The Use of Probability in Business

The word probability is often used to express uncertainty or likelihood of an action that is to take place. We unconsciously and informally apply the concepts of probability in our daily lives without really paying attention, either through past outcomes or by general beliefs.

The probability of rainfall? We instinctively look up at the skies and guess the outcome by the color and drifts of the clouds – the greyer the clouds, the more likely it is to rain.

Data Analytics provides a more refined understanding to the application and calculation of probability.

Probability is a statistical measure for quantifying the likelihood that events will occur. The probability of an event happening lies between 0 and 1, where 0 indicates impossibility and 1 indicates certainty. The higher the probability of an event, the more likely it is that the event will occur.

Here, we will discuss the various uses of probability in a business environment.

Finance

Probability in finance assesses the financial risk in decision making. It determines the possibility of profitability of a product, factoring in competition, current demand, and costs of production.

In the financial markets, investors use probability to predict ROI on investment instruments, stock, and assets and to hedge their risks.

Marketing

Probability in marketing directs sales projections and forecasting for an effective sales plan. It helps stakeholders determine future sales expectations in relation to demand and specific time frames. Business executives use probability to evaluate market competition and trends. It is used to measure market reactions on the efficacy of a product, and to determine the best marketing campaigns to deploy in relation to changes in sales.

Operations

Probability in operations measures product efficiency in its design and development, to identify any defects or successes in the product. It analyses past operational environments to predict future operational outcomes in instances such as purchasing and procurement, capacity planning, human capital, information, distribution.

Logistics

The logistic regression model calculates the predicted probability of an outcome occurring, out of two alternatives.

Managerial decisions

Data from the various facets of probability in business helps business managers make improved, effective decisions for the business. These probabilities help managers analyze past performances to project future outcomes. They can determine what risks to take and calculate gains against possible losses.

These can further be broken down to the following concepts.

Scenario Analysis

Probability distributions can be used to create scenario analyses. A scenario analysis uses probability distributions to create several, theoretically, isolated possibilities for the outcome of a particular course of action or future event.

Sales Forecasting

Another use for probability distributions in business is to predict future levels of sales – sales forecasting. In addition, using a scenario analysis, a business can frame its possible future values based on the outcomes of different scenarios. Here, a business can forecast and make business plans based on the likely scenario, but still be aware of the alternative possibilities.

Risk Evaluation

In addition to predicting future sales levels, probability distribution is a useful tool for evaluating risk.  If a company needs to generate NGN50,000,000 in revenue to break even and the probability distribution tells them that there is a 5% chance that revenues will be less than NGN50,000,000, then the company would have an idea what level of risk it might face.

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