Friday, April 4, 2008

Predicting Lost Luggage

I read an interesting article on prediction markets by Gary Stix in the March, 2008 issue of Scientific American. The bulk of article discusses the success rate of the Iowa Electronic Markets in predicting election results based on buying and selling “securities” – portfolios of contracts for both candidates. In presidential elections from 1988 to 2004, the Iowa Electronic Markets have predicted final results better than the polls three times out of four.

The article provides a great description of how the market works. It also highlights other prediction markets that allow speculators to predict almost any conceivable event, from a Chinese moon landing by 2020 (Foresight Exchange) to Katie Couric departing from CBS News (Intrade) to the first human-to-human transmission of avian flu (Avian Influenza Prediction Market).

While these events are important, and might be fun to risk a few dollars on prediction, I was most interested in the internal markets that are being established to gauge the success of business efforts:

“Attracted by the markets’ apparent soothsaying powers, companies such as Hewlett-Packard, Google and Microsoft have established internal markets that allow employees to trade on the prospect of meeting a quarterly sales goal or a deadline for release of a new software product. As in other types of prediction markets, traders frequently seem to do better than the internal forecasts do.”

I wonder whether an internal prediction market may have help with the disastrous opening of Heathrow Airport’s new Terminal 5. Despite headlines like this:

they clearly weren’t ready for their opening week - hundreds of cancelled flights, thousands of lost bags, and a financial and PR nightmare for British Airways and BAA.

There has been a lot of Monday-morning quarterbacking (or the equivalent soccer term) about the decision to open the new terminal in “big bang” fashion. Critics have suggested a phased approach might have reduced the problems, and citied other major infrastructure projects (like the new St. Pancras rail station) as examples. I’m guessing that the executive team considered both options and researched other airline terminal openings before making their decision. (I remember when the new Pittsburgh airport opened in 1992; the last flight landed at the old airport about 10 pm, and army of people and moving vans transferred all the operations equipment to the new terminal about a mile away, and the first flight landed at the new airport at 6:00 am. Despite some initial problems with the automated baggage-handling systems, this big-bang approach went much more smoothly that Heathrow’s.)

Would an internal market, reflecting the collective knowledge of the Heathrow employees, have predicted such a chaotic opening? Experts still don’t know exactly how prediction markets work. I’m wondering whether the accuracy might have something to do with the “degree of influence” the market participants have over the outcome.

For many events – like predicting the amount of snowfall in Central Park, or the outcome of the NCAA tournament games – a trader has no influence over the outcome and is, effectively, guessing.

For other events – like predicting an election outcome or the success of a new movie – a trader has limited influence. An individual vote influences election results (unless you’re a Republican living in Massachusetts). A person can attend the opening of a movie and tell all their friends how great it was.

Most intriguing are those events where traders have significant or considerable influence over the outcome – the sales manager responsible for meeting the quarterly target, the project manager trying to launch on time, or the baggage handlers at Heathrow who not only have to use the new systems but have to show up at a new location before they even see their first bag of the day.

Is there a correlation between “amount of influence” and “accuracy of prediction?” Can markets provide field-level insight that executives can’t (or won’t) see? If a “Terminal 5” market had existed and “successful opening” contracts were trading at low prices, would BA chief executive Willie Walsh have used this information to delay the opening, conduct more testing, and phase-in new operations over time?

Does your company use prediction markets? Have they been successful?

NCAA Update: Well, the Selection Committee looks pretty good as – for the first time in NCAA men’s basketball history – all four No. 1 seeds are in the Final Four. Would a prediction market have helped? According to this news story,

“…of the 500,000 fans playing on, more than 51,000 correctly predicted the final four teams…”

Assuming that some of those 10% were basketball junkies while others picked their brackets based the team’s jersey colors, can we can draw any conclusions about a “wisdom of the crowd” factor in the NCAA tournament?

1 comment:

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