Streamline Training & Documentation: The Market Approach to Decision-Making

Wednesday, June 21, 2006

The Market Approach to Decision-Making

One of the most interesting innovations in decision-making that I've encountered uses market dynamics to make forecasts about the uncertain future. You can find a good introduction to this technique in a June 19 Wall Street Journal article by Michael Totty.

Economists have been testing what they call decision markets or prediction markets for some years now. The researchers report good results from these markets' ability to tap the collective wisdom of people to make predictions about the future, even if the "wisdom" of any single individual participant is weakly informed.

The Iowa Electronic Markets is the example I'm most familiar with. Operated by faculty at the Iowa business school, "[t]hese markets are small-scale, real-money futures markets where contract payoffs depend on economic and political events such as elections." In the case of elections, the market predictions have consistently been more accurate than predictions based on polls.

The WSJ article reports on software you can buy to set up your own internal decision market. Your employees can "bet on future events, such as forecasting sales or betting on the most promising new product." Totty describes how GE's computational-intelligence lab used such software to evaluate project ideas:

With the market, anyone could float "stock" in a proposed project; lab members began with a fixed amount of money, and then could buy shares in their favorite. The price of projects,which began at $50, rose and fell based on demand, with prices capped at $99. At the end of three weeks, the project with the highest price was declared the winner, and the winning team received financing to develop its idea.

Totty also explains why this market approach tends to generate beter predictions than alternate methods:

[C]onsider the usual alternatives companies have for aggregating this sort of knowledge: committee meetings, polling, reports or focus groups. Meetings are often dominated by the person with the best arguments or most forceful personality, not necessarily with the best information. Sales quotas, budgets or other factors can distort or deter the accurate sharing of information.

In contrast, in decision markets, prices reflect all the information players have — data, opinions or intuitions — about the likelihood of some future event. While each player may have very little information, collectively they have a great deal. By rewarding winners, markets give players the incentive not only to share the information they have (by placing bets on the favored outcomes) but to make an extra effort to gather more data.

The markets also empower participants in ways that meetings or surveys can't. That's because companies can set it up so that a broad array of workers take part in the markets. "Guys on the shop floor think this is terrific because they get to talk to the CEO," says Justin Wolfers, a Wharton School assistant professor of business and public policy who has studied decision markets. "CEOs like it because they get to talk to the guys on the shop floor."

You can read more about the software mentioned in Totty's article at the Consensus Point, NewsFutures, and Inkling websites.

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Labels: Prediction markets

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