What prediction markets are and analyse their evolution

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Prediction Markets: Prediction markets is known by several names viz. information markets, decision markets, predictive markets, idea futures, event derivatives, or virtual markets around world. Prediction markets, defined in a recent Business Week article as "bets on ideas", ask groups of stakeholders the following question: "What do you think something is worth and more important, what will it be worth tomorrow?" The group's answers have proven to be accurate most of the time; the article goes on to say. "When groups of people bet on something, their combined intelligence is often remarkably prescient" [Kunz, Ben, 2008]. "There is an old Japanese proverb that states 'None of us is as smart as all of us,' and we are finding more and more that this is true" said Ron Hoffner, associate from Ingenix Consulting.

Prediction markets are based on speculations which are generated for making prediction for future. Market prices can be predicted based on the probability of occurrence of events which depends on many parameters. Prediction markets are used to gather information from range of sources to predict future outcome of an event. It also comes with built-in payoff tied to the outcome. Prediction markets are depend on following type of events such as political, sporting, entertainment, business and economic. In prediction markets prices are means of means of efficiently allocating resources. In prediction markets people make accurate prediction get rewarded and vice-versa. Evidence so far suggests that prediction markets are at least as accurate as other institutions predicting the same events with a similar pool of participants.

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Prediction Markets Evolution: Rhode and Strumpf (2004) detailed the existence of large-scale election betting even during the George Washington election. At times in the late 19th and early 20th centuries, betting on political outcomes at the Curb Exchange in New York would exceed trading in stocks and bonds. In contests such as 1896, 1900, 1904, 1916, and 1924, the New York Times, Sun, and World provided nearly daily quotes from early October until Election Day. In the 15 elections between 1884 and 1940, the mid-October betting favourite won 11 times (73 percent) and the underdog won only once (Wilson in 1916). The markets involved thousands of participants, had millions of dollars in volume in current terms, and had remarkable predictive accuracy.

One of the oldest and most famous is the University of Iowa's Iowa Electronic Market. The Hollywood Stock Exchange, a virtual market game established in 1996 and now a division of Cantor Fitzgerald in which players buy and sell prediction shares of movies, actors, directors, and film-related options, correctly predicted 32 of 2006's 39 big-category Oscar nominees and 7 out of 8 top category winners. HedgeStreet, designated in 2004 as a market and regulated by the Commodity Futures Trading Commission, enables Internet traders to speculate on economic events. Around 1990 at Project Xanadu, Robin Hanson used the first known corporate prediction market. Employees used it in order to bet on, for example, the cold fusion controversy. Prediction markets are championed in James Surowiecki's 2004 book "The Wisdom of Crowds", Cass Sunstein's 2006 book "Infotopia", and "How to Measure Anything: Finding the Value of Intangibles in Business" by Douglas Hubbard.

The research literature is collected together in the peer reviewed The Journal of Prediction Markets, edited by Leighton Vaughan Williams and published by the University of Buckingham Press. The journal was first published in 2007, and is available online and in print. In October 2007, companies from the United States, Ireland, Austria, Germany, and Denmark formed the Prediction Market Industry Association, tasked with promoting awareness, education, and validation for prediction markets.

Question 2:

Critically evaluate what is the relationship between Prediction Markets and the concept of Open Innovation.

Answer to Question 2:

There is very strong fundamental relationship between Prediction Markets and Concept of Open Innovation. Quite similar to blogs and wikis, prediction markets can initiate communication and collaboration within a company structure and initiate open innovation. Prediction markets add extra enrichment to business forecasts in various ways such as estimating the sales of a new product, the chances that a project will be finished on time or open a new super-store on time.

In corporate prediction markets employees and potentially some outsiders, make their wagers over the Internet using virtual currency, betting anonymously. They bet on what they think will actually happen, not what they hope will happen or what the boss wants. The payoff for the most accurate players is typically a modest prize, cash or an iPod. The early results are encouraging. "The potential is that prediction markets may be the thing that enables a big company to act more like a small, nimble company again," said Jeffrey Severts, a vice president who oversees prediction markets at Best Buy, the electronics retailer [Consensuspoint Blog]. This provides a great source of open innovation.

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At InterContinental Hotels, Zubin Dowlaty, vice president for emerging technologies, decided to create an online market last fall to "harvest and prioritize ideas" from within the hotel's 1,000-person technology staff. "We wanted to tap the creative class that may not be able to voice their ideas," Mr. Dowlaty said. With InterContinental's prediction market, players were asked to submit ideas anonymously, with a description and the benefit to customers and company. The bettors were given virtual tokens, each receiving 10 green ones to be placed on the best ideas and three red for bad ideas. There were no limits on the number of times bettors could change their wagers as new ideas came to market, and the market was open for four weeks. The five top ideas (most green tokens), five bottom ideas (most red) and the top five bettors (most accurate, according to market consensus) were listed regularly. The winners got $500, while second- and third-place finishers received $250 each. The winners, Mr. Dowlaty said, were engineers, analysts and contractors, not managers. More than 200 people participated, submitting 85 ideas. One person proposed bringing back quarter-operated vibrating beds. "That one got beat down really fast," Mr. Dowlaty said [Consensuspoint Blog].

The winning ideas were suggestions to improve searching the company's Web site to find and book hotel rooms. Two projects have been started as a result of the market, Mr. Dowlaty said. Next, he said, prediction markets may be opened up to InterContinental's customers, probably beginning with members of its Priority Club loyalty program. They could bet in markets for improving service and offerings, with points redeemed. "It's the next frontier and the natural progression for this," Mr. Dowlaty said [Consensuspoint Blog].

The open innovation is initiated by groups over internet and social media websites. The open innovation can be harnessed in organisations by encouraging its employees to think in creative way. Innovation cannot be only limited to any specialised department or person. To create a strong relationship between prediction markets and open innovation cultivate the idea of formulating question and seek answers from employees. By making suggestion box, companies can encourage its employees to come with open innovation. This can be done over intranet or email. Create passionate and interested group within organisation for open innovation. Many successful products were initially launched as Beta version. They were made available to innovative users to use and improve it. Companies should initiate prediction markets and open innovation within their own employees.

Question 3:

Discuss whether and to what extent business organisations can make use of Prediction Markets and critically evaluate what are the necessary modifications that organisations have to put in place in order to profit from the use of Prediction Markets.

Answer to Question 3:

In comparison with traditional methods to demand forecast, Prediction Markets provides more accurate forecast. This has been proved in various academic research conducted recently. As per the Ron Hoffner from Ingenix Consulting, prediction markets can predict better in healthcare sector that which programs are the most likely to succeed. Prediction Markets can add significant value by providing quantitative data on the impact proposed health reforms will have on the industry. "What we are doing is asking a variety of people with different perspectives - who traditionally have not been included in the discussion - for their input," Hoffner said, "For really the first time, we are going to have quantitative data on the impact of these proposed health reforms that participating organizations can use for planning"[ Consensuspoint Blog].   

Many big corporations and big companies have adopted the prediction markets forecast for formulating their business strategy. These include Google, HP, Best Buy, Cisco Systems, InterContinental Hotels Group, GE Healthcare, General Mills, Qualcomm and ArcelorMittal. Even recently Motorola has also started using prediction market to incorporated ideas and speedup their innovation. All of these corporations use prediction market to minimise risk, enhanced forecasting and improvise innovation by getting ideas from collective wisdom of their employees including masses.

In prediction markets, public markets for presidential candidates attract thousands of bettors, but a corporation may want to operate in restricted environment with certain type of people and with specialised kind of products. For example HP pioneered use of prediction markets with its BRAIN project (Dr. Leslie Fine, now Crowdcast's VP Market Design, was HP's BRAIN lead researcher). At HP, their research team try to develop various mechanisms to get software which provide efficient forecast even with small prediction markets. In their approach they narrow down the crowd wisdom to wisdom of 12 to 13 people. In their initial assessment they divide group in risk seekers and risk averse based on their behavioural risk characteristics. A small group within purchasing unit of HP started their prediction for computer memory chips price in advance (three to six months). This prediction market provided 70% better result than its traditional forecasting approach. This better prediction can be used in purchasing, marketing and product pricing.

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The HP BRAIN research project has become a service offering and used by its clients that include Swisscom, which is trying it to predict demand for new services like Internet Television on Cellphones [Consensuspoint Blog].

Business organisations can make use of Prediction Markets up to certain extent based on how much they are willing to logical development of prediction markets which suits their specific needs. This is well discussed in HP case. They developed the holistic approach for their business need and then implemented based on their customised requirement. Once they develop the prediction markets technique which suits their needs may extend to similar kind of industry or product.

The organisation require wide skills ranging from technical understanding for making markets perform within the culture of an organization, relationship building to engage participants and encourage contribution from everyone. The companies must have their quantitative skills, business strategy, relationship building and state of art technology in place for successful prediction markets to achieve the maximum profits. Technology is the most essential part of all these process to make organisations churn profit from prediction markets.

Appendix: Reference List

http://www.consensuspoint.com/prediction-markets-blog/betting-to-improve-the-odds

http://www.openinnovators.net/5-essential-thoughts-for-open-source-innovation/

http://www.thestandard.com/news/2008/03/05/google-bets-valueprediction- markets

http://c21org.typepad.com/21st_century_organization/200911/predictionmarket_chicago.html

http://en.wikipedia.org/wiki/Prediction_market

Rhodes, Paul W. and Koleman Strumpf, "Historical Presidential Betting Markets," Journal of Economic Perspectives, 18(2), 127-142, 2004.

Kunz, Ben, "Prediction Markets Meet Wall Street," BusinessWeek (Oct. 14, 2008)

Consensus Point

Burke, Edmund (1729-1797)

Consensus Point, "What is a Prediction Market?" (Web site accessed April 1, 2009). ," uses a "prediction market" to "unleash the collective wisdom of organizations and helps them gain a more accurate picture of what is going on in their organization and the industry," according to Ron Hoffner, associate, Ingenix Consulting