Creating adaptive companies to take care of the black swan

Before the discovery of Australia, Europeans had no reason to think that a black swan could exist. Until we arrived in Australia, and the discovery of a single bird wiped out centuries of evidence. This fact illustrates a serious limitation of our learning from observation and experience.

Nassim Nicholas Taleb, author of The Black Swan

Nassim’s reflection shows us one of the most common mistakes in human beings when faced with complexity and uncertainty. If we have lived in the northern hemisphere all our lives, we will think that all swans are white. The existence of a black swan seems impossible to us due to our limited experience. But the fact is that today, in an interconnected, complex and extreme world, in which information circulates at full speed and in all directions, it is increasingly possible that we will come across a Black Swan on the road. And that can change our lives.

Hence the importance of asking ourselves: How can we identify a Black Swan, if they are unpredictable? What can we do to adapt to their existence? In this first conversation about Nassim Taleb’s proposals, we will reflect on these questions and on our blindness to Black Swans. In the next conversation, we will talk about some practical tips that will help us focus our attention on what is truly important in our lives.

What is a Black Swan?

What Nassim calls a Black Swan is not a bird, but an event that has the following three properties:

1. It is a rarity that dwells outside the realm of normal expectations, because there is no element in the past that convincingly points to its possibility.
2. It produces an extreme impact with important consequences for our lives.
3. It is characterized by retrospective predictability. That is, we cannot predict it before it happens, but once it happens, we think that we “had seen it coming”.

There are many things that we are not able to predict, but that can change our lives completely. For example, the global financial crisis, or the 11M attacks. Not all of them have to be negative: we are also talking about the impact of the Internet, the rise of the computer, the discovery of penicillin, or the fall of the Franco regime. Let’s think about our own life, about the choice of career, for example; about how we have done financially, where we currently live or when we met our partner. How many really important events in our own existence occurred in a foreseen and programmed way, according to an established plan? In my personal case, the answer is very simple: most of the important events in my life have been Black Swans. That is, events that meet the three previous properties: rarity, extreme impact and retrospective predictability.

The question is this: why, despite the time and effort we put into studying and analyzing information, are we not able to anticipate these phenomena? Where does our blindness to Black Swans come from? What is surprising, according to Nassim, is not the magnitude of our prediction errors, but the lack of awareness we have of them. In other words, we find it hard to accept that what we don’t know is more important than what we know, and so we remain focused on the details, spending more time on small change than on banknotes. We see it every day in the triviality of the news, talk shows, or opinion forums. What a waste of energy! It’s as if our mind is operating with the wrong user manual.

The illusion of prediction

We spend much of our lives worrying about the future, trying to anticipate what will happen, in order to protect our families and maximize our opportunities. Experts analyze events and news on television, and offer their predictions. The government, sociologists, statistical departments, and the computer industry accumulate mountains of data that they then use to anticipate and predict the risks we face. But the reality is that we fail again and again. Events that later prove momentous take us by surprise, as happened with the market crash of 1987, with the tragic terrorist attacks of September 11, 2001, the bursting of the .com bubble in 2000 and, even more recently, with the collapse of the real estate market in Spain and the global financial crisis in which we are immersed.

The importance of creating adaptive companies

Transferring these concepts to the business world, we can say that we need to create adaptive companies to take care of black swans, that is, all the unforeseen events and novelties that we do not know about and cannot foresee in advance. For survive, we have to have adaptive companies, who are able to adapt to unforeseen changes and learn to continue operating taking them into account. The ability to Adapting to change in a company plays a fundamental role in its survival.

In his book The Black Swan: The Impact of the Highly Improbable,
Nassim Nicholas Taleb
-Lebanese-American professor, successful essayist and former stock market trader- proposes a deep reflection on a large part of the philosophical-mathematical assumptions that we currently apply to economics, to the conception of risk and to the management of uncertainty. This failed philosophy is what has been behind the current financial crisis. Taleb’s reflections will help us discover the errors we make in our reasoning processes when we are faced with the complexity, uncertainty and randomness of the world in which we live

Taleb’s thesis is that we are not very good at predicting the really important phenomena. Our ability is reduced to simple predictions in simple environments. At most, we are able to anticipate the number of accidents that are going to occur this week on our roads. Beyond that, our predictions are a mere illusion. Why? Let’s try to explain it.

The silent evidence

“Silent evidence” is the mechanism by which we maintain the illusion that we can understand the world, and that we are able to anticipate what is going to happen. After the event, we focus only on a part of the information, precisely the one that could explain it, and we leave aside the rest of the evidence and evidence. For Taleb, the clearest example is World War I. After the war, we study that the conflict broke out because of the tension between the United Kingdom on the one hand, Austria and Germany on the other. In other words, that the tension led to war and that, therefore, if there is tension, we can predict the outbreak of a war. But in this conception we do not take into account the episodes of tension that did not lead to a war, and which have been the majority. In Taleb’s words: “these episodes led kings and politicians to Baden-Baden to listen to opera and drink champagne”.

The fact is that, when making decisions, we base ourselves on certain information, and we leave aside all the rest: what we don’t see, what we don’t know, what we don’t observe, the lost texts, the different outcomes, etc. We tend to look at those who survive, those who succeed, and not those who don’t get anywhere. Among other things, because we know almost nothing about them.

Russell’s Turkey: The Problem of Simplified Induction

Taleb presents the problem of induction – drawing general conclusions from particular data – using the case of “Russell’s turkey”, named after Bertrand Russell

, who was the first to present the example, taking up the problem of induction initiated by David Hume

. The case is as follows:

The turkey found that he was fed every morning and, after several months of observations, he concluded that there was a universal law: “These kind humans must love me very much, since they feed me generously every day.” When Thanksgiving came, it turns out that the “kind humans” sharpened the knife and proved that the law formulated by the turkey was worth very little. To the turkey, that was a Black Swan; to the butcher it was not, because he knew what was going to happen. So the black swan depends on our knowledge. And we must keep in mind that there are many things we do not know.

Our way of thinking is not very different from that of “Russell’s turkey.” Much of statistical mathematics, risk calculation, and probability distributions are traversed by this way of thinking: the higher the frequency of an event, the less sensitive you are to the unexpected.

Why do we have trouble predicting the most important things?

Our internal mechanism for estimating the probabilities of significant events is too outdated for the current complexity of the modern world. Historically, we have had to deal with a much smaller number of variables, less information, and fewer theories to explain what happens to us. Our ancestors lived in a very predictable habitat. There were many small surprises, but few big ones.

Today, communication is global. Society is so complex that almost nothing of our future goes as planned. We worry and put our energy into irrelevant things. And we pay little attention to such momentous events as the fall of the Soviet Union, climate change, or the variability of oil prices. The biggest problem is that we resist the idea that our existence is becoming more and more unpredictable. We find it frightening to think that what happens is often just a matter of chance. We prefer to delude ourselves into the illusion that we really control our world.

Retrospective distortion

In his book, Taleb takes a look at the different errors in human reasoning when faced with black swans. The most relevant thing is that humans are not able to anticipate what is going to happen but, on the other hand, “we are very good at predicting events retroactively”… This distortion occurs because we overestimate the value of rational explanations and data, while underestimating the importance of randomness, of what cannot be explained with data.

For Professor Taleb, there is a genetic and philosophical basis that explains how poorly prepared humans are when faced with uncertainty and randomness. According to Taleb, evolution did not favor a complex and probabilistic type of thinking; quite the contrary: we are very quick to make instant decisions, based on a minimum amount of data or on superficial and unsound theories. This is the example proposed by an amusing Taleb to explain it:

Perhaps because those who spotted a lion and ran away – assuming that all wild animals always eat human beings – were more likely to survive than those who preferred to test such a hypothesis experimentally. Of course, there are friendly lions – in the same way that black swans exist – but it is preferable to be prudent and cautious beforehand than to suffer the consequences later. It is, again, a vision of the problem of induction that we have dealt with earlier.

The Platonic fallacy

For Taleb there is a fundamental philosophical problem. It is the “Platonic fallacy”. We are children of the Platonic school, which encouraged us to prefer structured, ordinary and understandable theory, as opposed to disordered and complex reality. We are also victims of a “narrative fallacy”. And, as we have already mentioned, we select only the facts that fit into our theories. And when the events have already taken place, we create post-hoc stories so that the event seems to have a cause. In fact, we always tend to remember that our forecasts were more adjusted to what later happened. It is a psychological mechanism by which we try all the time to build “consistent” stories, tweaking the real forecasts we made at the time.

Mediocristán and Extremistán

To explain the evolution of our economic system, Taleb proposes the existence of two very different “countries”: Mediocristan and Extremistan. Imagine that we gather 1,000 people chosen at random in one of these countries, and weigh them to extract the average. If we bring in the fattest person in the world – let’s say he weighs 350 kilos – will the average weight of the 1,001 people gathered in that country change much? The answer is no. The average will hardly vary. Welcome to Mediocristan, the country of mathematics, statistics, and probability theory. In that country there are exceptions, but they have hardly any consequences. Individual variations hardly alter the average. In Mediocristan, distributions such as that of Gauss’s Bell make sense.

Now let’s take those same 1,000 people and count their money to make an average. Next, let’s introduce Bill Gates, supposedly the richest man in the world, to the country. Will the average wealth of those gathered there change much? Yes. It will change in a brutal way. It is almost certain that Bill Gates, with his 50,000 million dollars, has much more money alone than all the rest of the inhabitants. Welcome to Extremistan, a country in which statistics, probability and most of the measurement tools we use do not work well. Extremistan is the country of least orthodox mathematics, such as the fractal geometry discovered by Benoît Mandelbrot. The distributions follow a power law like that of Zipf

, Pareto’s

or, to give a more recent example, Chris Anderson’s “Long Tail

“, which we have already talked about on previous occasions

.

In other words, Extremistan is the country of the Black Swans. It is the country dominated by the exception. Social justice belongs to Mediocristan, but the opportunities and, above all, the current economic life, is typical of Extremistan, a country in which a single exception can destroy the system. That is the complex world in which we live.

To summarize, our blindness to Black Swans

• A Black Swan is a rare event, with a great impact on our lives and that we can only predict retrospectively.
• Many of the most important things that have happened in our lives are Black Swans; that is, they have not happened in a predictable and programmed way.
• The logic of Black Swans makes what we don’t know more important than what we know. What we know really can’t surprise or hurt us. Often normal is irrelevant.
• We tend to overestimate the value of explanations of data, while underestimating the importance of randomness (which is inexplicable using data). We are ill-equipped to deal with uncertainty and the highly improbable.
• We prefer structured, ordinary, and understandable theory to disordered and complex reality. We select the facts that fit well into our history and reject the discontinuous.
• The inability to predict Black Swans entails the inability to predict the course of history, given the incidence and importance of these events in the course of events.
• Black Swans have been on the rise as the world has become more complex and global. The Age of Collaboration is a Black Swan with great impact on individuals and organizations.

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