How to Use Correlation in Business Decision Making
By Rachel Rinehart
Correlation is an important concept that can be used to analyse data sets and assist business leaders in gaining useful insights into the relationships between business outcomes.
In business, these relationships can be used for decision making tasks across all functional areas. For example, a business could analyse trends in sales over time to see whether lower pricing has consistently occurred in the same period as higher sales numbers. If a pattern is noticed, the business may have a better indication for the optimal pricing level to achieve their desired sales amounts.
Correlation is about repeated patterns – it takes more than one isolated instance to create a correlation. When conducting a correlation analysis, the more data points that are available, the more accurate the results of the analysis will be. It is important to have sufficient data before relying on correlations to make business decisions.
The strength of a linear correlation between two variables is determined by the degree to which they move together in a dataset. Using Pearson’s Correlation Coefficient, correlation can be any value between -1 and 1, with the weaker correlations near 0 and stronger correlations at the tail ends near 1 or -1. Weaker correlation values (close to 0) have less predictive power, but can still have valuable business insights.
If analysis determines that correlation strength is weak between two variables, it doesn’t mean the analysis is useless! There may be an opportunity for a company to make time or cost saving improvements. For example, a company notices that the relationship between high TV ad marketing spend and higher sales is not highly correlated. In this instance, the company may make the decision to reduce TV ad marketing, resulting in cost savings.
Distinguishing positive and negative correlations
Correlation can be divided into two main types: positive and negative correlations. A positive correlation means when one variable increases, the other also increases. This type of relationship is often seen in successful customer buying trends and healthy marketing performance. For example, a business may see a positive correlation between their promotional campaigns and sales, showing that when they increase their promotional efforts, sales go up during the same time period.
Negative correlations indicate that when one variable increases, another tends to decrease. One example of this could be that an increase in customer service employees correlated with a decrease in customer complaints. This relationship may help a business assess the success of hiring the new employees.
Important caveats to keep in mind
As the age-old saying goes: correlation is not causation. It is important for businesses to understand the difference to avoid falling into pitfalls with decision making.
Correlation does not necessarily imply causation; while there may be an apparent connection between two variables in a correlation analysis, it does not necessarily mean that one causes the other.
In order for an individual or business to draw meaningful conclusions from their data, they must take into account any other possible factors which could have caused the observed correlation such as external influences or seasonal trends. Additionally, further research should be conducted in order to understand the underlying reasons behind any observed correlations before making decisions based on them.
Businesses must also keep in mind that just because two variables are historically correlated does not ensure that the relationship will be the same in the future. Always consider outside influences that may have an impact on the relationship in the future.
The benefits of correlation in decision making
Correlation analysis uses historical data to help inform decisions such as those related to marketing campaigns, product offerings, and workplace efficiencies. It is critical for businesses to use both qualitative and quantitative strategies for decision making, and correlation is an efficient way of quantitatively assessing performance of current and historical initiatives to see what works well.
Understanding the impact of business initiatives on desired outcomes can help companies identify trends, uncover hidden opportunities, refine strategies, allocate resources more efficiently, and make better decisions overall.