In today’s lean, just-in-time, and over optimized world, it’s not uncommon for executives roll their eyes when the term “Black Swan” is brought up in risk management discussions. That’s because even though preparing for extreme events makes logical sense, there’s also a cost associated with redundancy and robust disaster planning. In addition, no one is ever judged a hero for saving the company from what never (or is never supposed to) happen. Business executives must fight back against Black Swan fatigue, because in today’s interconnected and highly correlated world, the next extreme event could be the one that shoves your company off a cliff.
When it comes to preparing for low probability but high impact events (i.e. Black Swans), the sad truth is most business executives will do nothing. Why? Nassim Taleb, author of the Black Swan, explains; “It is difficult to motivate people in the prevention of Black Swans. Prevention is not easily perceived, measured, or rewarded; it is generally a silent and thankless activity. History books do not account forheroic preventive measures.”
Taleb is right. No one will be labeled a hero for keeping extra inventory on hand. No one will be characterized a hero for divvying orders among various suppliers just in case the favored and most cost effective supplier goes belly up. And spending money on strategy and risk management consultants to disaster and scenario plan for worst case developments? Forget about it. These are all just costs, and cannot be afforded in today’s bottom line economy, right?
Someone wise once said that risk management is much like insurance. You hate to spend money on it, but you’re darn glad you have it when all hell breaks loose.
But wait you say, don’t most business executives plan for disaster? Perhaps, but there’s a difference between hiring a consultant to produce a disaster planning report which promptly collects dust, and actually preparing for and assuming extreme events will occur as part of your overall business plan. And even when managers believe they’re prepared for worst case events, sometimes it’s not enough—with potentially horrific consequences.
As detailed in the March 27, 2011 issue of the Financial Times, executives at Tepco’s Fukushima Daiichi plant were prepared for earthquake. In fact, they were also prepared for tsunami—having built a seawall 20 feet tall. What they did not expect is that the March 11, magnitude 9.0 earthquake would cause a tsunami wave 40 feet tall! The tsunami promptly washed away the sea wall and also the diesel powered generators cooling the spent nuclear fuel rods housed at Fukushima.
Executives at Fukushima had planned for disaster. They had built a 20 foot seawall. They had redundancy with backup generators in case the cooling system failed. And the nuclear plant powered down once the 9.0 magnitude earthquake hit. Everything worked as planned. But they were not prepared for the “unthinkable” extreme event.
Predictive modeling based on historical data will only take you so far. Even extrapolating with Bayes isn’t going to be of much use for “unknown, unknowns”. As business managers we must fight Black Swan lethargy, especially when all oars in the boat are rolling towards lands of “optimization” and “cost effectiveness”. As managers, we must continue to sound the alarm, even though probability of the extreme event is of the smallest percentages.
Play up the risk of future Black Swans and then prepare for the extreme event. Here’s to hoping you’ll never be proved right.