There are two approaches to forecasting: the inside view and the outside view.
The inside view is when we focus on the specifics of our own situation, try to form a coherent story and somehow convince ourselves that given the “special” nature of our situation success is just around the corner. In some ways this probably explains the enormously high failure rates of new products and the only slightly lower failure rates of new small businesses.
The outside view focuses on the statistics of a class of cases chosen to be similar in relevant respects to the present one. The outside view is one that takes into account the general failure rate of the reference class of objects. Assuming the reference class is properly chosen, the outside view should provide a nice ballpark of where the estimate is going to be.
Another name for the outside view is the reference class forecasting —it predicts the outcome of a planned action based on actual outcomes in a reference class of similar actions to that being forecast.
Human judgment is generally optimistic due to overconfidence and insufficient consideration of distributional information about outcomes. Therefore, people tend to underestimate the costs, completion times, and risks of planned actions, whereas they tend to overestimate the benefits of those same actions. Such error is caused by actors taking an “inside view,” where focus is on the constituents of the specific planned action instead of on the actual outcomes of similar ventures that have already been completed.
The (inside) estimate should be benchmarked or validated against or compared to historical experience and/or past estimates (outside view) of the enterprise and of competitive enterprises to check its appropriateness, competitiveness, and to identify improvement opportunities. Validation examines the estimate from a different perspective and using different metrics than are used in estimate preparation.
Summing-up: In practice it is better to start with the outside view and adjust it using the special knowledge of the inside view and thus avoid embarrassing predictions.
