When the probability of a Catastrophic Risk to materialize is small.. Actually I mean very very small.. The event is theoretically possible but the probability of it happening is so small that it may not have happened before (at least in human recorded memory). In such a case, the tendency of most people and of the organizations employing them, will be simply to ignore these low probability / very high impact Risks.
This attitude is extremely problematic as it will eventually lead to catastrophic outcomes as illustrated during the recent financial crisis where many banks were caught by surprise by a crisis they did not anticipate.
Nassim Nicholas Taleb – a finance professor, former Wall Street trader & philosopher – in his bestseller book “The Black Swan Theory” published in 2007, attempted to explain this human blindness to the risk posed by highly improbable events & he also highlighted the importance of Black Swan events as key drivers in human history.
WHY Should you care about Black Swans?
For at least 2 main reasons:
- It can DESTROY your Organization if NOT well managed
- Even with ‘negligible frequency’, the Murphy’s Law states that:
“If anything can go wrong, it eventually will!“
In other words, it means that no matter how improbable a risk event is, if there is a chance that it can happen then, sooner or later, there is a CERTAINTY that it will happen! We may not see it in our lifetime or on the contrary it could happen tomorrow. Hence the question is NOT whether the risk event will happen but rather WHEN it will come to pass.
So from a risk management perspective, we should NOT take into account the probability associated with such extreme events when evaluating their importance. We should focus on the criticality their IMPACTS. If the impact is likely to destroy us and our organization, then not matter how improbable, it is (i.e. Black Swans), we better prepare ourself and our organizations to deal with it because one day it will eventually happen! And if we are taken by surprise, most likely our organizations will not survive. The continuous change in the list of the Fortune 500 organizations over the past 50 years illustrate this point, no matter how big and powerful an organization is, most organizations will not survive more than 40 to 60 years. They will be hit by an unexpected crisis, manage it badly and collapse. The history of mankind and business is littered with risk events that were no supposed to happen but eventually did!
So in summary, ignoring the high impact, low probability risks is not a good risk management practice as eventually you will have to pay the price for sure. Hence instead you need to anticipate and prepare, build organizational resilience for the crisis that will inevitably come and you may be one of the few that will be sustainable for the longer term.
Risk Management Demystified 