Living with Black Swans: balancing the books in uncertainty
Thursday, 28 April, 2011 Leave a comment
OK I’m a self-confessed fan of NNT but early on in this interview with his former Professor he again hits the nail on the head. He reminds us of the lessons that every business (and political!) leader needs to learn..
“…You have to avoid debt because debt makes the system more fragile. You have to increase redundancies in some spaces. You have to avoid optimization. That is quite critical for someone who is doing finance to understand because it goes counter to everything you learn in portfolio theory…. I have always been very sceptical of any form of optimization. In the black swan world, optimization isn’t possible. The best you can achieve is a reduction in fragility and greater robustness. You may have heuristics, but not an optimization rule. I hope the message will finally get across because I haven’t succeeded yet.
People talk about black swans but they don’t talk about robustness, which is the real lesson of the black swans.”
Business Leaders of the current culture are not, generally, “agents of change”. As I have said before we need to cultivate Risk Leaders. Those who, not only, recognise the flaws of the current culture but are motivated to create, champion, execute and capitalise upon new models and strategies.
Apart from the clamour, from better informed and more demanding consumers, for greater transparency, accessibility and demonstrable sustainability, the pressing NEED is for this new breed to embrace the concept that robustness (or NNT’s anti-fragility) can ONLY come from by creating (and maintaining) a sound business infrastructure…from the bottom up or, as I feel is even more appropriate, from the “inside out”: i2o”.
The relevance of scaling and causality
Such problems as Taleb highlights can only be addressed if the owner can view the business (or system) at the appropriate “scale”. Otherwise how would one know where and by how much to “increase redundancy” to build RESILIENCE in order to survive unforeseen and unforeseeable future events?
After all redundancy and robustness cost NOW and need to be maintained, so, have an ongoing impact upon profitability.
The clue is that he does refer, briefly, to his friend the late Benoit Mandelbrot and, as the “father of the fractal”, I thought it particularly appropriate when it comes to identifying solutions.
Mandelbrot recognised that the smooth shapes of geometry did not exist in nature although there are plenty of familiar (self-similar) shapes and recurring patterns. From micro (even nano) scale in biology to macro level, as seen in such as lightning patterns or rivers systems.
Every part is similar to the whole. This is called “self-similarity“.
“In mathematics, a self-similar object is exactly or approximately similar to a part of itself (i.e. the whole has the same shape as one or more of the parts). Many objects in the real world, such as coastlines, are statistically self-similar: parts of them show the same statistical properties at many scales.
A Koch curve has an infinitely repeating self-similarity when it is magnified.
The significance to business may not be immediately clear but stick with me!
Autonomous Information Agents
To many people this coin and those of lesser denominations aren’t worthy of much consideration:
“a pound doesn’t buy you much these days…” BUT, as the characteristics or “genetic code” is inherent within every denomination issued, irrespective of whether the quantity is one penny, one thousand pounds, millions or more they all carry vital information about the system that created them – in this case an economy worth trillions of pounds – and the ecosystem in which it exists: the Global economy.
Interpreting the information requires the right tools and examination at an appropriate scale.
It may help to think of scaling in this way:
If you look at a picture from too great a distance you cannot see the image but, at best, a blur of colour. Look too closely and a similar problem occurs. Shapes and detail are difficult to recognise. Even when the picture is held in your hand it may be hard to focus on because of the light (environment), your eyesight, the quality of the equipment (or operator!) used to capture the image, or other factors such as the quality of the print process i.e. not relevant to the time it was taken or viewed…and these are only some issues affecting a 2 dimensional image! But similar problems apply and can have significantly greater impact when we attempt to assess a business: unless we examine at an "appropriate" scale we can be easily misled.
Creating win/win/win: balancing complexity, robustness and profitability
Complex business systems rely upon multiple, internal and external, interactions, across scales, to perform the many functions required to survive and thrive within their environments. Ontonix have developed the means to map data inter-connections to observe, otherwise, “hidden” structure – that transcends management silos – to measure operational effectiveness and track causality (cause and effect) of risk decisions across the system.
For good measure here are some example applications and uses:
- reveal business structure from system data – without management silos
- quantitative S.W.O.T. [objective NOT subjective]
- map operational inter-connections [nature/quality of information flow]
- map and assess supply chain complexity & robustness
- extend business “risk horizon” – reducing uncertainty
- gain “crisis anticipation” –
- reduce risk exposure [incl. systemic risk]
- create a single system (complexity) KPI
- make better business decisions – quantitative & verifiable
- track cause and effect (causality) of risk decisions
- monitor operational effectiveness
- measure and manage complexity
- monitor critical processes (in real time, if required)
- measure and maintain robustness – build resilience
- business process improvement
- assess potential Mergers & Acquisitions
In short, there are numerous, excellent, reasons why a business leader should look closely at the system for which they are responsible. If all it does is verify what they think they know that is good. But, IF, it tells them that the system is excessively complex, that represents a timely intervention and huge opportunity! Because, by working with Ontonix to manage that complexity, we may also be able to increase redundancy (build robustness) AND improve profitability.