Why Probability is important in Business

Business Management is all about decision-making. Most businesses in arriving at their business decisions apply the understanding of probability methods and models. Instincts alone seldomly lead to success in business. But applying the understanding of probability to business decisions will help one to make better and safe decisions. Probability helps one to weigh the available options and decide on the appropriate risk to take at each point.

To understand probability better, let us look at its concept. Probability can be understood as the numerical measure of the likelihood of occurrence. The probability of an event is the sum of the sample points that make up the events. It ranges between 0 and 1. Where 0 means the event to be an impossible one and 1 indicates a certain event. The probability of all the events in a sample space adds up to 1. An event is a subset of sample space while sample space is the set of all the possible outcomes to occur in any trial. Also, an event is any combination of outcomes.

Probability is always a positive value. For example, by flipping a coin once, you have a 50% chance of guessing the correct side. Flip three coins and your odds of guessing the outcome for all three coins reduce to only 12.5%. The probability of an event can be calculated by simply dividing the favorable number of outcomes by the total number of possible outcomes. Three ways to represent a sample space are, to list the possible outcomes, to create a tree diagram, or to create a Venn diagram.

In the business world, you need to make plans, draw a budget, draw some estimates, and plan based on your estimate. These estimates are normally made based on assumptions and previous history. There is a level of uncertainty in assumptions that involve risk. Uncertainty has to do with our lack of knowledge regarding the certain outcome of an event. Many events cannot be predicted with total certainty. There are different outcomes for a single event. Therefore, by applying probability models to an event, the different outcomes and risks involved will be analyzed and assist to deliver sound decisions.

There are three ways of assigning probability. These are the basic probability relations that can be used to compute the probability of an event. They are the classical method, relative frequency approach, and subjective method. The classical method is used in analyzing when you have equally likely outcomes. In making a business decision, we apply it where we do not know the likelihood of several possible outcomes. The relative frequency approach uses the past to make predictions about the future. It is the number of times an event occurred divided by the total number of opportunities for the event to occur. While the subjective method is the evaluation of the probability of an outcome based on one’s own estimation.

The importance of probability in a business decision cannot be overemphasized. Its concepts can be applied in several areas of business which include but are not limited to investment, product design, competition strategy, customer service, sales predictions, risk assessments, and so on. Therefore, a sound understanding of probability is a good prerequisite for good business decision outcomes.