Black Swans Cost and Prediction

A black swan is a highly improbable major risk event that diverges beyond what is normally expected and is extremely difficult to predict with a massive impact. The global economic crisis brought this term into the lime light, and in 2007 Nassim Taleb wrote popular book, The Black Swan: The Impact of the Highly Improbable, where he describes the futility of attempting to predict random events. As a result risk management efforts have been honed on addressing black swans in addition to traditional threats. In this article, we examine two common mistakes made by executives and managers in addressing major risk event or black swans.

Risk Management is a Cost

Benjamin Franklin said, “A penny saved is a penny earned.” In football (soccer for our readers from the States), when our favorite team beats a league rival, we call it a “six-pointer.” This outlook should be applied to risk management efforts within the organization. Often times, risk management efforts are viewed strictly as a cost, and in some cases avoided as a result. Organizations that focus on profitability in the traditional since, and fail to implement risk management principles to protect the revenue, often fall the furthest following a black swan event.

This idea suggests a paradigm shift for most organizations that risk management efforts should be viewed as profit-generating activities. In conversations, we have heard of the difficulties risk managers have in convincing executives for more resources. This is followed nine times out of ten with the statement, “If they only realized how much it is going to cost without a risk management program.”

Attempting to Predict Black Swans

Black swans by definition are extremely difficult to predict. In predicting a major risk event executives and managers take the focus away from more frequent, less damaging threats and vulnerabilities. By focusing on predicting black swans and implementing controls that are meant to prevent the occurrence (albeit a predicted occurrence), organizations are exposing themselves and as a result become more vulnerable to common events and threats. Black swans diverge from the norm and are unexpected. As such, statistical analysis and past events cannot serve as predictors for the occurrence of a black swan, which are unprecedented events.

It serves an organization better to focus on the results and consequences of a back swan and develop a business continuity and recovery plan (BCP), as opposed to attempting to predict its occurrence. By understanding the potential impact and vulnerabilities of the organization to a black swan and utilizing this information to develop a BCP, an organization is better equipped to address a major risk event if it occurs.

The concept of black swans and risk management go far beyond this article. Our hope is that this article is a starting point in examining your organization’s approach to risk management and assess if it falls prey to these two common mistakes.