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Deloitte Analytics Symposium 2010 Thoughts on “The Wisdom of Crowds” Bill Thomas October 2010

Agenda •“The Wisdom of Crowds" by James Surowiecki •Decision making challenges •Diversity of opinion •Independence •Decentralization and aggregation •Successful crowd-based activities 1 Thoughts on “The Wisdom of Crowds” Copyright © 2010 Deloitte Development LLC. All rights reserved.

The Wisdom of Crowds Why the many are smarter than the few and how collective wisdom shape business, economies, societies, and nations James Surowiecki 2 Thoughts on “The Wisdom of Crowds” Copyright © 2010 Deloitte Development LLC. All rights reserved.

Wisdom of Crowds • The findings, accounts, and statistics presented throughout this presentation are based on material reported in the book “Wisdom of Crowds” published by Doubleday and copyright 2004 by James Surowiecki. • Additional references include excerpt From: Michael J. Mauboussin “Think Twice: Harnessing the power of Counter Intuition.” • Deloitte does not endorse nor has validated the findings presented. As used in this document, “Deloitte” means Deloitte LLP and its subsidiaries. Please see www.deloitte.com/us/about for a detailed description of the legal structure of Deloitte LLP and its subsidiaries. 3 Thoughts on “The Wisdom of Crowds” Copyright © 2010 Deloitte Development LLC. All rights reserved.

Decision making challenges • We generally have less information than we would like. • We have limited foresight. • We often assume that the key to solving a problem or making good decisions is dependent on finding the one right person who has the answer. Surprisingly, when our “imperfect” judgments are aggregated in the right way, our collective intelligence is often excellent and is more accurate than any “expert.” 4 Thoughts on “The Wisdom of Crowds” Copyright © 2010 Deloitte Development LLC. All rights reserved.

Sir Francis Galton • Born February 16, 1822, died January 17, 1911 • Half-cousin of Charles Darwin • English Victorian polymath, anthropologist, eugenicist, tropical explorer, geographer, inventor, meteorologist, proto-geneticist, psychometrician, and statistician • He was knighted in 1909 • Galton had a prolific intellect and produced over 340 papers and books throughout his lifetime. He also created the statistical concept of correlation and widely promoted regression toward the mean 5 Thoughts on “The Wisdom of Crowds” Copyright © 2010 Deloitte Development LLC. All rights reserved.

Sir Francis Galton (cont.) Galton is credited with having identified the first known example of the wisdom of a crowd: • 1906 “West of England Fat Stock and Poultry Exhibition” • Contest to guess the weight of the ox on display after it had been “slaughtered and dressed” • 800 people entered the contest, yet nobody guessed the correct weight • Afterward, Galton calculated the average of all the entries • Galton’s average estimate: 1,197 pounds • Actual weight of ox: 1,198 pounds Under the right circumstances, groups are remarkably intelligent and are often smarter than the smartest among them. 6 Thoughts on “The Wisdom of Crowds” Copyright © 2010 Deloitte Development LLC. All rights reserved.

Real world examples • The TV studio audience on “Who Wants To Be A Millionaire?” picks the right answer 91% of the time. • While this is a fun fact, it really only highlights that a crowd may know more facts than a single individual. • What about predicting the unknown based on little or no information? 7 Thoughts on “The Wisdom of Crowds” Copyright © 2010 Deloitte Development LLC. All rights reserved.

How do you find a lost submarine? In May 1968, the U.S. submarine Scorpion disappeared. • The Navy knew nothing about what happened to the sub or where it was, they only knew: – the Scorpion’s last reported location. – the Scorpion’s destination should have been Newport News Virginia. • The Navy started a 20-mile wide search in water thousands of feet deep, a process that would eventually take many months to complete. 8 Thoughts on “The Wisdom of Crowds” Copyright © 2010 Deloitte Development LLC. All rights reserved.

How do you find a lost submarine? (cont.) • Naval officer John Craven took a different approach. • Craven brought together a large group of people with diverse backgrounds, such as mathematicians, salvage experts, and submarine specialist. • Although none of their individual guesses were correct, their combined guesses were within 220 yards of the Scorprion’s final resting space. 9 Thoughts on “The Wisdom of Crowds” Copyright © 2010 Deloitte Development LLC. All rights reserved.

Experiment I have just sent you an message to meet me in NYC tomorrow – Where would you go to meet me? • Text one of the following to 22333 – EMPIRE – LIBERTY – STATION – GARDEN – What time would you get there? • Text TIME {YOUR GUESS}” TO 22333 10 Thoughts on “The Wisdom of Crowds” Copyright © 2010 Deloitte Development LLC. All rights reserved.

Experiment results • In 1958, social scientist Thomas C. Schelling ran the same experiment • The majority of his students replied “The information booth at Grand Central Station” • Almost all of his students replied 12 noon 13 Thoughts on “The Wisdom of Crowds” Copyright © 2010 Deloitte Development LLC. All rights reserved.

Real world examples January 28, 1986 – The Challenger Disaster • By end of the trading day, the stock of all four major companies involved in building the shuttle fleet were down. – Rockwell down 3% – Lockheed down 3% – Martin Marietta down 3% – Morton Thiokol down 12% • Six months later, the President’s commission determined Morton Thiokol O-Rings were at fault in the disaster. 14 Thoughts on “The Wisdom of Crowds” Copyright © 2010 Deloitte Development LLC. All rights reserved.

Real world examples (cont.) The Iowa Electronics Markets (IEM) allows people to buy and sell futures “contracts” based on how well they think a given candidate will do in an upcoming election. • 1988–2000, 1.37% off on presidential elections • 3.43% off on other U.S. elections • 2.12% off on foreign elections • 75% of IEM contracts were more accurate than the 596 opinion polls they were compared against 15 Thoughts on “The Wisdom of Crowds” Copyright © 2010 Deloitte Development LLC. All rights reserved.

Real world examples (cont.) • Hollywood Stock Exchange (HSX) is an entertainment site where participants buy and sell movies and actors as if they were stocks • 2000, HSX predicted 6 out of 6 for “Best” • 2002, HSX predicted 35 out of 40 nominees 16 Thoughts on “The Wisdom of Crowds” Copyright © 2010 Deloitte Development LLC. All rights reserved.

Real world examples • The Stock Market, IEM, HSX are all examples of Decision Markets. • The sample markets mentioned here are successful because they satisfy the four conditions needed to tap into the “Wisdom Of Crowds.” 17 Thoughts on “The Wisdom of Crowds” Copyright © 2010 Deloitte Development LLC. All rights reserved.

Right conditions for making good group decisions Given the right conditions and the right problems, a decision market’s fundamental characteristics are guaranteed to make for good group decisions. These characteristics include: 1. Diversity of opinion 2. Independence 3. Decentralization 4. Aggregation • Unfortunately, satisfying the conditions of diversity, independence, and decentralization and aggregation are challenging. 18 Thoughts on “The Wisdom of Crowds” Copyright © 2010 Deloitte Development LLC. All rights reserved.

Diversity of opinion • Diversity insures meaningful differences between ideas to increase the likelihood one good idea will survive and adds perspective, which eliminates obviously bad ideas. • Markets are inherently diverse, corporations are not. • Adding a few people who know less but have different skills can actually improve a group's performance. “Homogeneous groups are great at doing what they do well, but they become progressively less able to investigate alternatives.” 19 Thoughts on “The Wisdom of Crowds” Copyright © 2010 Deloitte Development LLC. All rights reserved.

Diversity of opinion (cont.) The experts are often wrong: • Between 1984 and 1999, 90% of Mutual Fund Managers underperformed the Wilshire 5000 • Wharton professor J. Scott Armstrong said – “I could find no studies that showed an important advantage for expertise” – “expertise and accuracy are unrelated” • Notable exceptions: Warren Buffet  20 Thoughts on “The Wisdom of Crowds” Copyright © 2010 Deloitte Development LLC. All rights reserved.

Independence • Independence allows people to say what they really think. • Independence prevents mistakes by individuals from becoming correlated and spread throughout the group. • Independence is the hardest to maintain in a corporation because people are inherently social beings. “You can be biased and irrational, but as long as you are independent, you won’t make the group any dumber.” 21 Thoughts on “The Wisdom of Crowds” Copyright © 2010 Deloitte Development LLC. All rights reserved.

You are an national sporting league coach, it is 4th down and you are on your opponents 34 yard line 22 Thoughts on “The Wisdom of Crowds” Copyright © 2010 Deloitte Development LLC. All rights reserved.

Experiment • Conventional wisdom among NFL coaches is you go for the points, Berkeley economist David Romer says you should go for the first down! • According to Romer, going for the points has become a truism that has corrupted the independence of the group. • Based on analyzing three years of NFL games, Romer has concluded that NFL coaches, as a group, are way too conservative. The only coach that seems to have taken Romer seriously is Bill Belichick, whose penchant for rejecting the conventional wisdom has helped the Patriots win multiple Super Bowls. 23 Thoughts on “The Wisdom of Crowds” Copyright © 2010 Deloitte Development LLC. All rights reserved.

Decentralization and aggregation • Decentralization fosters and is fed by specialization and increases the scope and diversity of the opinions and information in the “system.” – Linux and the Internet are examples of highly successful decentralized solutions. • A decentralized system can only produce genuinely intelligent results if there is a means for aggregating the information of everyone in the “system.” – Pre-9/11, U.S. intelligence agencies are an example of a failed decentralized system because it lacked the aggregation needed to bring information to everyone in the system. For analytic solutions to be successful within corporations, they need to provide intelligent aggregation of the decentralized solutions found throughout the organization. 24 Thoughts on “The Wisdom of Crowds” Copyright © 2010 Deloitte Development LLC. All rights reserved.

Successful crowd-based activities Who discovered the SARS Virus? Answer: Everyone! • The World Health Organization provided coordination or “aggregation.” • Eleven labs from France, Germany, the Netherlands, Japan, the United States, Hong Kong, Singapore, Canada, the United Kingdom, and China all participated. • The coronavirus was identified in just a few short weeks, a task which could have taken months if an individual lab was working on the problem. 25 Thoughts on “The Wisdom of Crowds” Copyright © 2010 Deloitte Development LLC. All rights reserved.

Successful crowd-based activities (cont.) • In 1994, 450 different physicists were credited with the discovery of the quantum particle also known as the “Top Quark.” • SARS and the “Top Quark” projects are examples of very successful collaboration. • Collaborative activities work because it makes each participant more productive. “Today’s complex problem solving requires multiple perspectives. The days of Leonardo da Vinci are over.” 26 Thoughts on “The Wisdom of Crowds” Copyright © 2010 Deloitte Development LLC. All rights reserved.

I have been given $10 with instructions that I can split the money between us anyway I would like but the only way we both can keep the money is if we both agree with the split. 27 Thoughts on “The Wisdom of Crowds” Copyright © 2010 Deloitte Development LLC. All rights reserved.

Experiment • A rational person would say I am getting $1 more than I had, but more often than not the offer is rejected because it feels inherently wrong. – This is the basis for the show “Deal Or No-Deal.” – Would you change your answer if you got $100,000 and I got $900,000? • Key to fostering participation in crowd activities are the following requirements: 1. All participants must believe they are being treated fairly. 2. Participants must see value in contributing typically through increased productivity. 3. Information must be shared openly among all participants. 28 Thoughts on “The Wisdom of Crowds” Copyright © 2010 Deloitte Development LLC. All rights reserved.

Real World Example: Best Buy Excerpt from: Michael J. Mauboussin “Think Twice: Harnessing the power of Counterintuition” … So you can imagine the reaction when James Surowiecki, author of the best-selling book, The Wisdom of Crowds, strolled into Best Buy’s headquarters and delivered a startling message: a relatively uninformed crowd could predict better than the organization’s best seers. Surowiecki’s message resonated with Jeff Severt’s, an executive then running Best Buy’s gift card business. Severts wondered whether the idea would really work in a corporate setting, so he gave a few hundred people in the organization some basic background information and asked them to forecast February 2005 gift card sales. When he tallied the results in March, the average of the nearly 200 respondents was 99.5% accurate. His team’s official forecast was off by five percentage points. The crowd was better, but was it a fluke? 30 Thoughts on “The Wisdom of Crowds” Copyright © 2010 Deloitte Development LLC. All rights reserved.

Real World Example: Best Buy (cont.) Excerpt from: Michael J. Mauboussin “Think Twice: Harnessing the power of Counterintuition” “Later that year, Severts set up a central location for employees to submit and update their estimates of sales from Thanksgiving through year-end. More than 300 employees participated and Severts kept track of the crowd’s collective guess. When the dust settled in early 2006, he revealed that the official forecast of the internal experts was 93% accurate, while the presumed amateur crowd was off by only one-tenth of 1%. Best Buy subsequently allocated additional resources to its prediction market, called TagTrade. The market has yielded useful insights for managers through the more than 2,000 employees who have made tens of thousands of trades on topics ranging from customer satisfaction scores to store openings to movie sales. For instance, in early 2008, TagTrade indicated that sales of a new service package for laptops would be disappointing when compared with the formal forecast. When early results confirmed the prediction, the company pulled the offering and relaunched it in the fall. While far from flawless, the prediction market has been more accurate than the experts a majority of the time and has provided management with information it would not have had otherwise.” 31 Thoughts on “The Wisdom of Crowds” Copyright © 2010 Deloitte Development LLC. All rights reserved.

Summary: Thoughts on “The Wisdom of Crowds” • We often have less information than we would like when making decisions. • Crowd-based markets and collaborative efforts can yield breakthrough solutions to complex problems. • Crowd-based activities require creating the right environment that includes diversity of opinion, independence, decentralization and aggregation, fairness for all participants, and open access to information. 32 Thoughts on “The Wisdom of Crowds” Copyright © 2010 Deloitte Development LLC. All rights reserved.

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"This presentation contains general information only and is based on the experiences and research of Deloitte practitioners. Deloitte is not, by means of this presentation, rendering business, financial, investment, or other professional advice or services. This presentation is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional advisor. Deloitte, its affiliates, and related entities shall not be responsible for any loss sustained by any person who relies on this presentation. About Deloitte Deloitte refers to one or more of Deloitte Touche Tohmatsu Limited, a UK private company limited by guarantee, and its network of member firms, each of which is a legally separate and independent entity. Please see www.deloitte.com/about for a detailed description of the legal structure of Deloitte Touche Tohmatsu Limited and its member firms. Please see www.deloitte.com/us/about for a detailed description of the legal structure of Deloitte LLP and its subsidiaries. Copyright © 2010 Deloitte Development LLC. All rights reserved. Member of Deloitte Touche Tohmatsu Limited

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