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Understanding Correlation

by John Gross

Correlation is a word that is often used and often misunderstood. Correlation is defined as a relationship that exists between 2 variables which tend to vary, be associated, or occur together in a way not expected on the basis of chance alone. In business, understanding these relationships provide valuable insights for problem solving and decision-making.

While correlation is a useful tool for businesses, we need to understand its limitations to avoid poor decision-making. There are 3 types of limitations that can cause misinterpretation:

1. Spurious Correlation—when two variables appear to be related but are actually caused by a third variable or by random chance. For example, ice cream sales and shark sightings are positively correlated, but this is really due to hot or cold weather.

2. Overgeneralization—when a correlation observed in one context is wrongly applied to a broader context. For example, a marketing campaign correlates strongly with sales in one region but not in all regions.

3. Reverse Causality—when the direction of causation is misunderstood. For example, a company might observe a correlation between high employee morale and increased productivity and conclude that morale boosts productivity, when it could be that higher productivity boost morale.

You can avoid these limitations by:

1. Applying rigorous data or graphical analysis.

2. Understanding the data and applying subject expertise (as well as common sense).

Correlation is a useful tool in the business decision-making process. It aids in understanding relationships and predicting trends. However, it should be used with an awareness of its limitations. Properly used, correlation significantly enhances the quality of decisions and drives success.

John Gross is an EOS Implementer who helps businesses achieve Vision, Traction, and Healthy. You can contact John at John@ DrivingChangeInc.com or call 636.667.0579.
 

Submitted 28 days ago
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Categories: categoryEntrepreneur's Toolbox
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