Boss Lady

The ‘Tail Risks’ that threaten to undermine your firm

on


Risk is a tricky subject. The moment you think you understand it, new conceptual difficulties emerge, and you find yourself back to square one.

The business community has a precise notion of risk. It is equivalent to volatility. And outcome variables follow a nice, neat normal distribution – something that is easy to characterize mathematically.

But when you look at the real world, that’s not really what it looks like. Yes – some aspects of business do follow normality – such as the IQ of candidates you invite to interview. But a lot of things don’t – like COVID-19.

Companies, however, are notoriously slow at perceiving the risks in their midst. As truck accident lawyers, Rosenfeld Lawyers, point out, thousands of executives get caught off-guard every year when members of the public sue their drivers. It’s not a “normally-distributed risk” but rather something that can hit you out of the blue.

How to think about risk rationally

For several decades, companies have found it fashionable to develop risk management plans. The idea here is to identify risks and then take steps to mitigate them using the appropriate degree of company resources. Firms will do all kinds of things to this end, from buying insurance to reducing exposure in specific markets.

However, they base a lot of their thinking on old-fashioned notions of risk. Usually, they’ll look at the types of risk that they can easily plot on a histogram, like the numbers you get when you roll a dice. They don’t think carefully about the Black Swans – the unanticipated risks that come out of the blue. And those are almost always the ones that get them.

Blockbuster Video is a case in point. The VHS rental store was pretty much the only place you could go in the past if you wanted to rent a video. Streaming services didn’t exist twenty years ago. The chain could never imagine that the internet would come along and steal their thunder, but that is precisely what happened. A technological risk emerged out of seemingly nowhere and gutted their business model.

Mortgage lenders faced a similar kind of unexpected risk in the wake of the financial crisis. Most had assumed that money would keep flowing, no matter what, even if houses were becoming overpriced. Unfortunately, the moment subprime loans started turning bad, the system of bank lending locked up, and nobody could get the liquidity that they needed. The entire financial system nearly collapsed.

You can’t plot the most important risks on a chart

Risk, therefore, isn’t really something you can plot on a chart. If it were, then there would be no such thing as uncertainty. We’d be able to predict risk.

That, however, isn’t the nature of the world in which we live. So-called “tail risks” can come out of nowhere and devastate your operations at a moment’s notice. It could be something legal, environmental, technological, ecological, or financial, but you never know in advance. All you can do is prepare for the inevitable storm. Always assume that it is coming. Build up your business savings. And make sure that everyone understands why they exist.

About Business Woman Media

Our women don’t want to settle for anything but the best. They understand that success is a journey involving personal growth, savvy optimism and the tenacity to be the best.We believe in pragmatism, having fun, hard-work and sharing inspiration. LinkedIn

Recommended for you

What Do You Think?

Your email address will not be published. Required fields are marked *