The SME guide to living with black swans

Uncertainty is the only certainty there is, and knowing how to live with insecurity is the only security”.
John Allen Paulos 

My recent blog ‘What threatens SME business survival?’ emphasised the importance of paying sufficient attention to uncertainty caused by significant, but infrequent, large events (black swans) and described the difference between uncertainty and risk. In ‘The SME guide to dealing with risk’ ways of mitigating risk were examined. This article provides a guide to living with uncertainty.

We cannot predict uncertainty but we can classify things and systems according to their fragility (1). Your grandmother is more fragile to abrupt changes in temperature than you are; a military dictatorship is more fragile than Switzerland should political change happen; and a poorly built modern building is more fragile than the Chartres Cathedral.

It is far easier to figure out whether something is fragile than to predict the occurrence of an event that may harm it. The key is the emphasis on designing ‘antifragility’ into the system. You cannot say with any reliability that a certain remote event is more likely than another, but you can state with a lot more confidence that an object or structure is more fragile than another should a certain event take place.

The chances of surviving a black swan can be greatly increased by designing antifragility into the system.

Ways for SMEs to live with uncertainty

1. Specialise with care

Specialisation enables the best use of resources especially for SMEs where availability of skilled people is limiting. Specialisation certainly provides enormous benefits. The SME Story with Dave Connolly’s Bar Squared gives a dramatic example as to how an IT start-up cornered a very large share of the IT software market for barristers in the UK by intense focus on a single application. They continue to advance through innovation and, unlike their competitors, a rejection of spreading their resources across a whole range of other applications. 

But my company had found itself specialised in the British export abattoir market when the BSE crisis in 1996 effectively closed that market. We had not set out to specialise in that market, but it increasingly became the case that our offering was most attractive to very large feedlots, like Midland Meat Packers in Northamptonshire. MMP along with all the other major UK export abbatoirs went bust in 1997.

Where a company, like mine, is specialised in one market, it is exposed to change in regulation, taste, exchange rates or costs of production, the business is very vulnerable and it is highly fragile.

The moral is specialise with care. We can safely assume that barristers have some professional stability, people will continue to sue each other, and that there is substantial intellectual property in Bar Squared’s software. Whilst they continually innovate, focus on customer requirements and develop their offering they will remain at the antifragile end of specialisation.

2. Create an option to change

An option to change is what makes you antifragile and allows you to benefit from the positive side of uncertainty, without the corresponding serious harm from the negative side.

Prior to the BSE crisis my company had been running trials on developing other markets for our cellulose rich materials in oil drilling muds, plastic and rubber fillers and industrial absorbents. When the crisis hit we accelerated development and focussed on the oil and chemical spill control market. This kind of trial and error can be seen as our creation of an option to change. Unhappy errors should bring small costs. Happy trials can bring long-term gains.

In America the largest generators of wealth historically have been real estate companies (investors have the option at the expense of the banks) and technology companies which rely almost completely on trial and error. 

Sometimes the opportunistic trial and error leads to dramatic change. For illustrations of, rational and opportunistic business drift take the following: Coca Cola began as a pharmaceutical company; Raytheon, which made the first guided missile guidance system, was a refrigerator manufacturer; Nokia, who used to be the top mobile phone maker, began as a paper mill; and Avon, the cosmetics company, started out in door-to-door book sales.

3. Maintain a Financial Reserve

For many SMEs this is not easy to do but Dave Connolly’s Bar Squared case studies describes how hard the financial crash of 2007/2008 hit him. He survived, with difficulty, by having sufficient financial reserves to see him through.

Antifragility is therefore a key part of the planning process for any SME. Plan for the unexpected and then figure out how you can mitigate the risks. Be prepared, the best you can, for the black swans!

Sources:

1) Antifragile: Things that Gain from Disorder by Nassim Nicholas Taleb (2013)

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