The Flaw of Averages
Why It Can Mislead Your Business Decisions or make your reporting “wrong”
The concept of averages is often used in business to summarize complex data into a single, digestible number. Whether it's average revenue, average customer spend, or average profit margins, businesses rely heavily on these figures to make strategic decisions. However, as humorously illustrated in the image above, averages can be dangerously misleading and lead to poor decision-making.
The cartoon shows a person drowning in a body of water labeled "Average Depth: 3 ft." While the average depth suggests it is safe to cross, the reality is that there are deeper areas that pose significant risks. This metaphor perfectly captures the flaw of averages—a phenomenon where decision-makers assume that the average value represents the overall situation accurately, when in reality, significant variations exist.
The Danger in Business Metrics
When analyzing financial metrics such as gross margins, profit, or loss, relying solely on averages can obscure critical insights. Consider the following example:
A business has two product lines. On average, the gross margin is healthy at 40%.
Product A generates a 60% margin.
Product B, however, operates at a 10% loss.
If management looks only at the average, they might assume the business is performing well overall. However, breaking down the data reveals that Product B is dragging down profitability, and without corrective action, it could erode the business’s long-term health.
The Importance of Granular Analysis
To avoid the pitfalls of averages, business leaders should:
Segment Data: Analyze performance at a more granular level—by product, customer segment, or region.
Look for Extremes: Identify outliers that could skew averages and investigate their causes.
Use Distribution Overviews: Consider metrics such as medians, percentiles, and standard deviations to get a fuller picture.
Regular Reviews: Averages might mask emerging trends, so regularly reassess and adjust business strategies accordingly.
Conclusion
The flaw of averages can lull business owners into a false sense of security, leading to misguided decisions and missed opportunities. By breaking down key financial metrics, businesses can uncover hidden opportunities and risks, enabling better-informed, strategic choices.
Next time you encounter an "average" figure, take a deeper dive—you might be surprised at what you find beneath the surface.
