"The economic problem of society is thus not merely a problem of how to allocate "given" resources ... it is a problem of the utilization of knowledge which is not given to anyone in its totality."
Friedrich Hayek, the 1974 Nobel Prize winner in economics, wrote these words in his 1945 classic essay, The Use of Knowledge in Society, in which he argued that centrally-planned economies are unable to efficiently allocate societal resources because their planners, no matter how smart they were, would never have all the information required to make the correct decisions. Hayek, on the other hand, asserted that pricing systems, (e.g. stock markets), which reflect the collective knowledge of a myriad of individuals is a much better approach for performing resource allocation decisions. Market systems which signal the value of a resource through a numerical index (i.e. price), he said, are "a mechanism for communicating information", with the "most significant fact about this system [being] the economy of knowledge with which it operates, or how little the individual participants need to know in order to be able to take the right action."
The problems that Hayek said governments face in best allocating resources are nearly identical to what most organizations face. How can the corporate planners have access to all of the information they need to best allocate scarce corporate resources to increase shareholder value? And, as Dominic Dodd and Ken Favaro, in their book, "The Three Tensions," point out, is the best way to increase shareholder value to increase corporate profitability or growth? Allocate resources for results today or tomorrow? Allocate resources to increase the performance of the corporation as a whole or performance of standalone business units? Could it be some combination of all six
The Future Value of Decisions
The growth of business intelligence over the past decade reflects the idea that corporate planners - be they on the corporate executive staff, business managers or line managers - need better information to make their allocation decisions, and properly structured BI can often help fulfill this need. However, the focus of BI in many instances seems to be more on answering questions about "what was" or possibly on "what is," data that reflects the past or recent past - rather than on what will be. The current focus on BI corporate dashboards is an example. What planners truly need is information about "what might be." - i.e., what is the future value of present decisions
Markets systems fit this bill nicely since they are focused primarily towards predicting the future. A corporation's stock price, for instance, reflects not only information about the corporation's current course and speed but also its projected course and speed as perceived by its current investors and non-investors alike. When a corporation releases its quarterly earnings and investors react positively or negatively, for example, they are making a collective judgment on the corporation's future financial risks, not its current state of play.
It has long been recognized that collective judgment provided by market systems can be very useful in making accurate predictions about future events, but it has only been in the past 30 years or so that "maverick" economists such as Vernon Smith (who won a Nobel prize in economics in 2002), Charles Plott, John Ledyard and Robert Forsythe have focused on how to use the predictive power of markets for uses other than for managing financial risk. As detailed in James Surowieki's recent book, "The Wisdom of Crowds," the theoretical work of these four economists, combined with Internet's ability to quickly form markets, has spawned the creation of a number of prediction/information markets, like Forsythe's Iowa Electronic Market, which is used to predict elections, TradeSports in Ireland which focuses primarily on sporting events, and the Hollywood Stock Exchange, which focuses on the various goings-on of the film industry.
Market Systems and the Enterprise
In conjunction with using markets for "public" prediction purposes, a number of economists have investigated the use of predictive markets that also could be used by corporations internally. Economist Robin Hanson (who studied under Plott), came up with the concept of the idea or innovation future market, where specific questions of some future event could be evaluated for its likelihood of occurrence. One question of interest, Hansen says, might be the probability that the greenhouse effect and other causes will have raised the average world sea levels by 1 meter by 2030. By establishing a market focused on that question, a rapid consensus - in the form of a probability that is related to the going market price - can be reached about this particular issue.
Over the past decade, a small but growing number of companies have been creating their own internal idea, innovation or prediction markets. For instance, France Telecom Group created an internal predictive market called Project Destiny that examines certain technological trends. A France Telecom employee is able to place bets concerning different technology questions, for example, will Skype reach "X" million of users by a given date? France Telecom believes that by posing questions whose outcome can affect its business, executives and managers can be better prepared to address them. Of the 18 questions posed, Project Destiny claims its internal market to have correctly predicted 16 of them.
Similarly, Yahoo, in a joint venture with O'Reilly Media, has created a prediction market called the Tech Buzz Game. The game is made up of a number of sub-markets that match a small number of rival technologies against one another, Internet browsers for instance. The object of the game is to anticipate a technology's "buzz" as measured by the number of Yahoo!Search users seeking information about that individual technology. Yahoo hopes by conducting this game it can evaluate whether power of prediction markets can help forecast high-technology trends.
Google has created an internal predictive market that according to Google, aims to "forecast product launch dates, new office openings, and many other things of strategic importance to Google." Google says that over 20 percent of its staff has bid in the 100-plus online markets it has run, covering over 350 events in more than 40 different topic areas. Google says that the online market prediction accuracy is about 70 percent.
HP Labs created its own internal market system and supporting software called BRAIN (Behaviorally Robust Aggregation of Information in Networks) to help predict certain critical business issues such the quarterly sales forecast or the price of DRAM memory chips in one, three or six months. The importance of being right about a forecast can have major impact. If a chip price forecast is off by just a couple of pennies, a significant impact on HP's hardware profit margin can result. HP has found that its internal market predictions are often more accurate than the company's "official" forecasts (for instance, six out of eight times the market was better at predicting computer sales). HP is now working with Pfizer pharmaceutical to create an internal prediction market using BRAIN starting in 2007.
Many other companies are experimenting with or creating different types of internal prediction markets: Microsoft (for predicting product ship dates); GE (for discovering new ideas); Eli Lilly (for discovering new drug candidates); BP Amoco (for reducing carbon-dioxide emissions); Intel (for allocating computer chip production), and; Siemens AG (for improving the accuracy of product developments). As these companies and others report their experiences with the application of internal prediction markets, it is likely that others will follow suit.