The Black Swan Theory explained – Why you should beware of the “black swan”!

The “black swan” theory was popularised by the book of the same name by Nassim Nicholas Taleb. The term comes from an ancient Latin saying that something is as true or as probable “as a black swan”. Even second-century Roman philosophers used this phrase to describe a thing of impossibility. Later in the Middle Ages and into the 16th century, a black swan was a figure of speech for something that simply did not exist.

In the world known until then, a swan was white. All existing records about these animals described them with white feathers. A black swan was an abstract idea of something that did not exist or, according to current knowledge, could not exist. A thing of impossibility, something that would contradict all laws of nature and is therefore categorically excluded from any risk management or planning. In 1697, a group of Dutch adventurers, led by Willem de Vlamingh, finally explored the territories of Western Australia. Against all expectations of the time, they discovered something that was not supposed to exist: a black swan.

As a result, this designation was born for something that is currently considered inconceivable, but which later proves to be true. It is thus a term for a firm belief in something that is later falsified. In his first book, Taleb described a black swan as an event of the highest improbability in the financial markets, especially given the effects that such events can have there. In his 2007 book of the same name, however, he describes how these events can be found again and again in other areas outside the financial market.

The Black Swan Theory explained

Seen from this perspective, recent economic history is full of seemingly impossible events that were considered impossible until they happened. Almost all the great scientific and economic achievements of the last decades were just such a black swan. Until they finally happened, they were unpredictable, and considered impossible and their occurrence had inestimable dimensions:

World War I, nuclear energy, the rise and spread of the internet, the dissolution of the Soviet Union, the civilian use of GPS systems for everyone, the enforcement of smartphones, the subprime crisis of 2008, the boom of electric vehicles, the coronavirus, Russia’s invasion of Ukraine and much more.

All these events were unthinkable until they became reality. If you had tried to predict them, you would have been dismissed as crazy or silly. That is, of course, until one day these “impossible” scenarios occurred and became reality.

According to Taleb, a black swan can be characterized by the following three criteria:

1. The event is sudden and surprising.
2. The event has a significant impact.
3. After the initial analyses and records of the event, it is often claimed in retrospect that it could have been foreseen. Data or indications would have been available but were not heeded. It is similar to the perception of those involved.

One of the most recent such events, the Covid-19 global pandemic, is often referred to as one of the quintessential black swan events of recent decades. After all, even in a dream, no one would have thought that a virus would completely paralyze global life for a short period and subsequently lead to supply shortages, price fluctuations, crises, and high inflation rates around the world for a long time to come.

Virologists had been warning of the dangers of a possible pandemic for decades – and repeatedly pointing out how ill-prepared our society would be for such an event. Only nobody took these virologists seriously until it was too late. Historically, a pandemic is anything but impossible. Time and again there have been outbreaks of fatal viruses or infections around the world, as seen in the Spanish flu of 1918, the plague, and numerous other epidemics in the past. Such events have occurred again and again at regular intervals and are anything but unpredictable. The facts therefore all pointed to the fact that in the foreseeable future, another contagious disease would strike humanity. Only no one wanted to hear about it. After decades of unrestricted globalization, hardly anyone thought it was conceivable that such an event would ever happen again.

According to Taleb, Covid-19 was not even a black swan, but a white swan. The evidence for periodically recurring pandemics was obvious. Nevertheless, they were not heeded and Covid-19 caught the world economy completely unprepared, causing enormous damage.

How do you deal with a black swan?

Digitalization will mean a major upheaval for many companies. You have to get involved with new, previously untried ideas. The risk of encountering a black swan is always present. Familiar and seemingly safe waters have to be abandoned for something completely new and unknown, the outcome of which is uncertain. The theory of the black swan is therefore relevant for all those who implement innovations in an organization because in the end we never really know what will happen and what the future has in store for us. Even scenarios that seem completely unrealistic and fanciful from today’s perspective should nevertheless be examined and at least considered conceivable. A statement like “this is guaranteed not to happen” has often proved disastrous in recent economic history:

• The board at Nokia did not think that computer companies would soon be the biggest competition.
• The managers at Kodak also did not believe that digital photography would prevail in the market as a much worse business model for manufacturers.
• The NASA engineers of the Challenger would never have dared to dream that a few degrees of temperature difference would make the spaceship explode after only a few seconds.
• The management at Ford would never have expected that customers would not want a car (Ford Edsel) that was built exactly to their specifications.
• The Fukushima nuclear disaster occurred because they never imagined that such a high tsunami would ever hit the region. Etc.

All these assumptions led to partly catastrophic effects for the organization itself and partly far beyond. To ensure that your transformation into the digital era does not meet a similar fate, one should prepare for possible situations, even if they seem very, very unlikely from a current perspective. However, the right response to such events, which are unpredictable, is not to spend all day thinking about unthinkable scenarios.

Successful preparation for a black swan is rather done by preparing for possible negative events as a company and being appropriately armed for them. At the same time, however, it is crucial to make use of positive events even in good times and to build up financial reserves.

Preparing for a negative event, however, must not hinder the current daily routine in a positive economic cycle. Preparing for hard times does not mean not taking advantage of good times. On the contrary. If you can celebrate successes, do so and skim off your profits as best you can. Rather, preparing for a black swan is about creating a soft cushion in good times, in case those times turn and you might face lean years ahead. Metaphorically speaking, you need to prepare for winter during the summer months. This can be done in the form of capital reserves, by diversifying income sources or customer strata, through new business areas, etc., in order to stostable as possible if part of the core business were to unexpectedly break away.

Financial institutions such as banks are particularly vulnerable to black swans because their business model of lending money assumes permanent economic growth and a constantly functioning economic cycle. However, if this cycle falters or a large number of customers default on payments at the same time, the entire system is at risk of collapse and can lead to potentially unpredictable losses. In the 2008 crisis, a single investment bank that had speculated was enough to almost trigger a meltdown of the entire financial system.

Summary

As a company, therefore, for a successful transformation, the business model should be as stable as possible and be ready for any changes in the market. Taleb also notes that a black swan depends on one’s perspective. A turkey being led into a slaughterhouse will certainly consider this a black swan – but its butcher hardly ever will. Therefore, if possible, one should try not to be the turkey by trying to find one’s weaknesses and, provide them with a plan B or otherwise position oneself more strongly. Especially in the fast-changing digital markets with exponential growth, this is an important factor to consider. Responding accordingly to unpredictable events can thus make even a black swan appear white and generally makes the company more resistant to bad economic cycles.

Experiments with new technology are inherently uncertain and any attempt to digitize areas of the business cannot in truth be predicted in its outcome. Scenarios should therefore also be considered that are highly unlikely from today’s perspective, such as disruptive technological changes. However, we know that these can and will occur at regular intervals and in all markets.

David Schneider

David A. Schneider hat über 10 Jahre an vorderster Front im Vertrieb und im direkten Marketing verbracht. Sein erstes Unternehmen hat er mit 18 Jahren gegründet und war seither von den Möglichkeiten und Auswirkungen des Unternehmertums auf unsere Gesellschaft fasziniert. Seit Jahren hat er es sich zur Aufgabe gemacht, ein Buch pro Woche zu lesen und die Inhalte in der Praxis anzuwenden. In diversen Branchen hat er damit bereits überdurchschnittliche Ergebnisse erzielt, indem er seine Arbeitsweisen stets an die neuesten Technologien anpasst und orientiert. Derzeit hat er eine leitende Funktion in einem Familienunternehmen mit 150 Mitarbeitern und teilt sein Wissen als Autor, Blogger und Unternehmensberater mit seinen Kunden und Lesern.