People often speak of the law of averages, but very few fully understand what it means. It’s often misunderstood as chance, or luck, which isn’t the same thing at all. Understanding the law of averages is essential if you’re going to flourish in many different businesses and in many different walks of life. Before we get to how the law of averages can help you succeed in business, let’s explain what it really means.
The law of averages means that if you perform a random action enough times, the results will even out.
Sounds pretty simple, doesn’t it? That simplicity can lead to trouble. It’s easy to misunderstand the concept of results evening out, and it can lead you to make rash decisions. Take this example:
Flip a coin one hundred times. The law of averages states that the coin will land on heads about fifty times, and on tails about fifty times.
That’s true as far as it goes, but where people get into trouble is expecting the coin to land on heads every other time. That’s very unlikely. Results even out over time if the sample size is large enough, but there can be streaks of outcomes that happen during long runs of the same activity. Businesses like casinos and insurance companies understand streaks, and calculate their profit margin on the sample size to guarantee that they make money.
Human Nature Sees Patterns Where They Don’t Exist
If you were to spin a roulette wheel, and you won on your first try, you’d be smart to leave the table. But human nature being what it is, you begin to convince yourself that small sample sizes are enough to determine outcomes. If you kept spinning the wheel, and kept losing, you might make the same mistake in the other direction, and assume that you’re “due” because you’ve lost so many times in a row. The law of averages doesn’t work that way. Your chances on the next spin are the same as on any random spin, and aren’t affected by what’s already happened. The casino has more money than you, so it can afford to wait for you to run out of money before your winning streak returns.
Use the Law of Averages To Stay on Track in Business
In business, if you know the ratio of success for an activity you’re familiar with, you can extrapolate using the law of averages to determine how much work you’ll have to do in the long run to make a quota, for instance. If one person in one hundred that receives a phone call pitch for a sale buys something, and you have to sell ten things, you should expect by the law of averages that you’d have to call a thousand people before you make your quota. If the first three people buy something, that doesn’t mean everyone will.
By using the law of averages, you can keep yourself from getting too depressed when a streak of bad luck comes along, or from getting giddy when you’re on a hot streak. In the long run, you’ll always prevail if you stick to your plan, and the plan was based on sound statistical analysis.