What is Probability?
Probability is a mathematical technique used for improved business decision-making in the face of uncertainties and risks. Uncertainty may be expressed as “likelihood”, “chance” or “risk”. Probability ranges from absolute certainty (denoted by ‘1’) and absolute impossibility (denoted by ‘0’). Thus, probability takes a value within the range of ‘0’ to ‘1’. The higher the probability figure, the higher the chances of an event happening while the lower the figure, the lower the chances.
Probability may be objective or subjective. Probability is objective when the chance of an event is based on past data and the circumstances are repeatable by test e.g. tossing of a coin, throwing of advice, etc. In this case, the outcome is predictable with certainty.
Most often, the objective probability is less applicable in business, hence the use of subjective probability which is a quantification of personal judgment, experience, and expertise.
Probability models can greatly help businesses in optimizing policies and making informed decisions. The application of probability methods can increase the chances of profitability and success of a business. Probability has a wide range of applications in the business including Finance, Marketing, Operations, Logistics, and Managerial Decisions.
There are various financing activities with options available to a business. Such options include owner equity, bank loan, overdraft, debenture, and credit facilities. Other alternatives are public offerings, donations from families, and friends, money market, and capital market instruments.
There are risks and uncertainties attributable to all the alternatives. An organization must make a deliberate effort to determine the impact of associated risks before deciding on a finance option. The probability model is used to compute associated risks so that the best alternative or combination thereof that will maximize profitability and earnings may be adopted.
Equally, profitability outcome depends on investment strategy. One way by which a business can consider investment risk is by the use of probability. Following careful analysis of probabilities of gain and loss associated with each investment option, probability models can be applied to determine which investment or investment combinations yield the greatest expected return.
Marketing is a key component of business that deserves special attention due to numerous variables including the business standing, strength, weakness, opportunities, and threats. Market research variables such as market coverage, product offerings, and branding, customer behavior, supply chain, competitors and strategies, government regulation, public relations issues, consumer preference, logistics, weather, climate, etc. are some other factors that shape the choice of marketing strategies. Application of probability methods helps to minimize risks and uncertainties surrounding identified key various. This will assist the manager to identify viable marketing options and select the best fit that drives business policies and achieve business objectives. A basic application of probability distributions in marketing lies in anticipating future sales turnover. Businesses rely on sales forecasts to predict revenues, so the probability distribution of expected sales volume to achieve targeted turnover. Probability distribution will assist marketing decisions such as customer service, product design, and competitive strategy.
Decision-making in a business environment is surrounded by various events which are outside the control of the manager. This makes decision-making rather complex. There is little opportunity in trying to predict a single outcome from a series of events, but can be lots of opportunity in predicting a range of outcomes.
Faced with risks and uncertainties, four strategies may be used to increase the probability of business success:
- Identity unknown variables,
- Don’t rely solely on single outcomes,
- Target range of outcomes centered around what is most likely, and
- Identify trends or patterns in outcomes.
Probability gives us a way to proceed rationally where uncertainty exists. It assists us to make the best decisions given what we know and don’t know.
It is worthy of note that the use of probability does not make the decision itself. It, however, provides more information on which a more informed decision can be made.
Operations and Logistics
In business operations and logistics, probability can be used to determine the cost-benefit ratio or to analyze processes by addressing the likelihood of improved effectiveness, efficiency, delivery time, value for money, and profits. The application of probability is useful to calculate the possibility of success of a new distribution channel, market demand, market value, and operational, and logistics costs. In manufacturing operations, for instance, the probability is applied to ascertain the likelihood of producing defective products, and regional need and capacity.
Instinct and the rule of thumb have proved a poor technique in business decisions. Since business operates within a complex environment with numerous variables, decisions are strewed with risks and uncertainties. Probability distribution in addition to scenario analysis, risk evaluation, and forecasting, is a veritable tool for minimizing risks and uncertainties surrounding identifiable alternatives. Probability theory is used to determine long-term gains and losses and thus make informed decisions.