Question

Read the article titled “What Is the Importance of Probability Rules in a Business?” listed below.

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What Is the Importance of Probability Rules in a Business?

by Kevin Johnston

Probability has a popular meaning that is not the same as the mathematical meaning. As a small-business owner, you may act on hunches, guesses and instincts. After such actions, you might even say you thought a certain outcome was "probable." However, the mathematics of probability has rules that you can use in a much more disciplined way than guesswork to predict possible outcomes for your business plans.

Classical Approach

The classical approach to using probability depends on several future events that are equally likely to happen. In rolling a die, for example, the odds are equally likely for rolling a 1, 2, 3, 4, 5 or 6. If you roll the die once, you have a 1 in 6 chance of getting the number you want. The formula is the number of favorable outcomes divided by the total number of possible outcomes. Note that if you roll the die twice, the odds are 2 in 12 that you will get the number you want (this is the same value as 1/6). This is because the possible outcomes double if you throw the die twice.

Using the Classical Approach in Business

You can use the classical approach to probability when making business decisions where you don't know the likelihood of several possible outcomes. You assume they are all equally likely, then look at how many attempts you will be able to make. However, in your business, if 6 possible outcomes are equally likely, but they are not affected by how many times you try, you can cut your odds in half with repeated effort. For example, if you make 2 tries, your effort will have a 2 in 6 chance. Notice that 2/6 = 1/3. You have moved from a 1 in 6 chance of success to a 1 in 3 chance.

Relative Frequency Approach

The relative frequency approach uses the past to make predictions about the future. You look at how many times an event has happened and then look at how many opportunities exist for the event to occur. The formula is the number of times an event occurred divided by the total number of opportunities for the event to occur.

Using Relative Frequency Approach in Business

You can use relative frequency to improve your business decisions. For example if your research shows there are 75 failures for every 100 business startups attempted, you would say that 75 out of 100 startups fail. This reduces to 3/4. That would mean 3 out of 4 startups fail. If you don't do something to change your odds, you can expect that failure probability. This mathematical reality can give you a sense of urgency in your efforts to be the 1 out of 4 that succeeds. In fact, you could study the successes to see how they changed the odds in their favor.

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