The Black Swan: Rare, Unexpected, Highly Improbable–But It Happens…

“To the casual observer, the world nowadays is seeing freakish events happening in freakish proportions – from destructive weather phenomena to political revolutions to dramatic terrorist attacks. In truth, history is littered with events of a radically unexpected and ―unpredictable‖ nature. All create vast challenges for business leaders.” ~Spire Research

In Nassim Nicholas Taleb’s book “The Black Swan: The Impact of the Highly Improbable” he regards almost all major scientific discoveries, historical events, and artistic accomplishments as ‘Black Swans’; undirected and unpredicted. He gives the rise of the Internet, the personal computer, World War I, and the September 11 attacks as examples of Black Swan Events. Taleb’s assertion: What we call a Black Swan is an event with the following three attributes.

First, it is an outlier, as it lies outside the realm of regular expectations, because nothing in the past can convincingly point to its possibility. Second, it carries an extreme impact. Third, in spite of its outlier status, human nature makes us concoct explanations for its occurrence after the fact, making it explainable and predictable. Based on Taleb’s criteria, a Black Swan event is observed as follows:
• The event is a surprise (to the observer).
• The event has a major impact.
• After its first recording, the event is rationalized by hindsight, as if it could have been expected.

In the article “What Is a Black Swan?” by Larry Prusak writes: The Black Swan is a term you may hear in business and statistics, but what does it really mean? First I need to clarify what it is not. It does not just mean a rare event. Yes, it is a rare event but something else is required. It is an event when a rare event occurs that was never expected to occur and thus would result in a paradigm shift. To give you an example, it was believed that swans that are black could never exist.

The term was seen as almost being like an oxymoron to refer to something as such would be like referring to a waterless flood. However in 1697 Willem de Vlamingh came across such a swan in Western Australia. This resulted in a paradigm shift; black swans exist when believed they never could.

Something that would not be a Black Swan event would be winning the national lottery. It is a very rare event but you do expect that you could win. And if you do win, it’s a nice surprise but it does not change how you think about or view the lottery. It does not result in a change in paradigm.

What you may have figured out then is that you can never say something will be a Black Swan event or that you can see one coming. If you say that something could happen (but is unlikely to) then the term cannot be used. It is just something unlikely, and the fact that you are considering it means it is part of your paradigm. The term is often wrongly used in the business world.

The recent recession from the sub-prime mortgage crisis was sometimes referred to as a Black Swan event. It is not, as the crash was from over supply of credit to those unable to pay it (and derivative paper products that draw value from sub-prime mortgages). This always had a chance of resulting in a crash sooner or later; it a part of standard economic theory.

In the article How to Prepare for a Black Swan” by Matthew Le Merle writes: With the rise of global business, it is likely that Black Swans carry increased risks for your company, including negative impacts on your customers, suppliers, partners, assets, operations, employees, and shareholders. Today, not only can a catastrophe in one part of the world affect the sourcing, manufacture, shipping, and sale of products locally, but the interconnections of global financial, economic, and political networks ensure that the effects of such events ripple around the world.

Typically, a large company relies on its enterprise risk management (ERM) department to identify potential business disruptions, map out their most likely effects, and develop mitigation plans and preventive actions to reduce the risk exposures. But ERM simply does not have the capacity to also monitor high-magnitude, low-frequency disrupters on a continuous or regular basis.

This does not mean that Black Swans can or should be ignored. These events can threaten a company’s survival, and Boards and senior leaders are responsible for protecting shareholders and other stakeholders. They must ask: What else can go wrong? The solution to this conundrum is ‘disrupter analyses.

Disrupter analysis does not seek to predict Black Swans; that cannot be done. No company can be completely prepared for every possible Black Swan event. But the Board, the executive team, and the ERM staff can complement the day-to-day work of the ERM function with periodic ‘disrupter analyses’. These analyses can ensure that the company has adequately focused its attention on high-magnitude, low-frequency events, performed stress tests on its fitness in the face of such events, and prepared itself for unexpected catastrophes.

In the article “The Long Tail: Why the Future of Business Is Selling Less of More” by Chris Anderson writes: Our brains are wired for narrative, not statistical uncertainty. And so we tell ourselves simple stories to explain complex thing we don’t–and, most importantly, can’t–know.

The truth is that we have no idea why stock markets go up or down on any given day, and whatever reason we give is sure to be grossly simplified, if not flat out wrong. Nassim Nicholas Taleb first made this argument in Fooled by Randomness, an engaging look at the history and reasons for our predilection for self-deception when it comes to statistics.

Now, in “The Black Swan: the Impact of the Highly Improbable”, he focuses on that most dismal of sciences, predicting the future. The problem, Nassim explains, is that we place too much weight on the odds that past events will repeat. Instead, the really important events are rare and unpredictable. He calls them Black Swans, which is a reference to a 17th century philosophical thought experiment. In Europe all anyone had ever seen were white swans; indeed, “all swans are white” had long been used as the standard example of a scientific truth.

So what was the chance of seeing a black one? Impossible to calculate or at least they were until 1697, when explorers found black swans in Australia. Nassim argues that most of the really big events in our world are rare and unpredictable, and thus trying to extract general stories to explain them may be emotionally satisfying, but it’s practically useless. September 11th is one such example, and stock market crashes are another. Or, as he puts it, “history does not crawl, it jumps.”

In the article “Black Swan Events: What does the Future hold?” by Spire Research writes: To the casual observer, the world nowadays is seeing freakish events happening in freakish proportions – from destructive weather phenomena to political revolutions to dramatic terrorist attacks.

In truth, history is littered with events of a radically unexpected and ―unpredictable‖ nature. All create vast challenges for business leaders. Can such events be predicted and planned for, and if they could, what might the future hold? To the casual observer, it may appear that such freakish events – noted for their radical departure from the norm and their seeming “unpredictability”- are happening with increasing frequency.

According to Nassim Nicholas Taleb, who coined the term, these events are extremely rare or, in other words, have negligible probability of occurrence. However, if they do happen, they have a disproportionately major impact. In a globalized world, businesses are not only linked to each other but also dependent on the external environment.

After a Black Swan event, in hindsight, business owners might develop strategies to avoid impact from similar events in the future. But, the question remains – how can business predict events that have a major impact but are fundamentally dissimilar to anything that has happened before – what former U.S. Defence Secretary Donald Rumsfeld famously termed “unknown unknowns?”

To cope with such possibilities, companies would do well to heed Taleb’s advice. He advocates the use of counterfactual reasoning or, in plain language, “what-if” analysis. Despite Taleb’s argument on the usefulness of ‘What-If’ analysis, Black Swan events continue to be a ‘black box’ for most companies and most of humankind.

In the article “Can Boards Plan for ‘Black Swan’ Events?” by Elizabeth Judd writes: If disasters could have a silver lining, it’s that they are honing companies Board of Directors’ skills at Black Swan event planning. ‘Who would ever expect the Iceland volcano eruption to halt air traffic from Europe to the U.S.?’ asks Maryanne Peabody, Consulting Firm Board Options.

‘People are saying, Hmm – what we thought was solid really wasn’t solid. Charles Elson, University of Delaware, believes directors are rising to the occasion when it comes to anticipating corporate risk. ‘Boards are stronger than they used to be,’ he says. ‘They’re much better at asking questions.’

Alex Zmoira, Deloitte & Touche, agrees: ‘Before, a board member might have said, there are people paid to manage risk. It’s not my responsibility,’ he points out. “You’re not hearing that anymore”. Jill Fisch, University of Pennsylvania, believes boards are paying more attention to risk management but that there is a limit to what they can do. ‘To a large extent, a Board has to rely on management members and outside advisers in terms of bringing serious risks to the board’s attention and recommending a course of action,’ she explains. ‘Boards are asking more questions but – ultimately – these events are not something they are very well equipped to assess on their own.’

Peter Jewett, Law Firm Torys, poses the question thus: “How far do you go into the possible rather than the probable? Eventually you have to say, Okay, we’ve hit the point where we can’t justify spending more money on further precautions given the likelihood of this happening. What’s the cost benefit of devoting time to figuring out what your unknowns are? It’s a delicate balance.”

The logic in Black Swan makes ‘what you don’t know far more relevant than what you do know’. Consider that Black Swans are caused and exacerbated by their being unexpected… Isn’t it strange to see an event happening [e.g. collapse of the twin towers at the World Trade Center] precisely because it was not supposed to happen? What kind of a defense do we have against that?

Since Black Swans are unpredictable, we need to adjust to their existence (rather than naively try to predict them). But, what does Black Swan really mean? It’s a rare event but something else is required. It is an event that was never expected to occur and thus would result in a paradigm shift… Can a business ever be ready for these unknowns?

Planning has never been more important in business than it is today. In a New York Times article discussing The Black Swan, the reporter argues “that there are two ways to approach these phenomena. The first is to rule out the extraordinary and focus on the ‘normal’. The second is to consider the ‘extremes’, if their potential impact are significant”. Although it’s tempting to stick with the normal, it is prudent to plan for the outliers.

“To me a banking crisis was unavoidable and it was not a Black Swan, just as a drunk and incompetent pilot would eventually crash the plane.” ~Nassim Nicholas Taleb