Managers of corporations and entrepreneurs gifted enough to blag money out of venture capitalists live and die on their business growth and profitability.
The primary goal of SME owner managers is avoidance of business failure (cash) caused by shortage of orders or black swans or risk intolerance. Eight out of ten small business start ups fail within two years.
This article lays out the importance of paying sufficient attention to significant, but infrequent, large events and of the difference between uncertainty – black swans – and risk. Subsequent articles will offer solutions to SMEs.
What is a black swan? Everyone knows that swans always have been and always will be white – until a black swan appeared in Australia. A black swan describes a totally unexpected event. Uncertainty is at the heart of all our lives and black swans come in many forms(1).
Increasing speed of technological change and political upheavals is leading to increased uncertainty for SMEs.
But people have a susceptibility to blindness with respect to randomness, particularly the large deviations. We tend to focus on the minutiae instead of the possible, significant large events(2).
In March 1996, microbiologists and vets were linking the mad cow epidemic in cattle sweeping Britain caused by BSE (bovine spongiform encephalopathy) with vCJD (variant Creutzfeldt-Jakob Disease) in humans. Professor Richard Lacey of Leeds University predicted up to 500,000 deaths per year. The theory that BSE had “jumped” species from cattle and was infecting young people with vCJD was unprecedented with no known evidence on which to assess its consequences. It led to the destruction of the UK export meat industry and consumer-led reaction amongst UK supermarkets.
This was my black swan – completely unpredictable with devastating consequences. It stands in contrast to risk. Risks can be identified and measured.
In 1989, the thin hulled Exxon Valdez supertanker ran aground in Prince William Sound, Alaska, pouring quarter of a million barrels of oil into the surrounding waters. At the time it was America’s worst offshore spill and a huge blow to the reputation of the ship’s owner, Exxon. The firm paid $3 billion to clean up the area and settle legal claims.
But the disaster also led to a full-blown overhaul of Exxon Mobil’s safety and risk management culture. Single hulled oil tankers were phased out. Tankers now are double hulled(3). Every meeting begins with a “safety minute” akin to a blessing before a meal. Exxon’s 11 point Operations Integrity Management System is drilled into new recruits, incorporated into performance assessments and shared with contractors and suppliers. Environmental protection is top of their agenda(4). Exxon have had no subsequent significant environmental disasters.
In contrast, the BP Deepwater Horizon was no unfortunate accident. It was a culmination of years of cost-cutting, rejections of safety measures and reductions in skilled engineering expertise(5). High-risk tolerance was accepted in an intrinsically hazardous industry. Within five years, BP had three major disasters in the US. The Texas refinery explosion caused many deaths, the Alaskan oil pipe leaks polluted large areas of the tundra and then Deep Water Horizon cost $46 billion.
But it is clear from the contrast between Exxon’s and BP’s approach to risk tolerance that preparation and attitude to risk can have a dramatic effect. Low risk tolerance does mitigate risk.
An SME must take risks to build business. As Jim Ratcliffe of Ineos fame says “Risk can be avoided. But then very little happens. So, we don’t avoid risk. But if you accept risk, you need to have a clear head and an appetite for rigour.”(6)
In 2007, my company was a supplier of a full range of spill control products to a wide range of industrial end user clients , in the automotive, aerospace, engineering, construction and oil and gas industries. We sold via specialist and national industrial distributors.
The impact of e-commerce was becoming obvious. Price competition from on line competitors appeared a major threat. But, if we established an e-commerce channel to market and offered the brand on line at lower prices which cut out the distributor margin, the real risk was that the distributors would delist us. If we did not establish an e-commerce offering at lower prices we risked being undercut by e-commerce operations. This was a risky decision.
How an SME builds in antifragility against uncertainty and low risk tolerance whilst accepting risk must be assumed to build a business will be addressed in the next blog.
(1) The Black Swan: The Impact of the Highly Improbable by Nassim Nicholas Taleb (2007)
(2) Michael Shermer The Believing Brain. From Spiritual Faiths to Political Convictions. How We Construct Beliefs and Reinforce Them as Truths (2012)
(3) Economist August 10th 2019
(4) Private Empire by Steve Coll 2013
(5) Spills and Spin: The Inside Story of BP by Tom Bergin(2011)