My personal curiosity about human behavior and my business interests converge when I begin considering how people make choices. As a result, I read a lot of books about decision-making processes. As a marketer, I need to understand how customers make buying selections and what factors will impact their behavior. As a person, I’d like to improve the quality of my personal decision making.

“The Black Swan: The Impact of the Highly Improbable” by Nassim Nicholas Taleb

Because we all do risk-benefit analyses, I was enthused when I found a book called “The Black Swan” by Nassim Nicholas Taleb. This entertaining book explains the extreme limitations of our ability to make reliable forecasts about future conditions in order to mitigate adversities. As a result, we strive to control for every foreseeable eventuality but neglect to be prepared for the more significant impacts that result from more disastrous, but impossible-to-predict, catastrophes.

What is a Black Swan Event?

Taleb is a Distinguished Professor of Risk Engineering at New York University’s Polytechnic Institute and started his career as a hedge fund manager and derivatives trader. He has always been fascinated by unanticipated anomalies that do not conform to conventional expectations. He calls these “Black Swan Events” because, before the discovery of Australia, no one believed that black swans existed. Philosophers often referred to impossible occurrences as being “as rare a bird as a black swan.” No one believed that there were black swans because none had ever been seen but there are plenty of them Down Under.

Why Are the Biggest Risks Impossible to Predict?

Human brains create stories that allow us to manage the unorganized information we receive because, unfiltered and un-contextualized, we cannot make decisions. Unfortunately, when we select which facts to include (which we MUST do), we leave out other factors that also have had a significant impact on the outcome of an event. And because those Black Swan Events have not been anticipated, they will often have the greatest effects.

Our acceptance of a particular version of a story is determined by our personalities, experience, and the context of the situation, and we rely upon that story as being true when it satisfactorily explains our observations. Because we can only predict what we can imagine, when the unimaginable happens, we are caught unprepared. That is why the same facts can be “spun” in many different scenarios that will lead to different conclusions. In retrospect we rewrite the story to support the result of all the factors and forget that we didn’t see it coming all along.

The three fallacies that undermine people’s decision-making ability are 1) our overriding faith in our understanding of the present, 2) excessive confidence in patterns from the past as the predictors of the future, and 3) overreliance on factual information as evidence of the accuracy of our predictions. This leads us to overvalue risks that are less significant or those that are highly improbable and then not prepare for those that cannot be imagined because they are outside of our experience.

Examples of Black Swan Events

Throughout the book, Taleb describes Black Swan events like 9/11/2001 or the fall of Hosni Mubarak in Egypt that were totally unexpected and have changed the course of history. My favorite example was his discussion of the business risks incurred by a casino in Las Vegas.

While attending a symposium on risk management sponsored by the US Defense Department, Taleb was given a tour of a major casino and saw all the elaborate surveillance systems in place for reducing business losses from cheating. The managers then explained that, despite all those preparations, the greatest threats had not come from those foreseeable hazards. Greater business risks became apparent when

• During an engagement, the “tame” performing tiger in a headlining Las Vegas attraction mauled the animal trainer who had raised him. The casino losses were more than $100,000 and could have been much greater if the tiger had gone wild during a performance rather than in the performer’s private room.
• A disgruntled contractor tried to blow up the building and almost succeeded.
• IRS reporting documents entrusted to an employee were not filed for several years and the casino nearly lost its gambling license and paid monstrous fines for noncompliance in a heavily regulated industry.

None of those events were easy to predict. The tiger was considered a pet and slept in the performer’s bedroom; the contractor was bitter about an injury on the job that had been covered by workman’s compensation; the employee, who didn’t meet his responsibilities, had been carefully selected.

The problem is that, like the casino, we spend more time exhaustively managing the foreseeable threats and yet never build any awareness that there are always unforeseeable risks. As military risk analysts put it, there are always “unknown unknowns” along with “known unknowns.” Those are the Black Swans.

Reducing Negative Outcomes in a World with Black Swans

According to Taleb, the experts among us are often the ones wearing the biggest blinders because they have been schooled to believe that they have fully considered every eventuality in their field. Those of us who place too much faith in them are just as likely to be caught unaware when the bottom falls out.

In your business, despite all of your preparations, your website will eventually go down, leadership and succession plans will fail, and budget expectations will be wrong. Limiting risk assessment to specific hazards and not considering what you cannot imagine will result in not being able to adroitly manage an unplanned-for catastrophe when one occurs.

Preparing only for specific emergencies will limit our ability to respond when the crisis does not conform to our expectations. Our mental agility or ability to allocate resources will be undermined when we are too focused on specifics and haven’t considered the possibility of unknown unknowns. This is the purpose of a slush fund or over-budgeting time allocations in business project management. Things happen and it is impossible to completely control all the issues that can impact any system.

There will always be natural disasters, people who die or don’t perform, and technology that fails—these Black Swans will have much greater impact when we are under the illusion that we have controlled for every eventuality. Mitigating business risks means preparing for highly predictable hazards but also making allowances for what cannot possibly be anticipated like terrorist attacks or bank failures.  This is the most effective model of risk management.

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