Mercury's Blog

Chris Masse over at Midas Oracle has recently generated a fair number comments on his post “Are IBM Smarter Cities prediction markets too smart for people?” As the commenters rightly point out, what IBM was doing was NOT a prediction market, but instead a polling system.

This is something I’ve been talking about since May 2008. When you try to use a prediction market to forecast the “best” ideas, you get a “Keynesian beauty contest.” To quote (via wikipedia):

It is not a case of choosing those [faces] that, to the best of one’s judgment, are really the prettiest, nor even those that average opinion genuinely thinks the prettiest. We have reached the third degree where we devote our intelligences to anticipating what average opinion expects the average opinion to be. (Keynes, General Theory of Employment Interest and Money, 1936).

Starting from the wrong metaphor

Ideas in an organization are a long-term investment, where significant work and development is required before you can even get to the prototype stage of development. This is a very different concept than regular, known markets, such as the number of customers in the next quarter or “will me meet sales targets next year” which are asked in prediction markets. Prediction markets work well for the regular, known markets, because prediction markets involve liquid, easily-traded contracts.

Idea markets should be seen through the metaphor of venture capital. An individual sees lots of good ideas, but none of them are well developed. Just as a venture capitalist puts resources into ideas and those resources are locked-up and illiquid until the idea has proven its success or died, an individual in an idea market should see their votes as an illiquid, sunk cost.

The organization running the idea market then concentrates their resources where individuals concentrate their votes. But just like venture capital, this cannot be a one-time market. The organization needs to regularly run similar markets, say every quarter or every six months. If an idea gets resources but doesn’t make enough progress (or doesn’t look like it will be as effective as originally thought) the market will stop voting for it. As an idea makes good progress, it continues to receive resources for development. Finally, when an idea is implemented and made successful, all of the people that voted for it during its development will be rewarded. And just like venture capital, the earlier you contribute the more you are rewarded.

The key is that idea selection and development is long-term work, and thus when markets are used to forecast and help allocate resources, the market structure must match that long-term approach.

This entry was posted on Sunday, August 30th, 2009 at 12:56 pm and is filed under General, Innovation & Ideas.