An example is commodity extraction industries, where hedging future production is popularly considered as a “bad” decision. Most of this taint has come from outside analysts and commentators seeing the companies lose out on favourable price increases because the companies had a hedge in place. This is a typical example of how the decision to hedge or not hedge cannot be evaluated based on the outcome of the commodity price in question. The whole point of the hedge was to remove the exposure to uncertainty, to remove the risk exposure to events out of the control of management.

While practical Monte Carlo simulation is unlikely to be worthwhile for an SME, I understand Mr Taleb’s comments as more of a thought experiment than a suggestion to actually simulate everything. The real value is in understanding how the actual path taken could have been different. This is more important than modelling specific possible outcomes. With an understanding of risk, better strategic decisions can be made even without detailed measurement.

On the topic of entrepreneurs, I think I would answer your question as “Yes, exactly!“. Many entrepreneurs take risks. Some are successful; some are not. By definition, those that write books and give seminars on how to succeed are the successful ones. Their risks paid off. However, if one took a true sample of entrepreneurs without “conditioning” on success, I’m not at all sure that unconsidered risk-taking is necessarily a good thing, and many considered risks probably will turn out to have a negative expected outcome or “Return on Investment” as well.
The statistics (I don’t have any on hand) about the success of new businesses show a depressing picture – more fail than succeed. If this is the case, then I taking risks doesn’t sound quite as attractive as it did when only considering the winners. Mr Taleb uses the example of Warren Buffet as someone who may have skill, or may just have been lucky – with the number of people buying and selling companies, basic laws of probability would likely produce someone with Warren Buffet’s track record entirely without skill. For entrepreneurs, the same lessons apply. Richard Branson springs to mind.

It’s also clear that many risks (particularly operational and political risks) are very difficult to mitigate. However, the risk management opportunities currently available to SMEs cover a broad range of very real, very serious risks. I’ve already mentioned business interruption insurance and credit guarantees. Some other forms of insurance include key person risk and professional or public liability insurance. In terms of exposure to financial markets, for SMEs this exposure will relate mostly to interest rates and exchange rates. With YieldX and the large number of retail-relevant financial instruments available on the broader JSE, hedging currency risks and interest rate risks becomes accessible and cost-effective, whereas even a few years ago it would have been prohibitively expensive and in many instances restricted by regulations.

If the cost of this sort of risk management is “too high”, then this might indicate that your business plan doesn’t have a real competitive advantage, but is relying on luck to succeed. It may succeed, or it may not, and this outcome will be out of the entrepreneur’s hands. A coin that lands heads rather than tails isn’t a “better” coin that one than lands tails, and wouldn’t be expected to “succeed” in future at generating heads more often than tails.

To move away from practical examples though, the key point for SMEs in South Africa (and any country) is to understand very carefully what risks are being taken, and apply critical thinking to “success stories that prove how risk is a good thing”. The answer isn’t necessarily to throw in the towel and become a dentist (Fooled by Randomness’s typical low-risk example job). However, once you have understood the principles and become attracted to the low-risk high-self-determination, low-rely-on-dumb-luck opportunities, you have understood the problem of uncertainty and will not be as easily Fooled By Randomness. Then you are prepared to face randomness.

Coming back to the Black Swan, I think most people don’t know ALL the possible outcomes. They may think that they understand their risks, but have they really done their homework. I like his idea about using the Monte Carlo simulator, but again, Garbage-in-garbage-out. How many small businesses have the technical skills to find all the possible outcomes and to try and identify the risks involved?. If you could simulate every business risk/transaction, would entrepreneurs be in business? I agree that you need to understand the business in which you operate and the risks involved. But for example we all know that South Africa has a high mortality rate on our roads, does that mean that a person who has done his home work about car accidents and run this through his Monte Carlo simulator – should he get in his car or not? The fact is that we HAVE to drive our cars to work (but how can we reduce the chance of an accident, is that even possible ie the black swan). Is this not so with our businesses, most people know that there are currency/political/economical risks, should we do the business or not? Like I said earlier, not all business has the technical skills to identify the risks – especially the SME, where the entrepreneur is the business. He has started his business because he is a specialist in his field, but he doesn’t know about accounting/business risk/currency risk etc. So how do we tackle this problem in our country?