate news and social commentary, company data, sanctions, watchlists and PEPs, and legal data can "reduce supplier and reputational risks”.
Financial services organisations remain at the forefront of alternative data adoption, making use of general and adverse media, company data helps to improve analyses of “businesses, economic outcomes, and phenomena", according to the report.
The report adds that alternative data is particularly useful to support investment decisions. Traditionally these were based on companies’ internal data, financial statements and analyst ratings. But now a much wider range of datasets are providing insights, including patent data which helps to “understand company strategy and predict financial performance and organisational growth”
“Investment firms have established teams that assess hundreds of these data sources and providers and then test their effectiveness in investment decisions,” the report says. The data helps “to predict outcomes and generate investment returns.”
Aggregate enriched data for optimal results
One reason why most companies have not made the most of the possibilities of third-party data is that acquiring datasets is only the first step. Companies should take four steps to unlock the value of external data:
1. Use technology to link datasets together: Datasets can be combined and compared using Artificial Intelligence . “By consuming more data types and extracting relevant information from seemingly unrelated patterns, Machine Learning could generate credit scores for more individuals with greater precision,” the authors write.
2. Acquire normalized and enriched data: To apply data analytics to a dataset, the data needs to be in the right format. This is a time-intensive process, so it is best to acquire external data that has already been normalized and enriched to save time, effort and cost.
3. Develop trusted relationships with data suppliers: The report warns that acquiring individual datasets from multiple sources can lead to “a series of time-consuming vendor-by-vendor discussions and negotiations” and trialing a new supplier "often takes months”. Using a single, trusted and authoritative provider of numerous datasets will save time, and the relationship that develops with them can lead to new insights on how to optimize data use.
4. Enable continuous updates: Risk management and investing are not one-off decisions but require ongoing monitoring. Integrating data from third-party providers by using flexible APIs offers a“continuous conveyor belt" of relevant data.
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