Clients interested in using a prediction market for market research often ask us whether they should setup their market using internal employees or external consumers as traders. Since this is such a common question, I figured it deserves a blog post.
Before getting into the pro’s and con’s of each approach, I should note that this very question highlights a key differentiator between prediction markets and traditional research techniques like surveys or focus groups: prediction markets are non-targeted. A survey or focus group is always targeted at a particular type of consumer, often defined by some combination of demographics (18-25 year old males), psychographics (likes to try new gadgets), and behavior (goes mountain biking at least monthly.) Market researchers must take a targeted approach when using these techniques because they are essentially asking a particular consumer, “What would you buy?”
However, when using a prediction market for market research, we don’t ask, “What would you buy?” but instead “What will sell the most?” These are very different questions. The first question should always be directed at a targeted consumer, whereas the second question can be directed towards anyone in a good position to predict which product would sell the most.
Although one might choose to use targeted consumers as prediction market traders, the wisdom of crowds theory dictates that it’s not necessary. The theory outlines 4 characteristics that a crowd must have to be “wise”: (1) diversity of opinion; (2) independence of members from one another; (3) decentralization; and (4) a good method for aggregating opinions. There’s no requirement for unique knowledge or expertise.
When you setup a prediction market, you can invite any crowd that you wish to participate so long as they meet these 4 criteria. Since targeted consumers are often difficult and expensive to reach, most market creators instead opt to invite either their own employees or the general public. The former is called an “enterprise prediction market (EPM)” and the latter a “public prediction market (PPM.)” Below I’ll outline some of the advantages and disadvantages of each approach.
Enterprise Prediction Markets (EPM’s)
- Employees are convenience to recruit as traders
- Most employees know enough about the prediction market topic to make educated predictions (though traders needn’t be experts, they should have some basic knowledge about what they’re predicting)
- Employees needn’t be compensated directly for participation
- Intellectual property protection isn’t a concern
- Maintaining higher participation rates over time is challenging
- Diversity of trader opinion is questionable
Public Prediction Markets (PPM’s)
- Organizational buy-in isn’t required (this is a biggie)
- Traders don’t feel obligated to participate so must be offered a higher incentive
- Not all traders will have knowledge about the prediction market topic (this isn’t really an issue in practice due to trader self-selection)
- Intellectual property should be protected via NDA’s, digital image watermarking, and other special techniques
- There’s no need to maintain ongoing engagement amongst traders since brand new traders can be piped into every market
Once they understand their options, clients usually opt for an EPM if the market will deal with topics requiring specialized knowledge that only employees will possess. Otherwise, a PPM is preferred since it’s so much simpler to setup and maintain over time.
Regardless of which method a client chooses, they are consistently impressed with quality and accuracy of the market’s predictions. Crowds are indeed quite wise.