The International BS Book Club III – The Black Swan

The Christmas break has provided the opportunity to catch up on some books that have been on my “to read” list for a while. First of these is Nassim Nicholas Taleb’s The Black Swan. The book is subtitled “The Impact Of The Highly Improbable”, and offers some very thought-provoking arguments about the way we should think about opportunities and threats.

Taleb is a bit of a financial wiz who has parlayed his wealth into a bit of a Renaissance-style thinker lifestyle. His prime concern is with the issue of chance and randomness.

The thrust of his work is that too often we believe we understand probabilities, and even more concerningly, ascribe the Gaussian bell-curve to them. As such, we underestimate the likelihood of extreme events occuring and thus neglect to “price them in” to our models of the world. We also overstate our capacity to learn from the past, and too readily try and build post-hoc rationalisations of occurences based on loose theories.

His Black Swans are highly improbable, impactful events that we didn’t see coming. Among his examples are the World Wars, the rise of religions, of the internet, of Google, of Harry Potter and the September 11 attacks. Now, many of these have been explainedafter the fact, but Taleb argues that these events were not predicted beforehand and would have been deemed almost infinitely unlikely.

The book is a fascinating read. Taleb is enormously self-confident and delights in tearing down the tall poppies in a variety of fields, from philosophy to mathematics, economics to finance. His arguments are quite powerful and intriguing. I will leave to you to read through it and untangle his mathematical and philosophical arguments. Here’s the opening chapter. Below is a short clip of Taleb explaining the ideas.

Taleb has received enormous publicity in recent months, as his soothsaying has been proven very correct with regard to the financial crisis (not just because this event was pretty much unforeseen, but rather because his criticisms of risk models used by hedge funds were so accurate). His own fund has been highly successful (and counter-cyclical) He has got less coverage than he should have regarding the historical and artistic dimensions.

The most under explored issue in the book is the impact of Black Swans on firms and markets. Taleb tends to view this domain with considerable distaste (there’s that dilettante tendency again). He has far too little to say about how firms might utilise his idea (beyond financial management practices).

There are some clear implications for those in the creative arena and also in biotech (that the scale of “blockbusters” could be enormous and perhaps market-shifting). Also it could be illuminating for firms to consider the likely impact on them of a competitor growing to an extreme size (e.g. Google, Microsoft), or their market expanding extremely fast, or of a unforeseen disruptive technology blowing their business model apart. Of course, none of these ideas a new, but what Taleb argues is that their probabilities are almost inevitably underestimated. Firms may simply be underprepared to deal with them. Building contingency strategies would be a first step towards better dealing with a Black Swan world.

A higher order approach would be to build business models around benefiting from Black Swan events. This seems to work for Taleb in financial markets. The premise is to have most of your funds in low risk, certain return assets, and putting a small proportion in assets with huge upside but little downside. One might argue that this is what some of the big IT firms do in funding small projects (who knows, one could become a Google, a Youtube, or a WordPress), or what pharmas are trying to with biotech (although the downside risks are much higher than Taleb would like I suspect). It is not necessarily the case that firms could get away with this in most industries however, simply as it would be hard to explain the use of funds to accountants, investors etc.

There is a lot to digest from Taleb’s book. There is probably an International Business dimension to all this – Has the complex web of interactions and interrelationships made life more unpredictable for firms? Has the deepening of the pool of firms and markets and products increased the likelihood of outlier firms, products and ideas emerging?

All in all, a fascinating and provocative book. For more reviews, articles etc, check out Taleb’s website.

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3 Responses to “The International BS Book Club III – The Black Swan”

  1. brucehood Says:

    Very good and considerate review.

    Best
    Bruce

    http://brucemhood.wordpress.com/

  2. Steve Sammartino Says:

    I’d argue that building a ‘black swan’ contingency plan is largely a waste of resources for any company given the following:

    1. Any disruptive technology would blow an incumbent out of the water anyway
    2. With low probability, unknown changes also comes the inability to build a defense… Defend against what? Can’t build a protection against a game changing event, technology or business model unless we have a rough idea of what it will be.

    I absolutely agree it is a better approach to invest quickly in the changes when they occur, rather than try to predict them.

    Steve.

  3. Wal Says:

    While the event that causes the disruptive change may be almost impossible to foresee, surely a business should “Know Thyself” enough to be aware of what changes it is vulnerable to? The biggest risk is not in the freak wave that swamps the boat, but the little leaks that we dismiss as being “manageable”, yet undermine our ability to respond, or increase our vulnerability to change. The current bout of financial crises had it’s roots in practises that essentially said, “Money not being lent (regardless of to who it is lent) is profit not being made.” and consumption is the key to profit, even if we have to lend people the money to consume.

    Rare events may indeed be impossible to predict, but increases in risk, ignorance of the situation and by extension, vulnerability to failure, are not. People just didn’t want to think that the party was over. And the delay between realising the extent of the problem and the action to correct it was too long for the pace of the change.

    Wal

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