Electronic Prediction Markets (EPM): Better forecasting and decisions at lower costs

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How can I utilize all the relevant knowledge distributed among people, customers and employees?

Electronic Prediction Markets (EPM) are online stock exchanges, which can be used for forecasting or decision making. EPMs are proven to be at least as accurate as traditional polls or expert analysis (see below)!

Go to the Analyx demonstration EPM

EPMs do not trade company stocks but Virtual Stocks (VS) and usually play money is used for buying VS:

VS of future events whose outcome is to be forecasted, e.g. future sales or economic growth. VS of for alternatives on which a decision has to be made, e.g. to chose the best new product design out of 20+ alternatives.

Areas of application

Private EPMs: Companies like Hewlett-Packard, Google, Microsoft and Yahoo use private internal EPMs to forecast future sales and support new product development. With Analyx now companies can merge the distributed knowledge of selected customers, the sales force and suppliers for faster and more reliable forecasts and robust decision making, e.g.:

Forecasting:

• Sales planning: How many units of your product will be sold in the upcoming month/quarter? What will be usage rates of a given service for the upcoming moth/quarter? Economic indicators &
• Strategic forecasts: What will be market growth in the next year? Will the oil price rise above a certain limit? Will China continue supporting its under-valued currency to keep exports high? Etc.
• Project management: Will the announced project deadline be held?

• New product development: Which 4 models out of 25 alternatives should form our new line of products for a given market segment?
• R&D: Which new technology should be chosen for investment in future capabilities? Which out of 100+ molecules has the best chances to be turned into an active agent for a blockbuster drug?
• Project planning: Which deadline is the most realistic one and should be assumed in the planning stage of a (large) project?
• Employee satisfaction: EPMs can easily give thousands of employees a voice in difficult decisions. That way valuable information is flowing bottom-up, plus employee satisfaction is increased when management is considering the voice of the work force.

Public EPMs: Everyone is permitted to participate in public EPMs to forecast election results, society events or success of movies and songs etc.

Forecasting:

• Political events: For example elections (Will Tony Blair be re-elected in the next election?) or the likelihood of a bill to pass (Will the new tax law pass the hearing and come into effect?)
• Economic indicators: For instance next quarter's GDP growth rate, next months unemployment rate, the annual inflation rate or the likelihood of a hike in central bank interest rates
• And many other …

• Marketing: Which out of 10 candidates should be the next face for Calvin Klein?
• Market research: Which book cover should be chosen for a new book?, Which new car design out of 10 alternatives will prove most successful in the market?
• Entertainment: What will be the gross box-office of a new movie in the first 3 weeks? Which song from a new album is most likely to become a hit?

Advantages of EPMs

The picture below shows how EPM forecasts of an election outcome (Bill Clinton presidential re-election in 1996) compares to various polls (click to enlarge):

• Right from the beginning the EPM (green line) is much closer to the actual outcome (blue line) then any of the polls.
• Obviously, people act differently in EPMs then they respond in polls!
• EPMs are designed to optimally elicit the distributed knowledge from many individuals (customers, participating experts, etc.) and automatically aggregate it into a single highly precise forecast.

Compared to traditional methods of market research and decision making (e.g. surveys, market studies or single / group expert judgment) EPMs offer a number of important advantages:

Forecast precision: EPMs are at least as precise for evaluating decision options and predicting events as are surveys or expert analysis (proven by more than a decade of research*).

Availability & Cost: EPMs always provide up-to-date forecasts. No need to repeat expensive weakly polls or costly expert and market studies. The EPM always include latest information into forecasts / evaluation of each decision option.

Advanced information aggregation: ALL relevant knowledge from EPM participants is elicited by the internal EPM Information Aggregation Mechanism (IAM). Also the bias of uniformed participants is automatically removed by this mechanism!

Scope: EPMs can take dozens or more different decision options and quickly identify the best alternative. It would be impossible to design such a large questionnaire which surveys all possible options even for a dozen alternatives. Studies would become several hundred pages long.

No interviewer or bias of decision makers: True preferences and opinions are reported by participants due to the EPM incentive mechanisms. Non-verbal preferences are also automatically included, which cannot be elicited by other direct methods, e.g. surveys.

No IT cost on the client side: EPMs have no IT-footprint on the client side. Real-time results are easily access via the web browser (secure connection) while the system is hosted on Analyx' ressources (Intranet hosting is also possible, if deasired).

The advantage of surveys and polls is not found in better forecasting precision. It lies in the ability to conduct detailed customer analysis and segmentation (which is also possible to some extend in EPMs).

* See e.g. Berg et al. (2003): Accuracy and Forecast Standard Error of Prediction Markets, University of Iowa.

How to use EPMs

EPMs are easy to use for participants:

Once a forecasting / decision target is selected, an EPM website is set up by Analyx and participants are invited to participate in the EPM. Research shows that motivation of participants to use the EPM is proven to be high by various factors, such as small monetary awards or prizes (in exchange for the play money), the desire to be a good forecaster and the eagerness to win as well as the sheer thrill experienced by observing how the value of ones own event stocks develops.

For clients EPMs produce clear and precise information:

Clients who want to use EPMs receive reports or can observe the market in real-time. They can view the latest forecasting/decision figures and additional information such as the distribution of probabilities for the forecasting/decision target and statistical confidence intervals for the EPM figures.

Why EPMs work:

The internal Information Aggregation Mechanism of EPMs is much more advanced than simple averaging of data, opinions or survey results. Its main purpose is to calculate the current price of each Virtual Stock (VS). This price is determined by supply and demand from the EPM participants. Each participant decides based on his own information whether to rather buy or sell a VS (see picture above). Research shows that both real money (in the order of 1 EUR per share) or play money and prizes give equally good EPM results. Therefore, play money is used in order to limit costs for the EPM client.

Deployment of EPMs

The average time to get an EPM up and running is 2-3 weeks. Then any number of forecasts/decisions can be supported with that EPM. Set up of each new forecast/decision question requires a maximum of two weeks (for standard questions just a few days). First results are delivered by the EPM in a few days and from then on the EPM continuously displays most current forecasts/decision evaluations to the client user.

© 2006 Analyx sp. z o.o. sp. k.

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