The Black Swan Problem

CHAPTER THREEThe Black Swan Problem

IN THE PREVIOUS CHAPTER, we developed some ideas about how Black Swans can be interpreted from the vantage point of firms that are in the business of creating value. In this chapter, we will deepen our understanding of what makes firms special. Central to a firm's existence is its strategy. A firm invests resources to get a strategy in place, which hopefully is executed well and generates profits over time. Any strategy comes with risk – sales may not materialize to the extent hoped for and costs could end up much higher than expected. In fact, any number of disasters can befall the business plan and lead to wildly different outcomes from those anticipated. If we grant that firms have the means to reduce that risk and protect their strategy, would they be right to do so? Can we assume that managing risk is a good, value‐creating activity?

In thinking about these questions, a fallacy is often at work. People take it as a given that risk management is desirable because risk is perceived as inherently bad. We cheer at any proposal to do away with it, almost reflexively. However, managing risk means that resources have to be diverted from other uses. Risk management is rarely for free. This makes over‐management of risk a clear possibility: investing more resources in risk mitigation than what would be justified by the fundamentals of the situation. It would therefore be helpful to have a framework for knowing when spending money on risk management ...