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Discrete choice models

Chapter 16

Statistics for Marketing & Consumer Research Copyright 2008 - Mario Mazzocchi

Choice models and preferences


Choice modeling is the preferred model for studies on consumer preferences Choice models are closely related stated preference theory
Stated preference survey: consumers state their choices among a potential set of alternatives (e.g. different brands, different product characteristics, different stores) Options can include both real and hypothetical market alternatives Choice models start from stated preferences to go back to their determinants

The alternative to stated preference is revealed preference


where consumers are not asked directly what they prefer or choose but their actual choices and determinants are observed indirectly, for example considering what they purchase in different situations
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Stated vs. revealed preference


Example
A customer finds that the price of her favourite washing powder in her usual supermarket has doubled
Will she buy less washing powder, like a smaller pack? Or would she move to a different brand?

Would she go back home without buying washing powder at all? It could be difficult to define a model which explains choices using revealed preference, i.e. observing behaviors at the checkout till
if the customer decides not to buy washing powder at all, how would it be possible to infer this choice simply from a look at the products in her shopping trolley? if the customer buys an alternative brand with exactly the same size and price as before the price increase would a revealed preference model capture that consumer decision?
Statistics for Marketing & Consumer Research Copyright 2008 - Mario Mazzocchi

Stated vs. revealed preference


Revealed preference allows one to model these behaviors, but only after an expensive collection of information on the frequency quantity and brands of washing powder purchases Stated preference alternative
a survey where the consumer is asked to choose between a set of alternative choices which differ by brand, pack size and price Provided that the survey is designed in an appropriate way (not necessarily easy) the collected data open the way to a more effective model
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Choice models
Consumer models are usually targeted on the average behaviour With revealed preference one might apply a regression model; where we purchased the quantity is the dependent variable and price and other explanatory variables are on the right-hand side. With stated preference models a discrete choice variable is on the left-hand side of the equation
Example the choice whether to purchase washing powder or not (binary dependent variable); choice among a set of alternative brands (categorical DV)
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Why regression does not work


With binary or categorical dependent variables standard regression analysis is not appropriate Example
binary dependent variable y coded to be zero for non-purchases and one for purchases with X is a continuous metric variable y a b x

Problems

0 for non purchases y 1 for purchases

After least square estimation predictions of y using the value of x would produce many other values than zero and one including values below zero and values above one Different coding for the binary dependent variable (e.g. one and two, or zero and ten) would lead to very different estimates for the a and b coefficients which makes the interpretation of the regression parameters difficult The above model does not meet the assumptions of the regression model since multivariate normality of the dependent variable for any value of the explanatory variables is broken
Statistics for Marketing & Consumer Research Copyright 2008 - Mario Mazzocchi

Discrete choice models


yi a b xi
Discrete choice models generalize the regression model for the situations where y is a non-metric variable
a binary (0-1) variable or an ordinal variable (like a questionnaire item assuming the values completely disagree, disagree, neither, agree, completely agree) or a categorical variable (for example a nominal variable recording the preferred holiday destination).

The right-hand side variable is generally assumed to be metric Binary and categorical variables on the right-hand side can be translated into dummies and used as explanatory variables like in regression analysis Non-metric dependent variables violate the normality and the homoskedasticity assumptions of regression; an alternative approach is used to estimate discrete choice models
Statistics for Marketing & Consumer Research Copyright 2008 - Mario Mazzocchi

Binary choice model


Y can assume the discrete values zero or one To model y as a function of x one can exploit a latent variable (as for SEM)
y assumes either value zero or one depending on the threshold value d of a metric and continuous latent variable z

The regression model is rewritten as

yi 0 if zi d yi 1 if zi d

the dependent variable y is one when a latent continuous variable z is above the threshold d and zero otherwise The model is completed by a regression equation linking the latent variable to the explanatory variable

zi a b xi i

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The auxiliary regression


zi a b xi i
The above model has a metric and continuous dependent variable After some assumptions the distribution of is known Problems:
1) z is not observed and 2) d is unknown

Problem 2 is easily resolved: as long as the intercept a appears in the regression equation, one may arbitrarily choose d (the easiest way is to fix it at zero) and the only result which will change is the estimate of the intercept a Problem 1 requires one to create z for each observation as a function of y, taking into account the information which we have, that is the proportions of zero and one for the y variable It is necessary to make an assumption on the probability distribution for this latent variable and how it is linked to y, i.e. a link function between y and z must be specified
Statistics for Marketing & Consumer Research Copyright 2008 - Mario Mazzocchi

The link functions


The link function specifies the relationship between z and y through the expected value of the appropriate distribution function for the generic observation yi For example, with binary data, one can assume that the probabilities of each observation yi follow a binomial distribution there are a number of transformations of y which create a z variable compatible with the binomial distribution

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The logistic transformation

Probabilities that y=1 (on the vertical axis) concentrate around zero for values of x below a certain threshold, then go quickly towards 1 when x is above the threshold. The function fits well with the need for approximating the probabilities of a binary outcome as a function of the explanatory variable. The logistic transformation of y into z is obtained by applying the logit link function to the expected value of y.

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Logistic regression
The logit transformation is the link function for logistic regression The logit transformation is the log of the odds that y=1 relative to y=0 The logit link allows to transform the binary variable y into a continuous variable z The final equation is a regression model with a continuous variable on the left-hand side The only difference from the standard regression model is that the distribution of the error is not normal but logistic. Estimation of a and b can be obtained by maximum likelihood which works with any known probability distribution of the errors and returns the maximum likelihood estimates (the most probable values for the parameters)
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Types of discrete choice models


Logistic regression: at least one of the explanatory variables is metric and continuous Logit model: all of the variables on the right-hand side are non-metric (binary or categorical) This is a conventional distinction; often the two terms are used interchangeably In a logit model with a categorical or binary x variable, the coefficient b is mathematically related to the odds ratio (with respect to the baseline category of x) of having a positive outcome
For example, if the dependent variable is one when the consumer buys a specific brand and x measures whether the consumer has kids or not, one can compute with eb the odds ratio of buying the brand for consumers with kids as compared to consumers without kids.
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Probit model
The Probit model is also applied to binary dependent variables but with different assumptions on the link function and the error distribution The link function (called probit) is the inverse of the standard normal cumulative distribution function This link function guarantees that the distribution of the model which is finally estimated is still normal The choice between the probit and the logit distribution depends on the type of dependent variable
if the dependent variable can be reasonably assumed to be a proxy for a true underlying variable which is normally distributed then the probit model should be chosen if the dependent variable is considered to be a truly qualitative and binomial character then logit modelling should be preferred generally the two models lead to very similar results, unless cases are concentrated to the tails of the distributions in which case the logit link function should be chosen
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Generalizations
ordered logit (ordered probit) models
the dependent variable is not binary but categorical and the categories are ordered

multinomial logit (multinomial probit)


The dependent variable is categorical but categories cannot be ordered

multivariate logit (multivariate probit)


Several discrete choice models are estimated simultaneously (there are multiple dependent variable)
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Discrete choice models in SPSS


Trust data-set Binary logistic regression Example application (as for discriminant analysis)
Dependent variable: buying chicken at the butchers shop Explanatory variables:
weekly expenditure on chicken age safety of butchers chicken trust in supermarkets
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Binary logistic regression


Dependent variable

Explanatory variables It is possible to opt for step-wise selection of explanatory variables Declare categorical variables Additional statistics

Save predicted values or residuals


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Additional statistics

The test compares the expected frequencies with those actually observed after dividing the subject in ten equal groups according to their predicted probabilities

In logistic regression, the exponential function of the coefficients are odds ratio this option provides confidence intervals

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Output
Model Summ ary Step 1 -2 Log Cox & Snell likelihood R Square 467.079a .157 Nagelkerke R Square .217

These are goodness-of-fit measures similar to the regression R square

a. Es timation terminated at iteration number 5 bec aus e parameter es timates c hanged by less than .001.

Hosmer and Lemeshow Test

Step 1

Chi-square 3.030

df 8

Sig. .932

The hypothesis of equality between observed and predicted frequencies is not rejected
Classification Table(a)

Predicted
Butcher Observed Step 1 Butcher No Yes no 243 89 yes 34 54 Percentage Correct 87.7 37.8

Overall Percentage
a The cut value is .500
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70.7

The classification table shows the frequencies of correctly predicted observations

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Coefficient estimates
These are odds ratios and are interpreted as follows: A one-year increase in age (q51) leads to a 2.2% increase in the odds of purchasing chicken at the butcher shop (i.e. the ratio between the probability of doing it and the probability of not doing it)
V ariables in the Equation

Step a 1

q51 q43b q21d q5 Cons tant

B .022 -.269 .441 .085 -3.169

As requested, 95% confidence S.E. Wald df Sig. Ex p(B) intervals for the odds ratio are shown .007 8.988 1 .003 1.022
.074 .077 .028 .615 13.327 32.888 8.975 26.539 1 1 1 1 .000 .000 .003 .000 .764 1.554 1.088 .042

95.0% C.I.f or EXP(B) Low er Upper 1.008 1.037 .661 .883 1.337 1.807 1.030 1.150

a. V ariable(s ) entered on step 1: q51, q43b, q21d, q5.

All predictors are significantly different from zero

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A unit increase in trust in supermarket (q43b) 20 decreases the same odds ratio by 23.6%.

Logit and probit models


Logit and probit models (all explanatory variables are categorical) can also be estimated using this alternative menu However, SPSS data need to be structured as counts of success cases (response frequency), with an additional column for the total number of cases

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Data for logit/probit models


This can be easily accomplished: one can create the total observed variables by creating new variables of ones (for example tot). If does that, one can repeat the above analysis by selecting q8d as the response frequency and tot as the total observed variable.
This is the original binary variable

This is the artificial variable of ones

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Logit model estimation


Binary variable

Artificial variable

Covariates Results are very similar to those obtained from logistic regression Model choice
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The Generalized Linear Model (GLM)


The GLM is a comprehensive modeling procedure which includes logistic regression, logit and probit (among others) as special cases

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GLM
It is comprehensive modeling approach for discrete choice modeling where one or more dependent categorical variables are modeled as the outcome of one or more explanatory variables which can be metric or non-metric. Depending on the type of link function the GLM collapses into:
logistic regression logit or probit models multinomial or multivariate logistic regression logit or probit models
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GLMs
A binary dependent variable here leads to discrete choice models

It is possible to choose the dependent variable distribution and the link function

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Defining discrete choice models through GLMs

Here the explanatory variables are selected

Here more model options (e.g. interaction) are defined Note that this procedure can also be used for log-linear analysis

Provide some details on how to estimate parameters

Many additional statistics can be required

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Predictors
Factors are categorical variables

Covariates are treated as metric variables


If only covariates are considered, then the model is a logistic regression

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Model
It is necessary to specify how the predictors enter the model They need to be included as main effect If desired, interactions (also higher than two-way ones) may be introduced (see loglinear analysis)

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Output
As expected results are identical to logistic regression
Param e ter Es tim ate s 95% Wald Conf idence Interval Parameter (Intercept) q5 q51 q21d q43b (Scale) B Std. Error 3.169 .6152 -.085 .0283 -.022 .0072 -.441 .0769 .269 .0738 1a Low er 1.963 -.140 -.036 -.592 .125 Upper 4.375 -.029 -.008 -.290 .414 Hypothes is Test Wald Chi-Square 26.539 8.975 8.988 32.888 13.327 df 1 1 1 1 1 Sig. .000 .003 .003 .000 .000

Dependent Variable: Butcher Model: (Intercept), q5, q51, q21d, q43b a. Fixed at the dis played value.
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Ordinal logit

The dependent variable is ordered

Both factors and covariate can enter as predictors

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Output
The Pearsons Chi-square indicate a good fit, intended as the Warnings similarity between the predicted and observed data (but it is There are 975 (77.0%) cells (i.e., dependent variable levels by combinations of predictor sensitive variable values) with zero frequencies. to the large number of empty cells) A large proportion of Model Fitting Information The Pseudo R-square statistics are quite low, suggesting that empty cells may lead to the model could be improved by the inclusion of other covariates invalid goodness-of-fit -2 Log Model Likelihood Chi-Square df Sig. and factors. measures
Intercept Only Final Link function: Logit. Goodness-of-Fit Chi-Square 1088.968 816.931 df 1073 1073 Sig. .360 1.000 1004.627 987.352 17.276 7 .016

Pearson Deviance

A significant Chi-square statistic indicates that the ordered logit model is better than an intercept only model

Link function: Logit. Pseudo R-Square Cox and Snell Nagelkerke McFadden Link function: Logit.
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.051 .052 .014

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Parameter estimates
Param e ter Es tim ate s 95% Conf idence Interval Low er Bound Upper Bound -4.705 -1.017 -4.222 -.556 -3.560 .085 -2.486 1.142 -1.761 1.864 -.521 3.126 -.021 .004 -2.618 .928 -1.917 1.602 -1.857 1.719 -1.678 1.920 -1.947 1.786 -1.403 2.952 . . Threshold [q43j = 1] [q43j = 2] [q43j = 3] [q43j = 4] [q43j = 5] [q43j = 6] q51 [q60=0] [q60=1] [q60=2] [q60=3] [q60=4] [q60=5] [q60=6] Es timate Std. Error -2.861 .941 -2.389 .935 -1.738 .930 -.672 .925 .051 .925 1.302 .930 -.009 .006 -.845 .905 -.158 .898 -.069 .912 .121 .918 -.081 .952 .774 1.111 a 0 . Wald 9.250 6.528 3.492 .527 .003 1.960 1.961 .873 .031 .006 .017 .007 .486 . df 1 1 1 1 1 1 1 1 1 1 1 1 1 0 Sig. .002 .011 .062 .468 .956 .162 .161 .350 .861 .940 .895 .933 .486 .

The location parameters translate the predictors into a value for the latent variable.
Location

The threshold determines the cut-off points for allocating an observation of a given value of the dependent variable,according to the value of the latent variable.

The Wald test (corresponding to the t-test in regression) shows that the predictors Link f unction: Logit. do not actually significantly. This is consistent with the poor Pseudo R a. This parametercontribute is set to zero bec aus e it is redundant. square statistics.
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Marginal effects
What could be interesting (at least for a model with a better fit) is the computation of the marginal effects They represent the change in the probability of an observation of being classified in each specific category of the dependent variable according to the values of the predictors Unfortunately SPSS does not provide marginal effects
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Multinomial logit/probit
The process is similar to the one leading to the estimation of ordered logistic regression and the output should also be interpreted accordingly

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Statistical packages for discrete choice models


SPSS lacks some useful features like the estimation of marginal effects In SAS discrete choice models can be estimated with several procedures in SAS/STAT
CATMOD is employed for estimating logistic regression when the data are structured as a frequency table Binary and ordinal logistic regression can be obtained through the procedure LOGISTIC The same models can be estimated with the PROBIT procedure which also enables estimation of probit models. GENMOD allows one to specify a variety of link functions for generalized linear models

LIMDEP was specifically created for the estimation of limited dependent variable models,which include discrete choice models
It is extremely flexible and contains all the required features and the most up-todate diagnostics

STATA estimates discrete choice models with marginal effects Econometric views allow estimation of discrete choice models but the availability of diagnostics is rather limited when compared to LimDep and no marginal effects are displayed.
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Conjoint analysis
Very popular research technique in marketing closely associated with stated preference analysis Mainly exploited for the development of new products and the modification of product characteristics Conjoint analysis is not a model or an estimation technique but rather a methodology for constructing the data collection instrument when the final objective is choice modeling
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Marketing applications of conjoint analysis


The most common application in consumer research is the analysis of consumer evaluations of different combinations of product attributes Example
A car manufacturer needs to take some decision about some options to be provided for car configuration
range of colours model of car stereo presence of air conditioning, etc.

Rather than asking consumers about their evaluation of these attributes on a one-by-one basis,conjoint analysis starts by creating potential combinations of the product attributes E.g.
Combination 1: red car, with an mp3 stereo player and no air-conditioning, Combination 2: red car, but with a standard CD player and air-conditioning, etc.

Respondents choose among these alternative potential products defined by the combination of attributes From the final choice,conjoint analysis elicits the relevance of each attribute
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Conjoint analysis
When several attributes are considered simultaneously the number of potential combinations is quite high Conjoint analysis creates many different choice sets each one containing a limited number of options Conjoint analysis is based on the statistical control of
the way choices are allocated in the sample the distribution of attributes

Hence, the collected data enable inference on preferences and evaluations for the individual attributes
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Theoretical basis for conjoint analysis


The underlying theory for conjoint analysis is based on the economic concept of utility
each individual has a specific set of preferences for bundles of products (and attributes) individuals take decisions in a way to maximize the level of satisfaction from consumption (the utility level)

By observing many individuals it is possible to go back from stated choices to preferences Conjoint analysis is inspired by scientific experimental designs and the terminology reflects this association
Attributes are called factors (e.g. car colour) The different values factors can assume are the levels (red, blue, yellow, etc.)
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Factors and choice sets


An additional factor could be the price of the car By including price levels in the choice set it becomes possible to evaluate how much consumers would be willing to pay for the car they prefer Among the potential set of choices there are some nonsense choices e.g. including all car options but setting a very low price Nonsense choices can be excluded by the researcher who has control on the overall choice set Questionnaire
Respondents must choose from the preferred combination of attributes or Respondents must rank all possible choices according to their preferences

Conjoint analysis is a decompositional method (recall multidimensional scaling techniques),as it starts from an overall evaluation to infer preferences for the individual product attributes

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Theories attributes and choice


The experimental design and the modeling of preferences depend on theories which link the evaluation of single attributes to the final choice
part-worth model: assumes that total utility of a choice is equal to the sum of utilities of the attributes of that specific choice vector linear model: applicable when all attributes are measured on a metric (continuous) scale, assumes a linear relationship between the utility of individual attributes and total utility ideal point model: assumes that the consumer has an ideal level for all factors and the total utility depends upon the distance between the actual levels and the ideal levels
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Experimental design
The key problem of conjoint analysis is the large number of alternative combinations of attributes which arise when there are many factors and levels
E.g. a product with six attributes, each with three levels potentially allows for 729 different combinations

It would be unrealistic to assume that respondents are able to choose among so many alternatives This problem can be solved by an appropriate experimental design
Objective: understand the relationship between the factors and the potential choice with a number of observations as small as possible The experimental design sets the criteria to obtain the preference information from an aggregation of respondents (full factorial designs:
all potential products are compared (729 in the example)) fractional factorial designs: exploits the experimental design to reduce the number of choices, still guaranteeing that the sample will produce meaningful aggregate results 43

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Types of conjoint analyses


Traditional conjoint analysis
each respondent is faced with the whole set of attributes it requires either a full factorial design or a fractional factorial design all attributes appear in the choice set of each respondent (although not for all levels) becomes inapplicable as the number of factors or levels increases

Adaptive conjoint analysis


these design issues are dealt with each respondent only deals with a sub-set of potential choices these sub-set can be defined in different ways. For example: respondents could be asked to rank the factors first, then the ranking is exploited to adapt data collection Computer software learns from the earlier responses and builds the data-sets accordingly
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Choice-based conjoint (1)


The decomposition of the observed choices into weights and preferences for single attributes is generally obtained for an aggregate of consumers or for homogeneous groups of consumers Several techniques can be employed for this purpose The evolution of discrete choice models has given relevance to a specific type of adaptive conjoint analysis, choice-based conjoint Choice-based conjoint gives the respondent the possibility of evaluating all attributes, not in a single (often too complex) choice, but rather within a sequence of smaller choice sets where the possibility of choosing none of the alternatives is also given
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Example
Example
Car colour: red or blue Air conditioning: yes or no Single choice set
red with air conditioning (AC) red without AC blue with AC blue without AC

Choice-based conjoint
first choose among
red with AC blue without AC none of them

then choose between


blue with AC blue without AC none of them

These choices are related and with a smaller set of choices it is possible to compare all attributes
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Choice-based conjoint (2)


The advantages of choice-based conjoint are apparent with complex cases Respondents do not need to compare too many stimuli at once, They face a more realistic choice among a limited set of alternatives With many factors and levels, each respondent can be asked to face a limited number of choice sets The sufficient condition is that an homogeneous group of respondents (i.e. respondents that are similar in terms of characteristics that can influence the choice) is confronted with the whole range of alternatives, then the estimation technique will do the rest
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Estimation and models


The experimental design is at the core of a successful choice-based conjoint There is an evolving research effort to guarantee the quality of the analysis Once the data has been collected the natural estimation technique is the multinomial logit
choices represent the categorical dependent variable and the attribute levels are the explanatory variables

There are computer packages specifically developed for conjoint analysis SPSS Conjoint module
deals with the experimental design provides estimates based on an orthogonal decomposition of the design matrix

In SAS/STAT, the TRANSREG procedure is a useful support to define the experimental design
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