risk as a factor in management consulting and predictive markets

Earlier today, after explaining to my father for the 32nd time exactly what it is I do for a living, he asked me why huge corporations pay a fortune for management consultants who just graduated from college and have no real world experience.

There are a few really good reasons for this.

1. Companies have a nasty political furball on their hands, and anyone who touches it is instantly poisoned. No one at the company wants to deal with the issue, but it needs to be addressed, so let's bring in a consultant.
   
2. Companies know they need to do something, are motivated to do something, but have no idea what to do or how to do it, so let's bring in a team of consultants and have them figure it out.
   

Okay, so that addresses why a consultant is hired, but why are they all 23 years old? Doesn't GiantCorp actually want someone who knows what they're doing? Well, not necessarily. If I hire a big four (five? six? three? did you know that Tata and Infosys are bigger than Accenture? We're going to have to redefine what a "big consulting firm" is). Like I was saying, if you hire a big consulting firm, then you have Done The Right Thing. If the consultants can't handle it, it just proves that this was a big problem, and that we made the right decision in shipping it out to the big consulting firm. Fewer companies will actually reach out to find out who the people are who actually know the answer to their specific problem, because that entails more political risk. See "furball" in issue one above. And big consulting firms bring in lots of 23 year olds, because they will work insane hours and occasionally be brilliant, and not cost anywhere near what an experienced person would cost -- a $600/hr consultant is usually paid a salary well below $100k, which gives a huge margin for training and other investment costs in this young person, before she burns out in three to five years and we have to hire a new one.

I didn't explain this all to my dad, because he was really more interested in being indignant that companies don't value experience. It's not that experience is devalued -- it's just not as important as other factors. If I know that a problem will be solved using solution A or B, and A incurs more personal risk, B is going to a more appealing solution, especially in a company which does not demand mature risk assessments.

However, the absence of adequate risk management does lead to some rather entertaining situations, when viewed from the sidelines. I've been watching with some fascination the current fad of prediction markets. When used effectively, they can be not only accurate, but fun and engaging. However, whenever something like this enters the mainstream, we're sure to see poor implementation and corresponding abysmal results. Cass Sustein noted the reality of prediction markets -- when everyone has the same, accurate information, the results can be stunningly correct, like a class guessing how many jelly beans are in a jar, or a "dead pool" of people who are quitting a company with high attrition rates. However, when there is information which is not available to the group being polled, the "magic" of predictive markets disappears.

So why do I find this so entertaining? Well, because it's well known in the Valley that Google and Yahoo have been using prediction markets with great success, which means that we'll be seeing prediction markets pop up all over the Bay Area, in companies where communication is closed and information not easily shared. I can see companies employing predictive markets to figure out which of their products will be successful, when all they have to do is take a look at which of their product managers are quitting their jobs. Without open, available information, the predictive markets will fail, and management will be convinced that their employees are not smart enough to be trusted with information.