When the Swiss National Bank (SNB) decoupled the franc from the euro in January, it took financial markets around the world by surprise. Deutsche Bank and Citigroup were reported to have lost £97m each as a result of the move. Investors panicked as they hunted for safe havens for their cash. The price of gold rocketed by £32 an ounce in a single day.
The SNB’s decision was the latest in a series of “black swan” events – unpredictable happenings with a potentially devastating impact – that have shaken the business world in the past two decades. Others include the collapse of Lehman Brothers, 9/11, civil war in Ukraine, and the halving of the oil price during the past year.
As top executives around the world grappled to manage the impact of the SNB’s decision on their own businesses, economist Steen Jakobsen, chief investment officer at Denmark’s Saxo Bank, would have enjoyed a quiet smile. He had predicted that SNB would make such a move two years earlier. For nearly 12 years now, Jakobsen has been something of a global sage in thinking the unthinkable.
Every January he publishes 10 “outrageous predictions” for the coming year – which would be devastating black swan events if they happened. In the past, as many as three or four of them have come to pass. This year’s crop of predictions includes a massive eruption of the active Icelandic volcano Bárðarbunga – shifting world weather patterns, disrupting agriculture and doubling the price of grain – and aggressive hacking of online shopping sites causing consumer panic and slashing Amazon’s valuation by 50%.
These events often expose a company’s biggest strategic, operational or financial weakness, triggering a further cascade of negative events for the company
Jakobsen insists his predictions are more than an exercise in spreading gloom and doom. “It’s all about forcing people to look at the world slightly differently,” he says, adding that boards should try a similar exercise for themselves. “The world is too complacent and too many people spend too much time projecting the past into the future.”
And that is the key problem with black swan events: the past is no guide to what happens next. The black swan concept and theory were first developed by statistician and risk analyst Nassim Nicholas Taleb in his books Fooled by Randomness and The Black Swan. He argues that looking for patterns in the normal distribution of numbers, such as a bell curve, misses the outliers that may predict black swan events.
It is those outliers that cause businesses major headaches when they change from a random statistic into a real event. And the chances of that happening are not as remote as it may seem from the comfort of an oak-panelled boardroom. When Deloitte studied the performance of the world’s 1,000 largest companies over nine years, it discovered that almost 380 of them had suffered a “value killer” event – more than a 20% share price decline in one month compared to the average performance of the MSCI All Country World Index.
Among the 100 companies with the worst records, share price dipped by an average of 42% in the month following the value killer event. The biggest single cause was a black swan, which often triggered a chain reaction of other problems in the victim companies.
“These events often expose a company’s biggest strategic, operational or financial weakness, triggering a further cascade of negative events for the company,” notes the Deloitte research.
Steven Hall, partner in risk consulting at KPMG, says life has simply become riskier in the past 25 years, accelerated by more open and transparent global business. “Life moves more quickly now than it did then – so the transmission mechanism between events is shorter and faster. There is less chance to mitigate them before they become bigger.”
Bill Waite, group chief executive at the Risk Advisory Group, a risk management consultancy, is often called in to help pick up the pieces when a black swan event hits a company. He has been helping clients navigate the problems caused by the civil war in Ukraine. “Five years ago, they wouldn’t have seen this situation developing,” he says.
Ukraine had always been a high-risk investment target with corruption and political instability two of the main problem areas, he points out. “But outside investors believed they could manage those factors with internal controls and procedures – including political risk forecasting,” he says.
But Russia’s seizure of the Crimea coupled with its military sponsorship of rebels within Ukraine were not on their radar. “The situation has been like a flock of black swans,” says Waite. “Companies can respond to one event but when you’ve got several at the same time, it’s very difficult to keep on top.”
He says that ensuring the safety of staff has been a top priority for companies with operations in the region. That has been complicated because large numbers of workers have been drafted into the military on both sides of the conflict. Another priority has been protecting the value of assets in Ukraine. “You have to look closely at the micro-political situation and the reality of being able to protect them physically,” Waite says.
In the face of violence and uncertainty, it is tempting to pull out of the country. But Waite argues that one of the lessons of the Russian sovereign default of 1998 is that if a company withdraws from a territory it is difficult to re-establish there when the crisis has passed.
Every black swan event is unique and presents its own problems. “The world throws out so much novelty that the best scientists and computers won’t even be able to predict possibilities – let alone events,” says Jochen Runde, professor of economics and organisation at the University of Cambridge’s Judge Business School.
Runde has been delivering a series of lectures on how to avoid black swan events. One of the problems his research has identified is a “confirmation bias”. People are conditioned by their history, experiences, social position and other factors, he argues.
“Confirmation bias is a psychological tendency to look for and interpret evidence in a way which is consistent with our world view,” he says.
In other words, executives sitting round the boardroom table are more likely to think of the future in the way they have experienced the past. “So the trick is to find strategies that take you out of your normal way of looking at things,” he says.
He believes the 17th century philosopher Francis Bacon may have the answer. Bacon argued in favour of testing a whole range of different hypotheses to see if they challenged the accepted view. “When you look at a business plan, consider outliers that could be devastating for it,” advises Runde.
Some companies already adopt an approach very similar to this. One of them is Lego, maker of the famous building bricks. When the credit crunch hit the firm in 2008, the board found that financial projections for the core building bricks part of the business were less robust than those for its short shelf-life product lines, often based around Hollywood blockbuster films such as Pirates of the Caribbean.
Paul Dennis, who heads the EMEA finance division at business advisory firm CEB, was a partner in Lego’s review process and privy to the thinking of the company’s finance team. He says: “Lego decided to use the more agile planning process used for the short shelf-life products for the whole business.”
Now the company produces a baseline budget, but with three high-level variations on it, which it can switch to at short notice if the firm is suddenly hit by an unexpected change in its prospects. “As a result, Lego invests more time upfront, stress testing chosen scenarios more thoroughly. If it sees the scenario underpinning the base budget proves to be wrong, the company can switch to a variant of it quickly because the business has already given an implicit sign-off for it,” he explains.
The message, which comes through from companies that perform best when a black swan soars into sight, is that it is wise to be more flexible in your thinking. “You can never be sure about what you don’t know, or the best way to act when an unforeseen game-changing event happens,” warns Iain Coke, head of the Financial Services Faculty at ICAEW. “However, to manage the risks you can look at – and challenge any assumptions in your thinking – risk considerations should be integrated into business decision-making at an early stage.
“For more complex businesses with a separate risk function, the chief risk officer should be given sufficient authority to challenge and help shape the business strategy.
“If the unexpected does happen, you should have well-organised processes to deal with it. These could include being able to mobilise a crisis response team, set up emergency board and risk committee meetings, and get quick access to up-to-date management information.”
Nigel Peters, a former RAF group captain, trained in asymmetric warfare where the strength or strategy of belligerents differs considerably. He believes the flexible mind-set this training provides is why the military are so effective at handling black swan events, such as the fall-out from the 2001 foot-and-mouth epidemic.
Peters, now managing partner at Alium Partners, says: “Strong plans enable you to mitigate risk and an agile responsive workforce enables you to cope with the demands of a challenging and unexpected environment.”
But John Lunn, partner at transformation consultancy Moorhouse, believes that black swan events can have positive, as well as negative, consequences. Lunn has gained business perspectives in Africa where firms expect things to go wrong, such as last year’s west Africa Ebola outbreak. As a result, instead of trying to identify every risk, they focus energies on coping when a problem occurs.
Lunn believes European firms could learn from Africa’s can-do-under-pressure culture. When hit by a black swan, companies spend all their time trying to protect their assets, Lunn points out. “But if a company were to split off a small team tasked with finding new opportunities from the crisis – and have this capability as part of its delivery culture – it could find itself ahead of competitors when the problem subsides.”
Chartered accountants have a strong role to play if a black swan lands on their organisation. They need to challenge cause-and-effect- type thinking, says Dev Mookherjee, business director at Ashridge Business School, and a specialist on working with risk. “The idea that you can always project into the future based on previous experience is wrong,” he says.
Accountants should be well placed to encourage managers to think about a range of outcomes, he adds. “They should seek out and be open to data that challenges the organisation at an existential level. They need to challenge the idea that there are risk-free options. And they need to take on a facilitating role, helping to test out future scenarios by asking ‘what if?’ questions.”
Felix Naumann, professor at the Hasso Plattner Institute at Potsdam University, Germany, reckons he has just the tool to help.
He encouraged a group of students to build a black swan information system that enables researchers to ask ‘what if?’ questions about the past in a search for patterns that may hold a clue to future threats.
“The system contains practical lessons for business people who want to use the past as a guide to finding sets of circumstances that may recur in the future,” Naumann says. (The system is free to use online at blackswanevents.org)
No company is ever likely to be able to foresee every threat. But the experience of the past decade suggests that those who seek to plan for black swan events are more likely to emerge from them stronger and healthier than those that don’t.
“In my opinion, every single board should be under a legal obligation to make a worst case scenario for their business,” says Saxo Bank’s Jakobsen.
“They should be ready for a perfect storm.”
Black swans massing: potential chaotic events
Precedent North Korea’s apparent attack on Sony over its film The Interview, 2014.
Early warning signs Could be many but including small, unexplained errors; slower system performance; corrupted back-ups.
Likely impact Loss of data; disruption of business; significant need for rework.
Mitigation Focus on the basics, says Richard Anning, head of ICAEW’s IT Faculty. Install latest version of systems; use anti-virus software; train staff not to open dubious emails.
Global health pandemic
Precedent Severe acute respiratory syndrome (SARS) outbreak, South-East Asia, 2002/03. Early warning signs Cases exhibit resistance to existing vaccines with higher than expected death rate.
Likely impact Restrictions on travel; high workplace absenteeism; overstretched medical facilities.
Mitigation Crisis planning; identify key staff; plan for more temporary home working.
Precedent Russian invasion of Ukraine, 2014. Early warning signs Raised geo-political tension over regional issues.
Likely impact Volatility in stock markets; possible rise in oil price; restriction of some commodities depending on region of conflict.
Mitigation Stress-test business plans in various risk scenarios; seek alternative suppliers in event of conflict; limit exposure to high-risk markets.