The Flaw of Averages

A must-read for anyone who makes business decisions that have a
major financial impact.

As the recent collapse on Wall Street shows, we are often
ill-equipped to deal with uncertainty and risk. Yet every day we
base our personal and business plans on uncertainties, whether they
be next month's sales, next year's costs, or
tomorrow's stock price. In The Flaw of Averages, Sam
Savage-known for his creative exposition of difficult
subjects- describes common avoidable mistakes in assessing
risk in the face of uncertainty. Along the way, he shows why plans
based on average assumptions are wrong, on average, in areas as
diverse as healthcare, accounting, the War on Terror, and climate
change. In his chapter on Sex and the Central Limit Theorem, he
bravely grasps the literary third rail of gender differences.

Instead of statistical jargon, Savage presents complex concepts
in plain English. In addition, a tightly integrated web site
contains numerous animations and simulations to further connect the
seat of the reader's intellect to the seat of their
pants.

The Flaw of Averages typically results when someone plugs
a single number into a spreadsheet to represent an uncertain future
quantity. Savage finishes the book with a discussion of the
emerging field of Probability Management, which cures this problem
though a new technology that can pack thousands of numbers into a
single spreadsheet cell.

Praise for The Flaw of Averages

"Statistical uncertainties are pervasive in decisions we
make every day in business, government, and our personal lives. Sam
Savage's lively and engaging book gives any interested reader
the insight and the tools to deal effectively with those
uncertainties. I highly recommend The Flaw of
Averages."

--William J. Perry, Former U.S. Secretary of
Defense

"Enterprise analysis under uncertainty has long been an
academic ideal. . . . In this profound and entertaining book,
Professor Savage shows how to make all this practical, practicable,
and comprehensible."

---Harry Markowitz, Nobel Laureate in
Economics

Auteur

SAM L. SAVAGE is a Consulting Professor of Management Science and Engineering at Stanford University, and a Fellow of the Judge Business School at the University of Cambridge.

Résumé
A must-read for anyone who makes business decisions that have a major financial impact. As the recent collapse on Wall Street shows, we are often ill-equipped to deal with uncertainty and risk. Yet every day we base our personal and business plans on uncertainties, whether they be next month's sales, next year's costs, or tomorrow's stock price. In The Flaw of Averages, Sam Savage­known for his creative exposition of difficult subjects­ describes common avoidable mistakes in assessing risk in the face of uncertainty. Along the way, he shows why plans based on average assumptions are wrong, on average, in areas as diverse as healthcare, accounting, the War on Terror, and climate change. In his chapter on Sex and the Central Limit Theorem, he bravely grasps the literary third rail of gender differences.

Instead of statistical jargon, Savage presents complex concepts in plain English. In addition, a tightly integrated web site contains numerous animations and simulations to further connect the seat of the reader's intellect to the seat of their pants.

The Flaw of Averages typically results when someone plugs a single number into a spreadsheet to represent an uncertain future quantity. Savage finishes the book with a discussion of the emerging field of Probability Management, which cures this problem though a new technology that can pack thousands of numbers into a single spreadsheet cell.

Praise for The Flaw of Averages

Statistical uncertainties are pervasive in decisions we make every day in business, government, and our personal lives. Sam Savage's lively and engaging book gives any interested reader the insight and the tools to deal effectively with those uncertainties. I highly recommend The Flaw of Averages.
William J. Perry, Former U.S. Secretary of Defense

Enterprise analysis under uncertainty has long been an academic ideal. . . . In this profound and entertaining book, Professor Savage shows how to make all this practical, practicable, and comprehensible.
­Harry Markowitz, Nobel Laureate in Economics

Contenu

Foreword xv

Preface xvii

Acknowledgments xxi

Introduction Connecting the Seat of the Intellect to the Seat of the Pants 1
You cannot learn to ride a bicycle from a book,and I claim the same is true for coping with uncertainty. Paradoxically, this book attempts to dowhat it claims is impossible.

Foundations

Part 1 The Big Picture 9

Chapter 1 The Flaw of Averages 11
In planning for the future, uncertain outcomes are often replaced with single, so-called average numbers. This leads to a class of systematic errors that I call the Flaw of Averages, which explains among other things why forecasts are always wrong.

Chapter 2 The Fall of the Algebraic Curtain and Rise of the Flaw of Averages 22
The electronic spreadsheet brought the power of business modeling to tens of millions. In so doing, it also paved the way for an epidemic of the Flaw of Averages.

Chapter 3 Mitigating the Flaw of Averages 26
New technologies are illuminating uncertainty much as the lightbulb illuminates darkness. Probability Management is a scientific approach to harnessing these developments to cure the Flaw of Averages.

Chapter 4 The Wright Brothers Versus the Wrong Brothers 34
The success of the Wright Brothers' airplane was the result of carefully constructed models that they tested in their wind tunnel. Analogous models ca help us manage uncertainty and risk, but as we saw in the financial crash of 2008, models can also be used to obfuscate.

Chapter 5 The Most Important Instrument in the Cockpit 40
The proper use of models, like the instruments in an airplane, is not obvious.

Part 2 Five Basic Mindles for Uncertainty 45

Chapter 6 Mindles are to Minds What Handles are to Hands 49
Just as industrial designers develop handles to help us grasp the power of physics with our hands, informational designers develop Mindles (first syllable rhymes with mind) to help us grasp the power of information with our minds. Section 2will provide some important Mindles for grasping uncertainty.

Chapter 7 Mindle 1: Uncertainty Versus Risk 52
These two concepts are often used interchangeably but they shouldn't be. Uncertainty is an objective feature of the universe, whereas risk is in the eye of the beholder.

Chapter 8 Mindle 2: An Uncertain Number Is a Shape 55
Even graduates of statistics courses have a hard time visualizing uncertainty. A shape in the form of a simple bar graph, called the histogram, does the trick. Try running a simulation in your head or better yet, on your web browser at FlawOfAverages.com.

Chapter 9 Mindle 3: Combinations of Uncertain Numbers 67
When uncertain numbers are added or averaged, the chance of extreme events goes down. I cover a case study in the film industry.

Chapter 10 I Come to Bury Sigma, Not to Praise it 78
Just as the height and weight of a criminal suspect have been superseded by surveillance videos and DNA samples, sigma is pushing obsolescence.

Chapter 11 Mindle 4: Terri Dial and the Drunk in the Road 83
A banking executive discovers the Strong Form of the Flaw of Averages: Average inputs don't always result in average outputs. Designing an incentive plan around your average employee is systematically erroneous.

**Chapter 12 Who Was Jensen and Why Wasn't He Equal? 91
The Nuts and Bolts of the Strong Form of the Flaw of Averages
***This chapter shows how to identify the …