An ice-cream seller will definitely sell more ice cream in hot weather but is there a

correlation between your product and service and temperature? Correlation analysis
would allow you to work that out.
Alternatively you can use correlation analysis when you want to know which of
several pairs of variable shows the strongest correlation. So you may want to see
whether temperature affects sales more than time of year for example.
And finally you can use this type of analysis speculatively on quantifiable data
sets to see what emerges. Sometimes correlation analysis will highlight an unex-
pected relationship that could warrant further analysis and potential exploitation. For
example, Walmart discovered an unexpected relationship between the purchase of
Pop-Tarts and a hurricane warning. Apparently when there was a severe weather
warning in the US, the sale of Pop-Tarts increased. This knowledge allowed Walmart
to position Pop-Tarts at the entrance of the store following a hurricane warning,
further pushing up sales. An unexpected correlation was also discovered between
beer sales and nappy sales in the United States. Presumably the father sent to buy
nappies would be reminded that he wouldn’t be going out this weekend and bought
some beer instead. These types of insights can of course be extremely useful and
lead to even higher sales with a little in-store product positioning.

What business questions is it helping me to answer?

Essentially, correlation analysis can help you to make connections between quantifi-
able variables that can help you to make better decisions and improve performance.
It can help you to answer:
● Are our most loyal customers also our most profitable?
● Do customers purchase more when the price is lower?
● Does pay influence length of tenure?
● Does number of annual holidays influence absenteeism?
● Is there any relationship between factor X and factor Y?
Correlation analysis can be essential for testing assumptions prior to alterations in
strategy or product mix.

How do I use it?

If you are feeling brave and you have a scientific calculator to hand then you can use
what is known as ‘Pearson’s correlation coefficient’®.

(gX )(gY )
gXY -
n
r =

A
b a gY 2 -
(gX )2 (gY )2
a gX 2 - b
n n

3: C OR R ELAT I ON AN ALYS I S 13
 1 First you need to gather your data for the two variables you want to analyse.
You can calculate the correlation for any quantifiable data set.
2 Create a spreadsheet or table that lists the data sets vertically in columns.
In the first column, labelled x, add all the data for your first variable (x) and in
the second column, labelled y, add all the data for your second variable (y).
3 Label column three, four and five ‘x y’, ‘x x’ and ‘y y’ respectively.
4 Perform the relevant calculations in column three, four and five, i.e. ‘x y’ 5 x
multiplied by y, ‘x x’ 5 x multiplied by x, and ‘y y’ 5 y multiplied by y.
5 Add all the values in each column and add the total at the bottom of each
column.
6 Insert the numbers into the equation to establish the correlation between the
variables under investigation.
Alternatively you can use software and there are many correlation tools on the market.
You can make your life a little easier by using desktop software such as Microsoft
Excel that contains pre-installed formulas to calculate your correlations. There are
many simple online tutorials available to explain how you use it.

Practical example
Say you wanted to find out whether there was a relationship between the price
you charged for your product and the number of units sold at that price. Often the
assumption is that the cheaper a product is the more units of that product you
are likely to sell, but that hypothesis does not always hold true. Considering how
important price and sales are to revenue and growth you decide it’s time to actually
establish if that assumption is true or not.

x (price) y (units sold) xy xx yy

5.00 56 280 25 3136

7.50 54 405 56.25 2916

10.00 50 500 100 2500

15.00 40 600 225 1600

37.5 1785 406.25 10152

Sxy 5 (5)(56) 1 (7.50)(54) 1 (10)(50) 1 (15)(40) 5 1785

Sx 5 5 1 7.50 1 10 1 15 5 37.5
Sy 5 56 1 54 1 50 1 40 5 200
Sx2 5 25 1 56.25 1 100 1 225 5 406.25
Sy2 5 3136 1 2916 1 2500 1 1600 5 10152

14 PART ON E: BAR E ANALYT I C S

 (gX )(gY )
g XY -
n
r =

Aa
b a gY 2 -
(gX )2 (gY )2
gX 2 - b
n n
So:
(37.5)(200)
1785 -
4
R = = -0.389

A a406.25 -
(37.5)2 (200)2
b a 10152 - b
4 4

This result indicates that there is no statistically significant correlation between price
and unit sold.

Tips and traps

If you already have the data, you might like to try some speculative correlation
analysis to see if you can find unexpected relationships or connections that you
could exploit for additional sales.
If two variables are correlated that does not imply that one caused the other
it simply means there is a relationships between them. Don’t be caught out by
assuming causation. Equally, just because two variables are not correlated does not
mean they are independent of each other.
Remember, establishing a correlation between two variables is not a sufficient
condition to state categorically that there is a causal relationship between the two.
A business experiment would help to clarify if a causal relationship does exist.

Further reading and references

Correlation analysis is a basic statistical method that is covered in more detail in
most statistics books and websites. See for example:
● Urdan, T. (2010) Good Books are Statistics in Plain English, London:
Routledge
● Rumsey, D. (2011) Statistics For Dummies, Hoboken, NJ: Wiley Publishing

3: C OR R ELAT I ON AN ALYS I S 15
 4 Scenario analysis

What is it?
Scenario analysis, also known as horizon analysis or total return analysis, is a
method of projection. It is an analytic process that allows you to analyse a variety of
possible future events or ‘scenarios’ by considering alternative possible outcomes.
By planning out the detail required to implement a particular decision or course
of action you can observe not only the final potential outcome but also the viability
of the path leading to that outcome. Often it’s only when you really consider what
would be involved in the actual implementation of an idea that you fully appreciate
the scope of that idea. Scenario analysis therefore allows you to improve decision
making by fully considering the outcomes you expect and their implementation
implications without the cost and time involved in actual real-world implementation.
Scenario analysis does not rely on historical data and doesn’t expect the future
to be the same as the past or seek to extrapolate the past into the future, rather it
tries to consider possible future developments and turning points.

When do I use it?

Use scenario analysis when you are unsure which decision to take or which course
of action to pursue. It can be especially useful if the implications of the decision are
significant. For example, if the decision would cost a great deal of time or money to
implement or if the ramifications of getting the decision wrong could be fatal for the
business then scenario analysis can be a very powerful tool.
It can be used to assess the possible likely future of different strategic choices or
it can be used to generate a combination of different scenarios that look at the same
scenario but from three different perspectives – the optimistic version of events, the
pessimistic version of events and the most likely scenario.
It is also a very useful tool if you are unclear about what is going to be involved in
the execution of a strategy or decision as the process required pushes you to really

16
engage with the scenario you are testing. This amplified engagement can help to
anticipate more of the pros and cons of each scenario therefore reducing risk and
directing you to the best choice.

What business questions is it helping me to answer?

Scenario analysis can help the decision-making process by looking at the likely
implications of that decision and how it might or could pan out in the future. It can
help you to answer:
● Which strategic direction do we take?
● What are the best countries to expand our business into?
● Do I open in a new location or upgrade or expand the retail stores I currently
have?
● Do I invest in a new market or seek to increase market share in the one I’m
already in?
Scenario analysis can help to prevent errors of judgement and direct strategy.

How do I use it?

Essentially, what you are doing in scenario analysis is attempting to work out if the
world would turn out a certain way if certain conditions were met. The process
usually consists of a five-stage process:
1 Define the problem.
2 Gather the data.
3 Separate certainties from uncertainties.
4 Develop scenarios.
5 Use the outcome in your planning.

Define the problem

Obviously the only reason you would use scenario analysis is if you were trying
to gain insight into a particular challenge. The first step is therefore to define the
problem you are trying to solve or gain greater understanding of it so that you can
make the best decision.
It is also important to think about the time horizon. Most decisions need to be
made within a timeline so make sure you have enough time to conduct the scenario
analysis before the decision needs to be made.

Gather the data

So what is going to affect or influence the scenario you are considering? Identify
what data and information you need to make the analysis as realistic as possible.

4 : SC EN AR I O AN ALYS IS 17
 You may, for example, consider trends and what uncertainties exist around your
scenario.
You could use PESTLE analysis as a guide in gathering data – what could affect
the outcome when you consider politics, economy, social, technical, legal and
environmental issues? Also seek to identify the key assumptions on which the plan
might depend.

Separate the certainties from the uncertainties

You will invariably come into the analysis process with a host of assumptions and
preconceptions about how the analysis will turn out. It is important that you become
aware of what those assumptions are so you can really shine a light of enquiry on to
those assumptions and separate the certainties from the uncertainties.
Take a moment to challenge all your current assumptions and decide if they are
certainties or uncertainties. It is always best to err on the side of caution; that way if
the outcome is better than expected it’s a bonus, whereas an outcome worse than
expected could be a disaster and would negate the whole purpose of running the
analysis in the first place.
List the uncertainties in order of priority with the largest, most significant uncer-
tainties at the top.

Develop scenarios
Starting with the top uncertainty – what would you consider to be a good outcome
for that uncertainty? What would be a bad outcome? Once you’ve done this
develop a story of the future around each that marries the certainties with the
outcome you’ve chosen.
Do the same with each of the major uncertainties you’ve listed.

Use the scenarios in your planning

This process will give you much more knowledge and clarity around the situation
you face and you can use the scenarios to influence and guide your planning.
There are commercially available scenario analysis tools on the market that can
make scenario planning much easier.

Practical example
Scenario analysis is essentially a planning tool that can allow you to identify various
factors that could affect a proposed plan and assess how those factors may play
out in the future so you can see which alternative is most likely to work out well.
Say you are planning to start a new business that helps clients implement a spe-
cific new software program. You want the business to be turning over £1 million within
five years. But is that feasible? A friend suggests that you run some scenario analysis
to help you get a clear picture of that challenge and how likely that outcome really is.

18 PART ON E: BAR E ANALYT I C S