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The certainty of black swans

A black swan is an event with three properties. First of all, a black swan is a rare event, based on past knowledge, and one that is impossible to predict. However, although its probability is low, when the event occurs, it has an enormous impact. Last, the event is easily explained afterwards. People didn’t see it coming before the fact, but after the fact, everybody saw it coming.

To illustrate a black swan event, imagine you are a turkey. You are being fed and watered every day. Because you are fed, your happiness level will rise every day. Every time you eat, you feel better than the day before. Judging from past events, you consider yourself lucky and will continue to do so until the end of time. However, one day, your head gets chopped off: ‘Thanksgiving’. The slaughtering of the turkey is a black swan event. It is rare, as it could only happen to the turkey once. It obviously has an enormous impact, for the life of the turkey is now over. On top of that (assuming the turkey lives at least to the point where it figures it out), it becomes obvious that it was being raised for slaughter; the protection and vaccinations were to keep it healthy, the excess food was to fatten it up.

Psychology prevents people from recognizing a black swan event. The turkey’s belief that every day would be fantastic is reinforced by the fact that every day was fantastic. Besides, the accumulation of supporting information doesn’t just reassure the turkey, but also actively destroys the ability to think about things the turkey doesn’t know, even as worst case scenarios. The example also illustrates the importance of context and point of view. The sequence of events described above is a black swan for the turkey, but not for the butcher, as he already knows what is going to happen the day before thanksgiving.

The concept of rare, unpredictable, high-impact events was well-known, but naming them as black swans was popularized by Nassim Nicholas Taleb in his book ‘The Black Swan, The Impact of the Highly Improbable’ in 2007.

Black swan theory versus black swan problem

The black swan theory of Nassim Nicholas Taleb should not be mistaken with the black swan problem, which demonstrates the falsifiability of an observation, statement, hypothesis, theory, or argument. It is questionable whether one could compose a general theory from a limited amount of observations. For example, a scientist notices that all swans people have seen up until this moment in time have been white. Every time people saw a swan, their hypothesis ‘all swans are white’ was confirmed. It is impossible to see all swans in the world, or at least you can never be sure whether you’ve seen all swans in the world. Therefore, it is impossible to prove the theory ‘all swans are white’. This problem is solved by falsifiability. A statement is called falsifiable if it is possible to conceive an observation or an argument that proves the statement in question to be false. In short: all swans are white, until a black swan is witnessed; so a theory is proven until proven otherwise. Although Nassim Nicholas Taleb describes the discovery of black swans by Europeans in Australia in his book, it is not a black swan event, seeing as the discovery hardly had any impact. During an interview for the McKinsey Quarterly, he explained that he used the example to encourage people to ‘think of the unknown and of the potency of the unknown, particularly a certain class of events that you can’t imagine but that can cost you a lot’.

The impact of black swans on businesses

History shows that the impact of black swan events is bigger than all planning and predictions of companies and institutes can foresee. What does this mean for companies and their (strategic) planning methods?

To some disagree, one of the most well-known black swans is 9/11. If the terrorist attack on the world trade center in New York had been a conceivable risk on 10 September 2001, it would likely not have happened. Either way, the consequences of 9/11 were immense. In the short run, the United States of America activated SCATANA: Security control of Air Traffic and Air Navigation Aids. SCATANA is a procedure that allows to take control of the airspace in order to ground all the air traffic. It is a procedure that was designed to counter the Soviet Union and their long-range bombers. As a consequence, thousands of people were stranded, air cargo could not be delivered, and businesses were limited in their transport options. In the long run, security procedures and costs on airports and aircraft increased, which obviously had a big impact on the operation of airports, airlines, and aircraft manufacturers. To illustrate: since September 11, 2011, the United States of America alone has spent upward of $740 billion on security.

In 2011, Japan was hit by a magnitude 9.0 earthquake and tsunami that caused a nuclear disaster, persistent power outages, and a host of other major societal and economic challenges. Disasters such as the one in Japan do not only affect local companies, but can cause multiple supply chain disruptions. For example, Philips was a major supplier of semiconductors to Nokia and Ericsson in 2000, when a fire at a chip plant in Albuquerque destroyed chips for millions of cell phones. Nokia immediately set up a troubleshooting team to assess the impact and find alternatives. Nokia was able to make all customer shipments in time. In contrast, Ericsson took several weeks to respond to the situation, and by that time most of the market capacity had already been allocated to Nokia. The impact was devastating for Ericsson, which took a $2,34 billion loss in its mobile phone division. The example shows that being dependent on one supplier makes you vulnerable for black swans. This might have consequences to the outsource policy of a company.

In any case, with the rise of global business, it is likely that black swans carry increased risks for any company, including negative impacts on customers, suppliers, partners, assets, operations, employees, and shareholders. Today, not only can a catastrophe in one part of the world affect the sourcing, manufacturing, shipping, and sales of products locally — the interconnections of global financial, economic, and political networks ensure that the effects of such events ripple around the world, too. Typically, large companies rely on their 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. ERM has become an indispensable member of the global functional teams in most large companies. However, most ERM departments focus on high frequency risks instead of black swans. Besides, high-magnitude, low-frequency events can stem from sources too numerous and too varied for the ERM team to identify in full. In short, ERM does not have the capacity to monitor high-magnitude, low-frequency disruptors on a regular basis. How then can companies cope with black swans?

How to cope with black swans

First of all, one should not attempt to predict black swan events. A certain black swan will never happen twice. Businesses will take precautions to cope with the problem in the future. If the event were to happen again, it would be just as rare and unpredictable, but the impact would be limited. Second, a black swan event for one company might not be a black swan surprise for the other. One should ensure that the organization is flexible and/or robust enough to adequately respond to unexpected events with a big impact. Therefore, once black swan events emerge, businesses need to be very clear about the expected impact on their particular business, and they need to have a robust plan as to how best to mitigate against any negative implications. Last, not all black swan events are negative, e.g. the invention of the Internet or the Harry Potter phenomenon. Businesses should be ready to cope with negative black swans and take advantage of positive ones. Because of the enormous impact and possible distortion of the market, new opportunities arise that businesses could use to their advantage. In his The Ten Principles for a Black-Swan-Robust Society, Nassim Nicholas Taleb describes precisely how to cope with black swans. To look back on the turkey example, one should try to avoid being the turkey by identifying areas of vulnerability, so that blacks swans can turn white.

Avoid being a turkey by identifying areas of vulnerability in order to turn black swans white


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