Offered here are two class exercises that
demonstrate how estimating through a consistent, systematic and
calibrated process may enhance the profitability of your enterprise.
Intuition vs. Systematic Estimating
First, half a class views a slide showing a large
number of beans (far too many to count!) for 15 seconds, while the
other half looks away. At the end of this viewing period, this group
of students (called the intuition group) each write down their individual
best-guesses for the number of beans they think are on the screen,
i.e. deterministic estimating from an intuitive bent.
Now, for the other half of the class - they also
get 15 seconds, but they don't get to view the bean slide. Instead
they view a distribution of estimates made by a previous class from
the same slide of beans (during this viewing period the intuition
group looks away). The distribution from the previous class is arrayed
on a cumulative log probability graph, with the P10, P90, median
and mean values clearly labeled.
Not surprisingly, the graph shows a nearly straight,
sloping line on this coordinate system.
Does this seem strange? It shouldn't. It indicates
that the distribution of estimates is lognormal, implying that individual
estimates depend on multiplication of constituent factors, in this
case, height, width and density of beans on the slide. According
to the Central Limit Theorem, multiplication of constituent factors
yields a lognormal distribution.
We call this second group the systematic group. Everyone
in the systematic group must now write down their individual estimates
of the number of beans.
Deterministic? Sure, but they are providing their
best guess from a distribution, and thus benefiting from a broadened
At the start of this exercise, we collect 25 cents
from each student, and pay back four times that amount ($1) if their
estimate turns out to be plus or minus 10 percent of the actual
number of beans.
group tends to make money in this exercise -- the intuition group
or the systematic group? Well, take a look at our data (Figure
1). About 60 percent of the systematic group make a profit,
but only about 12 percent of the intuitive group do so.
What's the message?
A systematic estimating approach almost always outperforms
intuition, and group wisdom is better than individual best guesses!
Competitive Sealed Bid Sale: Antelope Ranch
Antelope Ranch is our fictitious-but-realistic township
in the western United States that was recently made available for
oil and gas exploration via the most common method for acreage acquisition
- the sealed bid sale.
For this exercise, multi-disciplinary teams:
- Make maps;
- Probabilistically analyze prospects for both their size and
probability profile leading to a chance of geological (flowable)
- Select a discount rate to convert the prospect reserves to
present value; and
- Select a bid strategy multiplier to protect their team from
the dreaded "Winner's Curse."
From all these data and analyses, the teams then
execute their exploration strategy and compete for acreage, bidding
with their own pocket money!
(The acreage winners then watch eagerly as their
prospects are drilled and the economic results of their exploration
campaigns become apparent.)
Just as in real life, some teams are shut out by
not securing acreage. Some teams secure attractive acreage, but
are left with dry holes. Some teams celebrate discoveries. But the
object of the exercise is to create value, to generate a profit
-- so some teams discover oil but suffer a loss, while other teams
discover oil and are wildly profitable.
All of these results (which in our business may take
years to unfold) are revealed over a few hours in the classroom.
post-appraisals of each team's geotechnical estimates are made,
compared against the school solution of the prospect parameters,
so that a "skill score" is calculated for each team. The skill scores
are then broken into thirds for each class, so that if there are
six teams, the best two skill scores will reside in the upper third
segment of the database, and the poorest two skill scores will reside
in the lower third segment of the database (Figure
What separates the money-makers from the money-losers?
Most of the time it is the efficient and effective
application of probabilistic risk analysis. Our database of over
400 teams' skill scores, bid expenditures and profit measures is
Profitability correlates with skill!
Teams with moderate or superior skill recognize tracts
with inherent value, bid widely wherever they calculate positive
expected value - and when unlucky, don't lose a lot of money. The
value of their discoveries, when made, greatly exceeds the capital
they have spent to secure them.
Teams with poor skill typically overbid dramatically
(oftentimes even more than the success value of the oil potentially
present in the prospect!) Sometimes teams with poor skill tend to
be conservative. For their efforts, they are shut out from securing
While they have not lost money, they have lost something
almost as valuable: their time.
The exercise reinforces the value of effective application
of probabilistic estimating systems in portfolio management efforts.