Monday, July 29, 2019

How Good Are You at Predicting the Future?

Determine what the next number in the sequence is supposed to be:

2, 4, 6, 8...

Most of you will probably answer “10”. And you’ll have determined that the rule governing the sequence is a+2. And if the next profit and loss report shows the result as “10” when given previous periods’ (months’?) sequence of “2, 4, 6, 8...”, your prognostication will have been validated.

But what if the next period’s result is “12” or “11” or even more astounding “27”—an outlier, a result outside normal variation? You probably will find it a little more difficult to determine the rule, processes, business systems, economics, market dynamics, etc. governing the results. But you will try because you’ll find it difficult to believe that results—effects—don’t have determinants (causes), that results are random or based on luck.

This is what we do when faced with a previously unforeseen event—a black swan in author Taleb’s perspective. We try to review the past to figure out how this happened. We try to figure out if the rules have changed. Did a new competitor appear suddenly or now start exerting influence on the market ‘stealing’ one of our top 5 customers? Did a competitor lose influence on the market and we picked up a lot of extra demand? Have consumers tastes changed? Have regulations affected us more or less than we realize? These unforeseen events may happen a lot. Imagine being Ford when Toyota had its ‘accelerator’ problem or the German automakers’ emission test fraud. Imagine being Airbus or any of the airlines’ operations centers trying to predict Boeing’s 737-MAX fiasco. Unfortunately, we won’t be able to ascertain all the aspects that influence our business results. We won’t be able to have 20/20 hindsight and therefore, we won’t be able to precisely determine the ‘rule’ that determined our results.

Thus, it’s better to create more robust business systems that can handle unforeseen catastrophes. This is called risk management, including contingency planning. Not only do we need to do this for physical disasters or computer system (cyber-)disasters, but also financial and strategic planning contingencies. It’s also why business consultants gave the cry for ‘agility’ in the 1990’s and maybe should renew the cry.

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