From Nobel Prize to Project Management: Getting Risks Right

A major source of risk in project management is inaccurate forecasts of project costs, demand, and other impacts. The paper presents a promising new approach to mitigating such risk based on theories of decision-making under uncertainty, which won the 2002 Nobel Prize in economics. First, the paper documents inaccuracy and risk in project management. Second, it explains inaccuracy in terms of optimism bias and strategic misrepresentation. Third, the theoretical basis is presented for a promising new method called " reference class forecasting , " which achieves accuracy by basing forecasts on actual performance in a reference class of comparable projects and thereby bypassing both optimism bias and strategic misrepresentation. Fourth, the paper presents the first instance of practical reference class forecasting, which concerns cost forecasts for large transportation infrastructure projects. Finally, potentials for and barriers to reference class forecasting are assessed. I n April 2005, based on a study of inaccuracy in demand forecasts for public works projects by Flyvbjerg, Holm, and Buhl (2005), the American Planning Association (APA) officially endorsed a promising new forecasting method called " reference class forecasting " and made the strong recommendation that planners should never rely solely on conventional forecasting techniques when making forecasts: APA encourages planners to use reference class forecasting in addition to traditional methods as a way to improve accuracy. The reference class forecasting method is beneficial for non-routine projects... Planners should never rely solely on civil engineering technology as a way to generate project forecasts (American Planning Association, 2005). Reference class forecasting is based on theories of decision-making under uncertainty that won Princeton psychologist Daniel Kahneman the Nobel prize in Reference class forecasting promises more accuracy in forecasts by taking a so-called " outside view " on prospects being forecasted, while conventional forecasting takes an inside view. The outside view on a given project is based on knowledge about actual performance in a reference class of comparable projects. Where Flyvbjerg, Holm, and Buhl (2005) briefly outlined the idea of reference class forecasting, this paper presents the first instance of reference class forecasting in practical project management. The emphasis will be on transportation project management, because this is where the first instance of reference class forecasting occurred. It should be mentioned at the outset, however, that comparative research shows that the problems, causes, and cures identified for transportation apply to a wide range of other project types, including concert halls, museums, …