Ford Motor Co. has been using prediction markets among internal employees for close to three years to help augment forecasts of sales and other key measures, like the expected popularity of new products. When Ford's cell-phone and iPod dock, Sync, was in development a few years ago, says Bryan Goodman, a technical leader in Ford's research and advanced-engineering department, "there was a lot of uncertainty about what the take rate would be — 10% of customers or 90% of customers?"
When the prediction market suggested it would be closer to the top end, Ford tooled its factories for high volume, to good effect. The system now sells on more than 70% of new vehicles, says Goodman.
One of the key benefits of a market versus a simple survey, says Ford chief economist Ellen Hughes-Cromwick, is that the volume of bets gives a sense of the confidence people have in their forecasts. If everyone is buying shares around a certain value, that would indicate higher market confidence than, say, market participants spreading their dollars across all available values.
Hughes-Cromwick, in collaboration with Prof. Charles Plott of the California Institute of Technology, is currently leading efforts at the National Association for Business Economics to use such markets to augment forecasts of macroeconomic indicators, such as GDP, unemployment, and inflation. So far, a panel of economists has produced fairly accurate results using the market (set up as an auction, in this case) to estimate monthly government figures, and Hughes-Cromwick says the method "is much improved compared with a consensus forecast, which only gives you an average of how much GDP is going to decline."
Another benefit: the anonymous nature of the market can help employees overcome the political pressure they might fall prey to if asked the same question in a meeting or in person. Electronic Arts, for example, has asked employees to bet on the ratings new video games are likely to receive from users and reviewers. The prediction market has turned out estimates that fall within two percentage points of the actual scores, compared with the average eight-point overshoot that in-person polling yielded. That, in turn, has helped the company fix ill-fated games before launching them.
Markets have their limits, of course. Don't look to them for generating new ideas for products, or imagining markets that don't exist, says Blau. They're also not great for predictions of very long-term trends, like what mix of products a company will be selling five years from now. Then again, accurate five-year forecasts seem like a pipe dream these days. Most companies would happily settle for a reasonable view of what the next year will bring.
Alix Stuart is a senior writer at CFO.
Cash Flow Meets the 80/20 Rule
Is there a simple way to forecast cash flow? With treasury teams leaner than ever and nearly every component of cash flow hanging in the balance, it may be time to adopt the 80/20 rule when it comes to cash forecasts. By focusing on the 20% of a company's cash-flow line items that are typically responsible for 80% of the company's results, treasurers can get reasonable results in less time, suggests the consulting firm Treasury Strategies.
Indeed, aiming for perfection when resources are thin can easily result in a lousy forecast, says John Herrick, a principal at Treasury Strategies. Plus, too much detail in a forecast can hamper its usability.
To gain more confidence in forecasts that don't exhaustively probe every component of cash flow, treasurers should compare the results with those obtained from back-of-the-envelope metrics such as cash flow as a percentage of sales. Meanwhile, if a company's cash forecasts have been consistently inaccurate, management should consider requiring business units to submit cash-flow inputs into a common system, and ding those that provide bad information.
"If the folks at the highest levels of the company reinforce the message that sloppy forecasting will not be tolerated," says Herrick, "the forecasting inputs are bound to improve." — David McCann
New on CFO.com: The CFO Prediction Market
Finance chiefs in need of accurate, timely information on the direction of economic indicators, financial markets, or even the likely date that U.S. firms will be required to adopt international accounting standards can now turn to the CFO Prediction Market for answers. This new feature of our Website lets CFOs and other executives "bet" on various economic and financial outcomes that are critical components of accurate business forecasts. What will the price of oil be a month from now? Will Congress pass a bill this year creating a cap-and-trade market for carbon emissions? Where are Treasury yields headed? Executives win prizes for betting on the right outcomes, but, more important, by tapping the wisdom of a crowd of executives, the Prediction Market produces data that any finance department will find indispensable in forecasting. Sign up at www.cfo.com/predictionmarket.
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