In 2003, widespread protest broke out around me in Azerbaijan, a country formerly part of the Soviet Union.Violence erupted just a few blocks from my office with clashes between protesters and the police, the torching of cars and mass arrests. The country’s capital was brought to a standstill, and the work of our organization was set back for weeks. Azerbaijan’s unrest had been what statistician and risk analyst Nassim Nicholas Taleb calls a black swan—a highly improbable event with significant impact.
We hear a lot about risk management these days, but when most organizations develop strategies for international growth or enter an international market, they tend to ignore political risks—the ways in which decisions by government or political actors in a country influence the organization’s activities. However, it is in political risk that black swans with the greatest and longest lasting impact can be found.
The reason associations pay little attention to political risk is that many fall directly into the “turkey problem,” imagining the future will look much like the past. For 364 days, the turkey lives in luxury: fed every day, surrounded by friends. He struts like a king through the yard, and expends little energy to fulfill his own wants and needs. He expects the 365th day to progress much the same…but soon realizes that Thanksgiving Day will diverge greatly from his expectations.
The turkey problem was what caught most Middle East observers off-guard during the 2011 Arab Spring. That year, I led the charge to open an office in the Middle East for an international association that served the oil industry. We spent a year researching the economies, politics, legal frameworks and markets of the countries. We had even examined the reports of various political risk assessment firms.
As we narrowed in on opening an office in either the United Arab Emirates or Bahrain, none of the political risk firms had predicted the contagion from the Arab Spring to reach Bahrain. They expected the country’s economic development and support from Saudi Arabia to insulate it from unrest. But on 14th February 2011, the Bahrain uprising began, leading to the Bahraini government’s declaration of a state of emergency that lasted from March until June, and having repercussions for years to come.
OVERCOMING THE TURKEY PROBLEM
To overcome the turkey problem, an association needs not to imagine the future in terms of averages or normalcy, but rather to understand the probabilities of a risk’s occurrence, and to identify the distribution and uncertainty in the data. As a person who loves data, I can tell you that a trend is a thing of beauty. We have to remember, though, that data points never fall directly on our trend line, but are scattered around it. And if we can look at how the data points are scattered around our trend line, we can better understand the risks we face, and prepare for tail events like Azerbaijan’s unrest or the Arab Spring.
Unfortunately, most political risk assessment firms only offer numerical risk indicators—between 1 and 100 or 1 and 5. Some even offer the easy to read traffic lights. But these are not enough for entering a market. Such assessments provide a false sense of security. Everything seems clear. A country with a four out of five or a green light should not suffer a black swan, right?
No, not right. The U.S. would have had a green light for financial risk right up to the moment of the 2008 financial crisis, or for political risk right up to the moment of 9/11. By understanding the distribution of political indicators and the probability of a black swan events occurring in the country, the association can better recognize the possibility of significant downsides, which leads to better preparation.
We always have to remember that the probability of black swan events will be exceedingly small, depending on the country being assessed, but the magnitude of potential revenue losses and increased costs make the risk from a black swan enough to be considered in a country analysis.
MANAGING POLITICAL BLACK SWANS
So if we can’t predict black swans, how can we manage them? Here are a few ideas:
Using data to understand the risks: Many of us in the association world rely on our intuition and experience for planning our work and expanding into new markets. But when we do this, we miss the possibility of black swans, particularly those in the area of political risk. Using data to understand the probability and impact of political black swan events can help us prepare for their eventualities. There is a wealth of publically available resources on the health of countries’ political and economic systems. When possible, utilize these.
Understanding the risk to the entire organization:Often we look at risks on the level of individual projects, but to help the organization understand the effects of a black swan, we need to connect the risk analysis to the rest of the organization. We would look at, for instance, how political unrest in Brazil causing a massive hit to revenues in Latin America would impact the annual meeting in North America, or how much stress it would put on other projects that have to make up for those losses.
Updating beliefs: Although a black swan can hit at any moment and without warning, the association may start seeing indicators of increased risk as the black swan event approaches. Updating risk assessments often is beneficial. But we have to use the new data to overcome our bias that everything will stay as it is. Rumblings in the Middle East had begun prior to the Arab Spring, but most analysts assumed the region’s governments would keep them in check. Given the magnitude of a black swan event, an organization does not have the luxury of making this mistake.
Creating strategies for unforeseen risks: An organization can protect itself by creating strategies for how to deal with unforeseen risks. One method is to look toward redundancy rather than a lean efficient structure. The scarcity of resources often makes associations look for ways to be as lean and efficient as possible. However, black swans call for redundancy to minimize their effects. If you run your operations in China from an office in Beijing, and a black swan event renders your office out of action for an extended period, the ability to run events in Shanghai from your Southeast Asian office can minimize the impact on your organization.
We like to think of black swans as rare, but although they are hard to predict, when viewed on a global scale we see that they are much more common than we expect. In this article, I have mentioned only four black swans, but during my time in the international sector, the Ruble Crisis, the East Asian financial crisis, unrest in Azerbaijan, Georgia, Turkey, Brazil and Bahrain, the great recession and the bottom falling out of the oil market have all affected my work at some point.
Although this article has focused on black swans in the political sphere, they are possible in all types of business risk (operational, compliance, strategic, financial and reputation). The ability to recognize the chance of such black swans, and to be prepared to manage them when they arise, is fundamental for new business development. If your association develops a strategy to handle them, your growth will be much smoother.
Kerry spoke in the “Exploring New Markets: How Research, Analytics and Risk Assessment Can Help” session during SURGE Spring, an interactive virtual summit hosted by AssociationSuccess.org on May 2nd-4th. Click here to learn more and to register to view the session.