The Flaw of Averages: Why We Underestimate Risk in the Face of Uncertainty

CHAPTER 46

The CPO: Managing Probability Management

If a man will begin with certainties, he shall end in doubts, but if he will be content to begin with doubts, he shall end in certainties.

—Francis Bacon, English philosopher, 1561-1626

 

 

This is the motto of the ideal chief probability officer, or CPO. He or she should not only know something about uncertainty but should ferret out excessive certainty within their organization and replace it with doubt to keep people on their toes.

Let’s return once again to the gas property, whose average value was doubled by taking into account the option not to pump. But this time we will extend it to an entire gas company, with hundreds of wells selling into the same market. Should they manage the firm based on a single average price of gas? If they do, they are leaving a lot of money on the table. Should they let the manager of each gas well make their own estimate of the distribution of the price of gas? That would be like letting them estimate the discount rate for the net present value of their own projects or appointing foxes to run the Department of Defense for the hen house. The chief financial officer (CFO) should provide the discount rate centrally, or you could never sensibly compare the NPVs of two projects. Similarly, the CPO should provide a DIST of the gas price distribution, whereupon managers can run simulations of their individual properties, which can then be consolidated into a coherent model of the entire enterprise. ...